Securities Fraud Litigation Recoveries: Breaking the Mold of Pennies-on-the-Dollar Settlements

By Matt Siben

Oftentimes while engaging in the normal small talk of life, I get to explaining that I represent investors in securities fraud cases – which invariably leads to a conversation about how so-and-so received a check for $0.42 as part of a class action.  Of course, these stories are often exaggerations.  Nonetheless, as set forth here at pages 29-30, the truth is securities class actions regularly settle for approximately 2% of investors’ losses.  How is this so?  And, what can an investor with large fraud-related losses do about it?

Securities class actions settle for pennies-on-the-dollar for many reasons, perhaps the most prominent of which is inertia. Newton’s first law of motion asserts that objects move at their current speed until some outside force causes a change. Securities class actions settle for pennies-on-the-dollar because that is what they’ve always settled for.

A recent entry to “The D&O Diary” by Kevin LaCroix – whose blog is a must-read for practitioners in the field – gives valuable insight into this inertia-effect I’ve described as causing securities class actions to settle for such small amounts.  Mr. LaCroix’s piece entitled “Can Separate Settlements Improve the Securities Suit Settlement Process?” is written for the purpose of analyzing an academic paper by Fordham Law School Professor Richard Squire.  In critiquing Professor Squire’s analysis, Mr. LaCroix correctly recognizes two related points that drive securities class action settlements.

First, Mr. LaCroix emphasizes an important dynamic lost on most everyone outside the securities class action bar: “A final point about securities suits that should be emphasized is that securities class action lawsuits go to trial so rarely that the possibility of trial can safely be disregarded for most practical purposes.  Everyone involved in the case knows it will never go to trial.”

Second, and related to his first point, Mr. LaCroix criticizes Professor Squire’s seemingly naïve view that there is a “knowable” value to a securities class action.  The very last sentence in the following excerpt is both true, and extraordinarily under-appreciated by most everyone analyzing securities fraud settlements:

With respect to Professor Squire’s analyses of the settlement dynamic, I note that in all of Professor Squires hypothetical settlement examples (and all of his examples are in fact hypothetical), he refers to the “expected trial liability” or “the actuarially fair settlement amount.”  These are abstractions.  There is no such thing in the securities context as “expected trial liability,” simply because there is effectively no data to describe such a thing. (For the same reason, talk of a party’s “bias to toward trial” or “aversion to trial” is equally inapposite.)  By the same token, the idea that there is an objectively knowable amount equivalent to an “actuarially fair settlement amount’ is equally unwarranted.

What we actually have is a much rougher, much more approximate concept that usually is described as “what cases like this settle for.”

As Mr. LaCroix recognizes, securities class actions settle for pennies-on-the-dollar because that is what securities class actions settled for in the past.  There is powerful inertia in the system – regardless of whether it is right or wrong – that strongly inhibits plaintiffs from recovering a greater percentage of their losses.

Plaintiffs’ counsel have recognized this problem for years, to no avail.  For instance, a 2006 article authored by two partners at a major plaintiffs’ class action firm recognized this very issue:

During settlement talks, defendants in securities class actions frequently attempt to inject the notion of a statistical comparison of so-called comparable settlements.  Relying on publications by industry consultants, like Cornerstone Research and NERA Economic Consulting, defendants attempt to characterize virtually all class action settlements as pennies on the dollar. . . .  The median settlement amount of such purported comparables then becomes the defendant’s metric for determining settlement value.

Yet, despite identifying the problem years ago, securities class action settlements continue to settle for pennies-on-the-dollar (see here at pages 29-30).  There hasn’t been any real improvement.

So what can investors who want a real return of their losses do?  In my opinion, securities class action recoveries, as a whole, will never compensate investors fairly for their losses.  There is simply too much history preventing anyone from being able to re-create the securities class action into a meaningful mechanism for investors.  Class actions cannot be fixed; rather, they should be viewed as something to escape.

By breaking out of the mold (or breaking the mold), individual institutional investors who file their own private actions can escape these historic settlement parameters.  Individual cases are a different animal altogether.  As a result, the old rules do not apply.  And, as set forth here, the empirical evidence demonstrates that individual plaintiffs fare far better than their class action counterparts.

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Enron Ten Years Later: Lessons Learned, Lessons Forgotten (Part 2)

I really enjoy taking depositions. (I’m prepping for depositions now, so indulge me, I’ll get to the point.) The preparation, the strategy, the fluid interaction, the battle of wits; depositions are one of the better parts of the job. And, nothing beats deposing smug liars.

