Down Market Sparks Federal Suits

The market is volatile, to say the least, and investors and shareholders are on edge. And why shouldn't they be? Between the failure of the auction-rate securities market, sub-prime woes and hedge fund and investment bank implosions, the market sometimes looks a bit like a winter graveyard. Many investors are looking for someone to blame, and seeking justice in the form of securities class-action lawsuits.

The market is volatile, to say the least, and investors and shareholders are on edge. And why shouldn't they be? Between the failure of the auction-rate securities market, sub-prime woes and hedge fund and investment bank implosions, the market sometimes looks a bit like a winter graveyard. Many investors are looking for someone to blame, and seeking justice in the form of securities class-action lawsuits.

Of course, this is par for the course: Unforgiving markets typically breed unforgiving investors, who then pile into securities lawsuits (this is not to say that financial services firms, their advisors and the public companies on the market don't deserve some of the blame). Last year was no exception. The number of federal class-action securities lawsuits filed in 2007 was up nearly 50 percent versus 2006 to 163 cases, reversing a two-year decline, according to a recent PricewaterhouseCoopers Securities Litigation and Investigations Practice study. (That said, the number of overall class-action securities lawsuits-including federal and state cases-dropped to 169 in 2007 from 219 in 2006.)

The vast majority of the class-action securities suits brought in 2007 were related to the sub-prime mess. "Without a doubt, most notable in 2007 was the escalation of what has been termed the 'sub-prime crisis,' the full implications of which have yet to be seen in the financial and legal worlds," says Grace Lamont, a partner at PricewaterhouseCoopers.

Sub-prime related issues represented 30 of 103 filings in the second half of 2007, and 23 percent of overall 2007 filings. "One can expect 2008 to be 'Round 2' in this multi-state, multi-defendant fight," says Jonathan Dickey, partner at Gibson Dunn & Crutcher. "Regulatory proceedings are likely to expand, led by the SEC and various state attorneys general ... More investigative proceedings are expected in the year to come."

Hedge funds were another class-action hot spot in 2007. In October alone, the Department of Justice reported 60 civil and 33 criminal indictments against commodity pools and hedge funds, according to the report. And then there's the Bear Stearns hedge fund that collapsed last summer, vaporizing over $1.5 billion, which is now being investigated by the Department of Justice. "Not only could litigation against hedge funds by investors increase, but large institutional investors such as pension funds-which have added hedge funds to their portfolios over recent years, and which are increasingly active in shareholder lawsuits-may also begin to focus with similar activism on hedge funds in order to recover losses associated with the sub-prime crisis," the report states.

Federal securities class actions filed in 2007 by U.S. investors were not limited to U.S. borders. In fact, cases against foreign entities doubled in 2007 to 27 from 17 in 2006. Chinese companies carried the brunt of such suits facing 10, or 37 percent, of the federal suits-more than any other geographical group. (Between 2002 and 2007, just six cases were filed in companies based in China.) According to the report, the increase is reflective of the number of foreign IPOs in the U.S. in 2007.

While the actual number of federal cases was higher in 2007, the dollar value of settlements was consistent with 2006. Total settlements were valued at $6.37 billion compared to $6.44 billion in 2006. The average settlement, of $56.3 million, was also on par with the prior year's average.

The outlook for securities class-action suits in 2008 is not much better. According to the study, if the downward direction the economy continues, then private securities class actions will most likely trend upward over the next few years, "above the recent average number of filings since Sarbanes-Oxley."

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