lessons from the first year: the emerging impact of sarbanes-oxley plus 2003 16th annual...

Lessons from the First Year:The Emerging Impact of Sarbanes-Oxley

PLUS 200316th Annual International Conference

Lisa Klein WagerMorgan, Lewis & Bockius LLP

Stephen RadinWeil, Gotshal & Manges

John F. McCarrickDuane Morris , LLP

Vinita M. Juneja, Ph.D.National Economic Research Associates

Robert WallnerMilberg Weiss BershadHynes & Lerach LLP

2

Topics

Overview of Relevant Sarbanes-Oxley Provisions Impact on Class Action Litigation Impact on Derivative Litigation Strategic and D&O Coverage Implications

3

Overview of the New World Under Sarbanes-Oxley

Signed into law on July 30, 2002 Response to rapidly spreading Enronitis Virus

– and the Sergeant Shultz defense Designed to restore investor confidence by:

– improving corporate disclosures– increasing personal accountability of officers – expanding the role of the audit committee/outside directors– improving independence and reliability of outside auditors– addressing analyst conflict of interest concerns

Broad ranging set of reforms– some immediately effective– some mandating SEC rule-making

Only one piece of a sea change

4

Key Provisions Impacting Litigation

More detailed MD&A Principal officer certifications

– of disclosure controls and procedures– of fair presentation

Code of ethics disclosures

5

Key Provisions Impacting Litigation

Current event disclosures– enhanced and expedited 8-K filing– expedited disclosures of discretionary insider sales

Pro forma financials

6

Key Provisions Impacting Litigation

Greater Audit Committee Responsibilities Prohibition on personal loans to D&O’s

– implication for advancement of defense costs Principal officers must disgorge profits/bonuses during

periods subsequently restated Expanded statute of limitations

– lesser of 2 years from discovery/5 years from event

7

Key Provisions Impacting Litigation

Whistleblower protections

Attorney conduct rules

8

Key Provisions Impacting Litigation

New/Enhanced Criminal Offenses

– Destruction of documents

– Fraudulently Misleading an Auditor

• note warning for lawyers, non-audit accounting firm personnel, and

bankers in Final Rule Release

Additional Increased Penalties Under ERISA

– separate program this afternoon

New Private Right of Action for Retaliation by Whistleblowers

– mock mediation this afternoon

9

Impact on Federal Litigation

Are more cases being filed?

PLUS 200316th Annual International Conference

November 10, 2003

Lessons From the First Year:The Emerging Impact of Sarbanes-Oxley

Vinita M. Juneja, Ph.D.Senior Vice President

Heard on the Street

Filings are on the rise?

Huge settlements are the norm?

Settlements are bigger than they used to be?

Heard on the Street

Filings are on the rise?

Huge settlements are the norm?

Settlements are bigger than they used to be?

Federal filings seem to be on the rise,

* Through late June, 2003

1991 1992 1993 1994 1995 1996 20001997 19991998

164

202

163

233

191

127

193

268

241223

2001

503

2002

280

0

50

100

150

200

250

300

350

400

450

500

129

252

2003*

123

Federal Filings by Year

123

129

252

1991 1992 1993 1994 1995 1996 2000 2001 20021997 19991998

164

202

163

233

127

193

268

241223

503

280

2003*0

50

100

150

200

250

300

350

400

450

500

Federal Filings by Year

…but, that includes laddering and analyst cases

* Through late June, 2003

40

240

Analyst Cases Laddering CasesStandard Filings

191

110

13

303

1955

Filings Vary by Circuit

2002 Filings by Circuit

1st 2nd 3rd 4th 5th 6th 10th 11th0

10

20

30

40

50

60

70

80

90

100

7th 9th8th

12

88

25

7

19 1621

16

47

4

22

What Is Your Likelihood ofBeing Sued?