In the litigation over Enron’s collapse, I deposed plenty of investment bankers, relationship managers, credit risk managers, etc., in connection with Wall Street’s role in the Enron fraud. (There is a list here.) I couldn’t swing the proverbial dead cat without hitting a smug liar.

As I wrote in my last blog piece, I believe there were a lot of Wall Street bankers responsible (in part) for the collapse of Enron (see here). Given their sins and/or incompetence, one would think these specific bankers would be run out of town never to be trusted again. Au contraire, it seems Wall Street is imminently tolerant.

The point of this blog is that Enron’s collapse exposed Wall Street’s tolerance of — perhaps encouragement of — risk management procedures that turned a blind eye to wrongdoing and rewarded those whose incompetence and/or improper behavior would have caused them be fired in any other line of work.

Why should you care? As discussed in my last blog, the collapse of the entire global economy in 2007-2008 was partly the result of a housing bubble enabled and encouraged by Wall Street. In several ways, Wall Street’s sins in the housing bubble mirrored Wall Street’s enabling and encouraging of Enron’s fraud. As I wrote previously, structured finance played a large role in both. Had “we” as a society held persons on Wall Street responsible for their conduct in relation to Enron, perhaps “we” would have avoided the predicament “we” now find ourselves in.

While a “Where are they now?” documentary of the lives of Enron’s aiders-and-abettors is beyond my capacities here (I’m interested if anybody wants to write it), a case study is illustrative of the point I’m trying to make.

In March 2005, I had the distinct pleasure of deposing David Bushnell. Mr. Bushnell testified before the Senate Permanent Subcommittee on Investigations in 2002 concerning Citigroup’s role in Enron’s fraud (opening remarks here), so let’s let him describe his job responsibilities:

My name is David Bushnell. I am a Managing Director at Citigroup’s Global Corporate & Investment Bank and its head of Global Risk Management, which functions as an independent control over our business units and is responsible for monitoring market and credit risk.

* * *

At Citigroup, I oversee a sophisticated and comprehensive process for reviewing structured finance transactions.

Bushnell was the man with the power to stop Citigroup’s much maligned structured finance transactions for Enron. Citigroup’s structured finance deals for Enron caused the Company a great deal of bad press and damage to its reputation. Moreover, and more concrete to the bottom line, Citigroup’s structured finance deals cost the Company a great deal of money, including (i) a $2 billion civil liability settlement with Enron investors in the securities class action (here); (ii) the $1.66 billion settlement paid to Enron’s creditors in bankruptcy court (here), and (iii) a $120 million settlement with United States Securities and Exchange Commission (here) (which also included settlement related to the Dynegy structured finance deal that landed some Dynegy executives in jail). Citigroup’s structured finance deals with Enron cost Citigroup approximately $4 billion in litigation costs alone, not including the substantial, confidential settlements of private actions related to Enron’s collapse.

While there is some evidence that Mr. Bushnell tried to stop one of the criticized structured financings for Enron (see here), labeling the accounting “aggressive” and the deal a “franchise risk,” he ultimately did not do so.

In my opinion, David Bushnell failed to perform his duties as Citigroup’s head of risk management. But, rather than lose his job, Bushnell remained atop Citigroup’s executive structure as the Company’s Chief Risk Officer.

Unfortunately for all of us, in 2007-2008 the problems with Citigroup’s risk management processes were exposed when Citigroup collapsed under the weight of billions of dollars in toxic mortgage backed securities. Mr. Bushnell was replaced as Citigroup’s chief risk officer in November 2007, and a new group of risk management advisors was empowered to deal with Citigroup’s MBS mess. (See here.)

In November 2008, The New York Times published an expose highly critical of Citigroup’s risk management unit that allowed Citigroup to build up such a massive amount of subprime exposure, and David Bushnell in particular was singled out. According to sources within Citigroup, risk management “wasn’t independent at Citigroup” and Mr. Bushnell suffered from conflicts of interest due to his relationships with other Citigroup executives. Indeed, according to the November 2008 story in The New York Times:

Earlier this year, Federal Reserve examiners quietly presented the bank with a scathing review of its risk-management practices, according to people briefed on the situation.

Citigroup executives responded with a 25-page single-spaced memo outlining a sweeping overhaul of the bank’s risk management.

In May, Brian Leach, Citigroup’s new chief risk officer, told analysts that his bank had greatly improved oversight and installed several new risk managers. He said he wanted to ensure “that Citi takes the lessons learned from recent events and makes critical enhancements to its risk management frameworks. A change in culture is required at Citi.”

Sadly, the problems at Citigroup exposed by Enron were not fixed. Hopefully, true changes are being made now and Wall Street learns from its mistakes.

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