About Class Actions
Although class actions are often discussed in the media, many people are unfamiliar with what they are and how they work. Here are answers to some of the most frequently asked questions that our clients have about shareholder class actions. Please note that this general information might not apply to your particular situation, and you should always consult an experienced lawyer about any specific problem or question you may have.
Securities Class Actions
- What is an action?
- What is a class action?
- How is a class action handled by the court?
- What types of cases become class actions?
- What is a shareholder class action?
- What securities laws are relied upon by shareholders?
- When is a securities class action filed against a company?
- What does the Securities Act prohibit?
- What does the Exchange Act prohibit?
- Can investors bring a class action for violations of the Sarbanes-Oxley Act of 2002?
- What does a typical lawsuit allege?
- Who typically violates these laws?
- Who enforces these laws?
- How long does a class action take?
- What is a Lead Plaintiff?
- How does a court select a Lead Plaintiff?
- What does it take to be a class representative?
- What are the duties of a class representative?
- Do I get paid for my time and effort as a class representative?
- How much do I have to pay a lawyer in order to bring a class action?
- How much money is recovered?
- How much do institutional investors increase recovery for the class?
- What happens if there is money left over in the settlement fund?
- How will I know that a settlement will be fair?
- I received a printed notice that says I am a class member in a case. What do I have to do?
- Can a non-U.S. investor be appointed as Lead Plaintiff in a U.S. class action?
- Why do non-U.S. institutional investors seek appointment as a Lead Plaintiff?
- Can non-U.S. investors be excluded from settlements when they are not Lead Plaintiffs?
- Can a shareholder bring an action under U.S. securities laws without participating in a class action?
- What fiduciary duties does an institutional investor have in regard to a shareholder action?
- Do U.S. securities class actions improve corporate governance?
- What type of corporate governance changes may be implemented in a settlement?
- Is there a benefit to joining U.S. shareholder actions rather than non-U.S. actions?
- Is it a large financial burden to participate in U.S. actions?
- What is a derivative action?
- What types of charges are filed in a derivative lawsuit?
- Do I have to own stock in the company to bring a derivative action?
- How do shareholders benefit from derivative actions?
- Will I have to pay anything if I bring a derivative action?
1. What is an action?
In United States courts, an “action” refers to a lawsuit. In other words, once a complaint is filed with the court, the judicial proceedings are called the action.
2. What is a class action?
A class action is a procedure recognized in federal court and in most state courts for handling lawsuits that affect large numbers of people. A plaintiff in a class action sues not just on his or her own behalf, but on behalf of all persons “similarly situated” who have been injured as a result of the same misconduct. Thus, when the court appoints the plaintiff as a “class representative” he/she represents the class of injured people and their interests as well as his/her own. The courts have special rules to ensure that the class representative will fairly represent the interests of the other class members, and to ensure that any settlement of the case will be fair for all class members.
Class actions serve a number of purposes. They eliminate the need for individuals who are members of large groups to file their own individual actions and incur the associated costs and expenses.
Class actions also help the court system to resolve claims involving many people in an efficient way, as well as to guarantee that people with similar claims are similarly treated. In the WorldCom securities litigation, the court noted: “If a class were not certified, most investors would be left without any recourse.” This is true in most cases of securities fraud, which is why the class action device is so necessary for recovery.
Without U.S. class actions, “most investors would be left without any recourse,” explained the Judge overseeing the litigation related to the WorldCom fraud.
3. How is a class action handled by the court?
Procedurally, class actions are not too different from any civil case. The plaintiff files a complaint, which must be answered by the defendants. The parties engage in discovery, a process by which each side gets to uncover all of the documents and information in the possession of the other side related to the case. At times, the lawyers will file motions with the court to seek to dismiss some or all of the claims, narrow the issues or, in general, to resolve procedural disputes. Normally, the defendants will seek to have the complaint dismissed prior to trial, on the grounds that the facts could not possibly support a finding against them. If those motions fail, the case ultimately goes to trial or is settled.
However, class actions do tend to be larger and involve more complicated issues than most other civil cases. This means that although many of the procedural steps are the same as other civil cases, the judge will be more involved in the handling of the case than normal, conducting more frequent status conferences to ensure that the case is proceeding, and to resolve procedural disputes.
In addition, a case cannot proceed as a class action unless the court certifies the class. The plaintiff must demonstrate that this case is appropriate to be handled as a class action and that the plaintiff is an adequate class representative. The plaintiff must show, among other things, that the number of injured parties is sufficiently large, that the claims of the individual plaintiff present common issues of fact and law with those of the class, and that the individual claims are typical of those of the class.
