Most Suits on Stock Declines Valid, Study Says

Most lawsuits filed because of steep drops in company share prices are justified, according to a university study released Monday.

Researchers at the University of Colorado at Boulder reviewed 503 shareholder lawsuits settled between 1990 and 1993. They compared the performances of sued companies with others in the same industries and also reviewed 8,000 news releases and articles.

About 95% of the companies that were sued had an average share price drop of 25% or greater. They were also more likely to have issued optimistic news releases during periods of questionable performance.

“It’s pretty strong evidence that the shareholders could claim to have been misled by the news releases,” said finance professor Sanjai Bhagat, one of the study’s authors.

The findings don’t support claims of frivolous shareholder lawsuits that were the basis for Congress passing the Common Sense Legal Reforms Act last year, the researchers found.

“These lawsuits are not being filed by irrational people and settled by judges gone wild,” Bhagat said. “On average, the suits are being tried and settled on rational grounds.”

In a typical year, shareholders file between 90 and 150 lawsuits seeking class-action status. The lawsuits most frequently allege that problems within a company were concealed from shareholders or that there was outright fraud, the researchers found.

A successful shareholder lawsuit costs a company $9.6 million on average, plus $2.7 million in legal fees, the study found. The largest settlement was $200 million, with $60 million in lawyer’s fees.

Despite the cost, Bhagat said, such lawsuits are helpful because they encourage managerial honesty.

The study did not look at lawsuits that were not settled, and a review of those cases might lead to different conclusions, Bhagat said.