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Study finds institutional lead plaintiffs have significantly greater success than individual lead plaintiffs
There is compelling new evidence that institutional investors achieve significantly better results than individuals when they take charge of fraud lawsuits against corporate wrongdoers.
Securities class actions led by institutional lead plaintiffs more often survive defendants’ motions to dismiss, generate significantly larger settlements, and are more likely to force management to improve their corporate governance, according to a rigorous new academic study.
The study, "Institutional Monitoring through Shareholder Litigation," provides additional evidence of the profound impact that public pension and union pension funds have had on securities class actions since passage of the Private Securities Litigation Reform Act of 1995. By directing federal courts to select as lead plaintiffs investors or groups with the largest losses in their stock holdings, the PSLRA ushered in an era in which institutional investors increasingly take charge of securities fraud lawsuits.
"Securities litigation has long been criticized as attorney driven and ineffective in punishing defendant firms," the authors write. "Our evidence indicates that institutional investors’ involvement in securities litigation enhances not only investors’ success in seeking financial recovery, but also the quality of the defendant firms’ corporate governance." The paper added that institutions can use this effective tool "to discipline management and to secure the long-term health of the firms."
Courts dismissed only 16 percent of lawsuits with institutions as lead plaintiffs, compared with 44 percent of suits with individuals as lead plaintiffs, according to the study. Looked at another way, institutions reduce the probability the court will grant a defendant’s motion to dismiss by 38.2 percent. The study concluded that the presence of an institutional lead plaintiff plays "a significant role in defeating the defendant firm’s motion to dismiss."
The authors present a daunting array of statistical regression analyses to make their case. The paper, to be published in the Journal of Financial Economics, examined all 1,811 class actions filed between January 1996 and July 2005 by investors. Of those, 286 were filed by institutions, including public and union pension funds, mutual funds, hedge funds and endowments. The authors are Professors C.S. Agnes Cheng of Louisiana State University, Henry He Huang of Prairie View A&M University in Texas, Yinghua Li of Purdue University, and Gerald Lobo of the University of Houston.
The authors said their research was "motivated by the lack of evidence” of whether institutions can be effective in exercising their power to influence corporate behavior through litigation.
Among the paper’s other findings:
•Twenty-seven institutions acted as lead plaintiff in three or more cases during the time period analyzed.
•When institutions were lead plaintiffs, the average settlement was $104.2 million, compared with $9.8 million when individuals were lead plaintiffs; the median settlement in institution-led cases was $15.7 million, compared with $4.3 million in individual-led cases.
•Even when the authors controlled for the fact that large institutions gravitate to cases against the largest companies, the settlements generated by institution-led suits are 60 percent larger than those for individual-led suits.
•Within three years of filing a lawsuit in court, defendant companies are far more likely to increase the number of independent members of corporate boards when an institution was the lead plaintiff than when an individual was. This finding "suggests that securities litigation does not automatically lead to governance improvement. Rather, it is the institutional involvement that drives, either directly or indirectly, governance changes," the paper said.
•Institutions are more likely to get involved in cases with severe fraud claims or massive damages: "We propose and find that when the likelihood of winning is high, the potential damage is large, and the defendant firm is important to the institutional owners, institutional owners are more likely to step forward to serve as the lead plaintiff."
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Class actions led by institutions settle for $104.2 million, on average – 10 times more than individual-led cases.
-- "Institutional Monitoring for Shareholder Litigation", forthcoming in the Journal of Financial Economics, C.S. Agnes Cheng
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