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Class actions fall in '06, but settlements rise

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Despite the emergence of options backdating scandals last year, the number of securities fraud class action filings dropped dramatically during 2006, according to two reports released last week.

But the settlement amounts that corporations paid to shareholder plaintiffs in 2006 rose 37% over 2005, which was also a record year for loss severity, according to an annual report from Washington-based NERA Economic Consulting, a unit of Marsh & McLennan Cos. Inc.

A rise in "mega settlements," including those valued at more than $100 million and four surpassing the $1 billion mark, drove 2006's severity increase, NERA reported.

In a separate annual study released last week, the Securities Class Action Clearinghouse reported that plaintiffs filed only 110 securities fraud class actions during 2006, a drop of 38% from 2005.

The Securities Class Action Clearinghouse, a joint project between Stanford Law School and Cornerstone Research of Boston, found that the 2006 securities class actions represent a 43% decrease from the 10-year average of 193.

Last year also produced the fewest number of suits recorded in a calendar year since adoption of the Public Securities Litigation Reform Act of 1995.

Cornerstone attributed the decline to strengthened federal enforcement of corporate conduct, a strong stock market combined with lower stock price volatility, and the resolution of a majority of class action lawsuits filed in the late 1990s and early 2000s.

The most surprising discovery for researchers came from the limited number of options backdating-related filings, said John Gould, vp for Cornerstone Research.

Despite all the attention paid to options backdating, plaintiffs have filed only 22 related federal lawsuits, Cornerstone reported.

That number, however, represents substantial claims activity, especially considering that no one in 2005 foresaw the emergence of backdating claims, said Kevin M. LaCroix, a directors and officers liability coverage expert and a director at OakBridge Insurance Services L.L.C. in Beachwood Ohio.

"Even though there are quote 'only 22 securities lawsuits alleging options backdating' that is still a lot of lawsuits and a lot of losses for something no one anticipated," Mr. LaCroix said.

Last year's decline in frequency is welcome news, but insurers are not ready to pop the champagne yet, said Evan Rosenberg, senior vp of Chubb Specialty Insurance in Warren, N.J. Several factors remain in play that could still drive up claims frequency.

For example, NERA reports that one possible reason for the decline in frequency stems from a federal indictment and personnel changes at Milberg Weiss & Bershad L.L.P., one of the nation's largest law firms associated with securities lawsuits.

The law firm's resources may be distracted, NERA said. If so, lawsuit filings could return to higher levels in the future, Mr. Rosenberg and NERA agreed.

Additionally, factors that drive securities lawsuit filings often emerge unexpectedly, Mr. Rosenberg and Mr. LaCroix said. The options backdating scandals that came to light in 2006 offer such an example.

"A lot of unexpected things happen in the D&O sector," Mr. LaCroix said. "That alone would be a reason for carriers to be somewhat cautious before assuming that 2006 frequency or severity is enough to make a wholesale change in your underwriting or pricing philosophy."

While observers say the decline in frequency may not impact D&O policy pricing, it is still good news for employers. The drop in filings means that the average corporation now faces less than an 8% probability of being a target at least once over a five-year period, NERA reports.

But those getting sued will pay more. NERA found that more than 10% of settlements in 2006 exceeded the $100 million mark. On average, only 3% of settlements reached that level in prior years.

The average settlement price, meanwhile, climbed to $86.7 million, up from 2005's average of $73.6 million.