Annual Probability of Facing aSecurities Class Action Lawsuit

20021998-20011995

1.6%

1.9%

2.3%40% Increase

0.5%

1.0%

1.5%

2.0%

2.5%

0.0%

Disposition

Dismissal 19%

Lawsuit Filed

Dismissals Have Slowed PostSarbanes-Oxley

Two Year Dismissal Rate

Year Filed

0%

5%

10%

15%

20%

1996 19981997 1999 2000

Dismissal Rates Vary by Circuit

1st 2nd 3rd 4th 5th 6th 10th 11th7th 9th8th

Two Year Dismissal Rate

0%

10%

15%

20%

25%

30%

5%

11%

7%

20

Impact on Federal Litigation

Are more outside directors being sued?

21

Impact on Federal Litigation

What has been the impact of the expanded statute of

limitations?

– Are time-barred claims revived?

22

Expanded Statute of Limitations

[A] private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws, as defined in section 3(a)(47) of the [Exchange Act], may be brought not later than the earlier of (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation.

23

Retroactivity

The limitations period…shall apply to all proceedings addressed by this section that are commenced on or after the date of enactment of the Act.

24

Impact on Federal Litigation

What has been the impact of the expanded statute of

limitations?

– Is the statute of limitations changed for section 11 claims?

25

Expanded Statute of Limitations

[A] private right of action that involves a claim of fraud, deceit, manipulation, or contrivance in contravention of a regulatory requirement concerning the securities laws, as defined in section 3(a)(47) of the [Exchange Act], may be brought not later than the earlier of (1) 2 years after the discovery of the facts constituting the violation; or (2) 5 years after such violation.

26

Impact on Federal Litigation

Will litigation be more protracted?

– What has been the impact of the Principal Officer Certifications?

– What has been the impact of the new MD&A requirements?

• Creation of a duty?

– What has been the impact of the real time disclosure requirements?

– Has there been more record-keeping and note taking?

• To what end?

Continuing complications of PSLRA lead plaintiff procedures

27

Impact on Federal Litigation

Is settlement more expensive?

Disposition

Dismissal 19%

Settlement 80%

Lawsuit Filed

Judgment 1%

Heard on the Street

Filings are on the rise?

Huge settlements are the norm?

Settlements are bigger than they used to be?

Huge Settlements Are Rare

Percent of settlements over $100 Million

After Enron

4.4%

1996-Enron (October 2001)

3.4%

Most Settlements in Jan – Late June 2003 Were Under $25 Million

Nu

mb

er o

f C

laim

s

0

5

10

15

20

25

< $ 2 $2 -$5 $5-$10 > $100$10-$25 $25-$50 $50-$75 $75-$100

17

4 42 2

2021

12

Settlement Amount in Millions

Heard on the Street

Filings are on the rise?

Huge settlements are the norm?

Settlements are bigger than they used to be?

Average SettlementsHave Been Rising

Since Enron the average settlement has been $24.6 mm.

* 2000 Average Settlement Excludes Cendant

1996 1997 1998 1999 2000* 2001 2002$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

2003

Ave

rag

e S

ettl

emen

t ($

Mill

ion

s)

Investor LossesHave Also Been Rising

1996 1997 1998 1999 2000 2001 2002$0

$150

$300

$450

$600

$750

$900

$1,050

$1,200

$1,350

2003

Ave

rag

e In

vest

or

Lo

ss (

Mill

ion

s)

But Investor Losses Have Been Rising Even More Rapidly

Ave

rag

e S

ettl

emen

t ($

Mill

ion

s)

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

1996 1997 1998 1999 2000 2001 2002 2003

Ave

rag

e In

vest

or

Lo

ss (

Mill

ion

s)

$0

$150

$300

$450

$600

$750

$900

$1,050

$1,200

$1,350

* 2000 Average Settlement Excludes Cendant

There Is Good News for Companies

Expected Settlement for a Case with Investor Losses of $600 M

$0

$4

$8

$12

$16

$2

$6

$10

$14

1998

Expected Settlement

$2002

Expected Settlement

$

What DeterminesSettlement Values?