4. What types of cases become class actions?
In general, class actions arise where the wrongful conduct of one or a small group of entities, such as governments or corporations, act in a way which impacts a large number of people. For example, if two corporations conspire to fix the prices of their products, that would be an antitrust violation that affects all the people who purchased the product at unlawfully inflated prices. Similarly, a publicly traded corporation which lies to the public about its financial condition in order to keep the price of its stock up has typically committed securities fraud, harming all those investors who purchased the stock on the strength of the misrepresentations and then suffered a loss when the stock price dropped. Many other situations are appropriate for class actions as well.
5. What is a shareholder class action?
A class action that relies on U.S. securities laws is typically brought by one or more shareholders on behalf of all other shareholders who bought securities during a particular time period (i.e., the class period). This lawsuit is often referred to as a shareholder class action and is sometimes used interchangeably with securities class action. As one court has commented, class-wide adjudication under Rule 23 of the Federal Rules of Civil Procedure is particularly well-suited to securities fraud cases.
6. What securities laws are relied upon by shareholders?
Most shareholder actions rely on two laws passed by the U.S. Congress in the aftermath of the 1929 stock market crash and subsequent Great Depression. The first law is the Securities Act of 1933, which regulates the initial offering of securities to the public. This law is sometimes called the Securities Act or 1933 Act.
The second law is the Securities Exchange Act of 1934, which mostly regulates post-distribution purchases and trading of the securities on stock exchanges (in certain circumstances, this law can also apply to the initial offering of stock). This law is sometimes referred to as the Exchange Act or 1934 Act.
7. When is a securities class action filed against a company?
A securities class action is a class action filed by investors who purchased a company’s debt or equity offering within a specific period of time known as a class period and who have suffered economic injury because a significant negative public disclosure about the company during that class period caused a serious drop in the company’s stock price. Securities class actions generally are brought under the anti-fraud provision of the federal securities laws including Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 and the Securities Act of 1933.
8. What does the Securities Act prohibit?
As the main law that regulates the initial offering of securities, the Securities Act allows investors to sue certain parties when the registration statement, which contains the prospectus, includes false or misleading information. A registration statement is a document required by the Securities Exchange Commission prior to an offering that details important information about the company’s financial condition, operations, management and the purpose of the offering.
The Securities Act extends liability to any person that signs the registration statement and any person or entity who sells the securities in the offering.
9. What does the Exchange Act prohibit?
Although the Exchange Act prohibits a number of things, one provision of the Exchange Act deserves particular emphasis: Section 10(b), which is the general “securities fraud” provision of the Exchange Act. It prohibits any manipulative or deceptive device or contrivance that violates a regulation passed by the Securities Exchange Commission (“SEC”).
In turn, the SEC passed Rule 10b-5, which prohibits two things. First, it prohibits market manipulation. “Washing, matching, jumping, capping, pegging, churning, pooling, ramping, marking, and warehousing are some of the more well-known forms of market manipulation that the law prohibits,” as one court has explained.
Rule 10b-5 also prohibits companies and individuals from making false or misleading statements in connection with the purchase or sale of a security. This provision of Rule 10b-5 is similar to the Securities Act, and it is the most frequently relied upon provision in litigation under U.S. securities law. The Exchange Act extends liability to (1) any person or company that issues a false statement or omits material information such that the statements are misleading and (2) to any person or entity that controls another person who violates the Act.
10. Can investors bring a shareholder action for violations of the Sarbanes-Oxley Act of 2002?
No. Investors do not have the right to bring a cause of action for violations of the Sarbanes-Oxley Act.
11. What does a typical lawsuit allege?
Although every lawsuit depends on its own circumstances, the most common claim alleged is that the defendants made certain false and misleading statements about the company, thereby artificially inflating the price of the stock. Once the truth becomes known, the stock price drops and investors lose money.
The false statements that artificially inflate the stock are usually made in (1) annual and quarterly financial reports, (2) press releases, and (3) conference calls with analysts.
12. Who typically violates these laws?
The most common defendants in a shareholder action are the company and certain high-ranking officers such as the CEO and CFO. Various directors of the company may also be sued, although this happens less frequently. A small percentage of cases involve suing the Company’s outside auditor when the company's financial statements are falsified. When the action involves an initial offering of securities (e.g., stocks or bonds), the banks that underwrote the offering may be sued as well, on the grounds that the registration statement contained false and misleading information.
13. Who enforces these laws?
The U.S. legal system relies heavily on a system of private enforcement by investors who bring class actions on behalf of all investors harmed. As Congress recognized in 1995: “Private securities litigation is an indispensable tool with which defrauded investors can recover their losses without having to rely upon government action. Such private lawsuits promote public and global confidence in our capital markets and help to deter wrongdoing and to guarantee that corporate officers, auditors, directors, lawyers and others properly perform their jobs.”
The U.S. Congress reaffirmed in 1995 that “private lawsuits promote public and global confidence in our capital markets and help to deter wrongdoing.”
14. How long does a class action take?
That depends on the nature and complexity of the case and the judge. A few class actions are settled very early in the process. Some courts have case loads that permit quick handling of the case with short time periods for the taking of discovery, filing of motions, and preparation for trial. On the other hand, the litigation can be significantly delayed due to the complexity of the case, the number of parties involved in the action, the amount of time needed to complete discovery and when the judge fails to promptly decide motions and other disputes. Sometimes a case will be dismissed and only reinstated upon a successful appeal. While every case is different, it is not unusual for a class action to take 2-4 years from the filing of the complaint to a final resolution.
15. What is a Lead Plaintiff?
A Lead Plaintiff is the investor chosen by a court to represent a class of investors in a shareholder class action. In 1995, the U.S. Congress sought to encourage the participation of institutional or other large shareholders in securities actions by amending both the Securities Act and Exchange Act with specific provisions to govern the appointment of Lead Plaintiff.
16. How does a court select a Lead Plaintiff?
The selection of the Lead Plaintiff is based on the presumption that the investor with the largest financial interest is the one most capable of representing the interests of all the class members. The process essentially has three stages. In the first stage, the plaintiff that files a securities class action must post a notice of the action in a widely circulated national business-oriented publication or wire service. Any member of the purported class may then request the court to serve as Lead Plaintiff within 60 days after the first public notice is made. In the second stage, the court, after reviewing the investors who have requested to be class representative, identifies the investor that it believes has the most to gain from the action and appoints that investor Lead Plaintiff. In the third stage, other investors have the opportunity to show that the Lead Plaintiff is either not sufficient or adequate to serve as a class representative.
17. What does it take to be a class representative?
A plaintiff must meet certain basic requirements in order to be certified by the court as class representative. The plaintiff’s situation must be typical of the situation in which other class members find themselves, and the plaintiff must have suffered an economic loss. He/she must have read the complaint and have at least a basic understanding of the nature of the dispute. Finally, the plaintiff must be represented by competent and experienced class action counsel. Most class representatives are not experts or professionals, but are normal, everyday people who have suffered a loss due to the defendants’ wrongdoing. Organizations such as small businesses and employee benefit plans also often serve as class representatives.
18. What are the duties of a class representative?
Although the duties of a class representative are important, they are not very burdensome. The most important thing is that a class representative act in the best interests of the class as a whole. A class representative must cooperate with his/her counsel in providing information and documents that are relevant to the case. The class representative’s lawyer will ensure that these tasks do not become unduly burdensome or intrude into private and irrelevant matters.
A class representative will normally have to sit for a deposition. This means that lawyers for the defendants will ask him or her questions under oath, which must be answered honestly and accurately. The lawyer works with the class representative to make sure he or she is thoroughly prepared for the occasion. Preparing for and taking the deposition usually takes a day.
In addition, it is necessary for the class representative to keep up with the progress of the case and to read the updates provided by class counsel. In the event the case goes to trial, the class representative may be required to testify.
19. Do I get paid for my time and effort as a class representative?
You do not get paid a fee for agreeing to be a class representative. However, in some class actions it is appropriate to ask for — and courts have granted — incentive awards to compensate the class representative for the time and effort expended on behalf of the class. However, there is no guarantee that such an award will be granted in any given case. In class actions involving securities fraud, such incentive awards are not permitted, but the class representative is entitled to compensation for the time spent in assisting class counsel in preparing the case.
20. How much do I have to pay a lawyer in order to bring a class action?
Nothing. Class action lawyers typically represent you on a contingent fee basis. That means they are paid their fees and reimbursed their expenses only if they obtain a favorable result in the case, either by winning at trial or through a settlement. Thus, their fees and expenses, which must be approved by the Court, come directly out of the monies recovered for the entire class at the end of the case. Typically, class action lawyers also advance the costs of litigation, including filing fees, transcript costs, travel expenses, copying and courier charges, and expert fees.
Finally, Plaintiff’s counsel must submit detailed records to the court in support of their petition for attorneys’ fees. Most courts award attorneys’ fees as a percentage of the total settlement fund, but they also look to the nature of the relief achieved in the settlement, the quality of the legal work, the amount of time reasonably spent by the lawyers, and other factors.