Investor Losses

Types of Plaintiffs Included– Debt holders => 70%+– Preferred shareholders => 60%+– Option holders => 30%+– Institutional lead plaintiff => almost 20%

What DeterminesSettlement Values?

Investor Losses

Types of Plaintiffs Included

Types of Allegations– Accounting fraud => 10%+– Admitted accounting irregularities => 20%+– Restatements => almost 30%– Accounting codefendants => 40%+– Section 11 claim => almost 30%

What DeterminesSettlement Values?

Investor Losses

Types of Plaintiffs Included

Types of Allegations

Market Capitalization of Firm

Whether the Issuer Is Bankrupt

When the Case Settles

Cases Are Taking Longer

Percentage of Filings Disposed Within 5 Years

0%

20%

40%

60%

80%

100%

1991–1995 1996–2002

One Impact of SOX on Directors’ & Officers’ 10b-5 Liabilities…

Statute of limitations on securities fraud: Two years after

discovery; Five years after

violation

DefensesLiability RisksProvision

Extends class period and increases damage volume

Effect on damage volume will be relatively small

Settlements and the Expanded Statute of Limitations in Sarbanes-Oxley

The average settlement would have increased by 9%. The median settlement would have increased by 6%. The range of settlement increase was from 0% to 33%.

Sample: 15 post-PSLRA cases in which the 3-year statute of limitations may have constrained the class period

Analysis: Compute expected settlement with the actual class period and a hypothetical 5-year class period

Results:

43

Anticipated Impact of SOA on Federal Class Action Litigation

Still to come– interpretation of terms– availability of private right of action where not explicit– will certifications of disclosure controls facilitate particularized

scienter pleading?– Will certification of content coupled with expanded MD&A facilitate

omission pleading?– Will discovery be complicated by an increase in note-taking/record-

keeping?– Will the new criminal penalties for attempting audit

influence/document destruction raise settlement pressure and costs?

44

Anticipated Impact of SOA on Federal Class Action Litigation

Is there an increase in requests for individual separate counsel or for separate counsel for D&O’s and issuer – implications of attorney conduct rules for “issuer’s” counsel – SEC emphasis on full cooperation

45

Impact on Derivative Litigation

Are we seeing more? – New rules versus new/evolving expectations– Warnings from Delaware judges in articles and speeches– Recent Delaware Supreme Court cases– Use of the Act and Exchange Listing Rules– Due Care versus Good Faith– Disney– Oversight “Caremark” claims– Section 220 Books and Records Actions

Settle for More Than $0

31%

Dismissed 28%

Non-cash settlement

39%

Trial Plaintiffs Win

0.6%

Trial Defense Wins

0.4%

Disposition of Derivative Suits

Millions of Dollars

1

12.5

25

50

100

200

400

0 4 8 12 16 20 24 28 32 36 40 44 48

Pay-Outs of Derivative Suits1977 to the Present

Millions of Dollars

1

12.5

25

50

100

200

400

0 4 8 12 16 20 24 28 32 36 40 44 48

Median $0

Pay-Outs of Derivative Suits1977 to the Present

Millions of Dollars

1

12.5

25

50

100

200

400

0 4 8 12 16 20 24 28 32 36 40 44 48

Pay-Outs of Derivative Suits1977 to the Present

Mean $3 Mean $3 MillionMillion

50

Strategic and D&O Coverage Implications

D&O underwriting environment Litigation defense strategies Settlement strategies

Where to Learn More About NERA

For more information on NERA’s Securities Practice, please contact:

Vinita M. JunejaSenior Vice President

New York, NY212.345.3148

vinita.juneja@nera.com

For more information on NERA’s services and capabilities, please visit our global website:

www.nera.com

Lessons from the First Year:The Emerging Impact of Sarbanes-Oxley

PLUS 200316th Annual International Conference

© Lisa Klein Wager

kleinwager@aol.com(o) 212-309-6113(c) 917-881-8426