21. How much money is recovered?
While recovery typically depends on a number of factors including the size of the fraud or other securities violations, average settlement values hit a new high in 2005. Even if one excludes the settlements from the WorldCom and Enron litigation, the mean or average settlement in shareholder actions was $24.3 million, which surpassed the previous high of $23.7 million in 2002. Inclusion of the WorldCom settlement brings the average to nearly $71 million.
It is noteworthy that the number of “mega-settlements” has also dramatically increased. Seven of the top ten settlements were reached in 2005 and 2006. Before 2005, only one settlement exceeded one billion dollars. Today, there have been six settlements for over a billion dollars. Moreover, two of those new settlements involved foreign companies: Nortel Networks of Canada and Royal Ahold N.V. of the Netherlands.
22. How much do institutional investors increase recovery for the class?
Cornerstone Research has found that the size of settlements on average doubles when institutional investors serve as Lead Plaintiff. According to the study, median settlement amounts with institutional leads were twice those of non-institutions. The effect of institutional investors on the settlement remains true even if one takes into account that institutions tend to get involved in only the biggest cases, the study concluded. Likewise, the economic consulting firm NERA found a 20 percent increase in securities settlements when institutions were in the Lead Plaintiff role.
23. What happens if there is money left over in the settlement fund?
On occasion, there is some money left over after all of the initial checks are mailed. The remaining money is then disbursed according to the terms of the settlement agreement. Sometimes, it provides that the remaining money go to a charity or nonprofit organization approved by the court.
24. How will I know that a settlement will be fair?
The terms of any settlement of a class action must be submitted in detail to the court, with evidence demonstrating why the settlement is fair and reasonable and in the best interests of the class. In addition, all class members are notified of the terms of the proposed settlement and are given an opportunity to object to the terms of the settlement and to appear in court to present their objections in person (if they so choose). The court examines all the evidence and objections and only then decides whether to approve the settlement.
25. I received a printed notice that says I am a class member in a case. What do I have to do?
Although class notices sometimes seem complicated, it is important to read them carefully. They will usually explain specifically what you have to do. Usually, if you agree with the settlement and want to receive your share of it, you simply have to file a Proof of Claim by the due date listed in the notice. If you object to the settlement, or want to “opt out” of the settlement and pursue an individual claim against the defendant, the notice will tell you how to do that.
26. Can a non-U.S. Investor be appointed as Lead Plaintiff in a U.S. class action?
Yes. In fact, non-U.S. investors have been appointed as Lead Plaintiffs in a number of high-profile securities cases including the litigation involving Parmalat, Vivendi, Lernout & Hauspie, Chicago Bridge & Iron, and Converium.
27. Why do non-U.S. institutional investors seek appointment as a Lead Plaintiff?
There are at least four reasons why non-U.S. investors seek appointment as Lead Plaintiff in a U.S. class action:
- to increase their recovery,
- to guarantee that non-U.S. investors are included in a settlement,
- to ensure that they are discharging certain fiduciary duties, and
- to improve corporate governance of that company.
28. Can non-U.S. investors be excluded from settlements when they are not Lead Plaintiffs?
Yes. There are some notable examples of non-U.S. investors being excluded from a settlement. For example, in the U.S. class action against Deutsche Telecom, the U.S. Lead Plaintiffs excluded non-U.S. investors from the action — which meant that the $120 million recovered was distributed only to those who purchased Deutsche Telecom shares in the U.S.
Likewise, when DaimlerChrysler AG settled a lawsuit for $300 million, foreign investors were excluded from the class settlement, and therefore did not receive any of the monies recovered. The same was true in the original action involving Lernout & Hauspie. If non-U.S. investors had been appointed Lead Plaintiff in these cases, these exclusionary results could have been prevented.
29. Can a shareholder bring an action under U.S. securities laws without participating in a class action?
Yes. Some actions are better suited for an individual action, rather than a class action. This is often the case where an investor has suffered a particularly large loss or when a currently pending class action is being led by investors that are unlikely to adequately protect the interests of all members of the class, particularly the interests of foreign investors.
30. What fiduciary duties does an institutional investor have in regard to a shareholder action?
While the duties of an institutional investor will depend greatly on the jurisdiction where the investor is located and on the specific facts of the situation, acting as Lead Plaintiff may help ensure that the trustees of a fund are discharging their fiduciary duties. For instance, when the trustees of pension funds actively participate to enforce the U.S. securities laws against corporate fraud, they are seeking to recover fund assets that have been diminished and are thus fulfilling their fiduciary obligations. Likewise, a fiduciary duty may also arise when the institutional investor believes that an alternate class representative with a less substantial stake in the outcome may compromise the interests of the class, for example, by reaching an inadequate settlement or in failing to vigorously prosecute the action.
31. Do U.S. shareholder actions improve corporate governance?
Yes. A recent study of the 49 largest stock markets in the world showed that laws facilitating private enforcement through disclosure and liability rules, such as those in the U.S., significantly improve the strength of a stock market. Moreover, in an increasing number of cases, investors negotiated as part of shareholder action settlements the implementation of numerous good corporate governance practices, including increasing the number of independent directors, annual election of all board members, term limits for directors, and changes in director and officer compensation.
32. What type of corporate governance changes may be implemented in a settlement?
Shareholder class actions are being used in new ways to improve corporate governance, according to a NERA Economic Consulting report.
For example, in recent years, investors have sought the following governance improvements from corporations:
- Defining who is an independent director;
- Increasing the number of independent directors;
- Increasing the openness and disclosure of board decisions and processes;
- Annual election of directors rather than staggered multi-year terms;
- Term limits for directors;
- Increased participation by shareholders in director nominations;
- Rotation of a firm’s outside auditor;
- Changes in director and officer compensation; and
- Creation of public policy and corporate governance committees.
In short, Lead Plaintiffs can enhance good corporate governance practices in a number of ways.
33. Is there a benefit to joining U.S. shareholder actions rather than non-U.S. actions?
Yes. There are a number of reasons why non-U.S. have brought their actions in the U.S. One of the most important reasons is that U.S. law generally provides a more effective and efficient remedy for investors who have been damaged by fraud, corporate wrongdoings or misleading information.
For example, in the Parmalat litigation, the Associate Press reported that 70,000 Parmalat investors wanted to join an Italian civil suit if the case against various banks went to trial in Italy. Despite the fact that these investors lost their money over two years ago, the court has yet to decide which investors will be allowed to join the Italian lawsuit.
Meanwhile, Parmalat investors who brought suits in the U.S. have found the U.S. court receptive to resolving their claims. Indeed, the U.S. class action litigation involving Parmalat has already made substantial progress in prosecuting investors’ claims, and the court has already determined not only who will be allowed to represent the potential class of Parmalat investors but which financial institutions, auditors, law firms and individuals can be potentially held accountable at trial.
34. Is it a large financial burden to participate in U.S. actions?
No. There is no cost to you if you choose to participate in a U.S. class action. U.S. legal practice permits attorneys to represent clients on a contingency fee basis, meaning that you will not be responsible for attorneys’ fees or the costs of the litigation — even if you lose the case, you are not responsible for your own attorneys’ fees or those of the defendants.
Attorneys are only compensated if there is a recovery on your behalf and upon court approval. So, for example, if the attorneys are able to secure a $100 million recovery and are awarded a 15% fee, $15 million would be deducted from the recovery before the remaining monies are distributed to the class. In this way, the attorneys’ fees are shared by the entire class of investors.
35. What is a derivative action?
A derivative action is a lawsuit brought by a shareholder of a corporation, on behalf of the corporation, to enforce a cause of action against a third party, such as an officer or director of that corporation. Derivative actions are brought when a corporation possesses, but does not enforce, its rights against third parties. It is often necessary for a shareholder to institute a derivative action because the corporation, which is run by officers and directors, will not bring a lawsuit against one of its own, even if there has been serious wrongdoing.
36. What types of charges are filed in a derivative lawsuit?
Derivative actions most often involve charges that officers and directors are wasting corporate assets, or that a corporation’s management or board of directors breached fiduciary duties owed to shareholders by negligence, mismanagement or self-dealing.
37. Do I have to own stock in the company to bring a derivative action?
Yes, you must be a current shareholder and continue to hold the stock until the derivative action is resolved.
38. How do shareholders benefit from derivative actions?
Any relief granted pursuant to a derivative action is a judgment against a third person requiring them to pay money to, or make changes for, the benefit of the corporation. If money is recovered as a result of a derivative action, it would be paid back to the corporation, which could have a positive effect on the company’s stock price and benefit all current shareholders. Most derivative cases result in the implementation of corporate governance reforms designed to prevent future wrongdoing and enhance shareholder value.
39. Will I have to pay anything if I bring a derivative action?
No. All expenses are advanced by Spector, Roseman Kodroff & Willis. We will recover attorney’s fees only if we obtain a benefit for the corporation and the court approves a fee.
If you have a specific question about one of our cases, please contact us.