Securities litigation is not just for shareholders anymore
A new study by James Park, Professor of Law at the UCLA School of Law, discusses how bondholders have become increasingly active participants in securities litigation. The new research was recently highlighted in the Harvard Law School Forum on Corporate Governance and Financial Regulation. Park says his study, Bondholders and Securities Class Actions, challenges the conventional view that securities litigation is just for shareholders “in light of new evidence that bond investors are increasingly recovering losses through securities class actions.”
Data on bondholder participation in securities litigation
The study examines a data set of 1660 securities class actions filed from 1996 through 2005, and notes a trend of increasing activity by bondholders. Park notes that bondholder recoveries were quite rare for the first five years, only averaging around 3% of settlements from 1996 through 2000. However, the rate of bondholder recoveries almost tripled over the next five year period to an average of 8% of settlements (2001 through 2005).
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Park notes that bondholder recoveries are not only becoming more frequent, bondholders are also more frequently participating in the largest securities class action settlements. The proof of the pudding is that, for the decade of the data set, bondholders participated in recoveries in 4 of the 5 largest settlements and 19 of the 30 largest settlements.
Bondholders are making new legal arguments
Also of note, Park emphasizes that bondholders are not simply parroting the arguments of shareholders. The attorneys for the bondholders in securities class actions often raise allegations of clear harm to bondholders. He notes that firms sometimes commit securities fraud hoping they will increase shareholder value by taking on additional undisclosed risks. Obviously, bondholders do not benefit these kinds of activities and can be harmed by these hidden risks. This kind of securities fraud is basically distributing wealth from bondholders to shareholders and can be fought in court.
Quite a few bondholder class actions are related to a downgrade of a firm’s credit rating, which of course means a major increase in the credit risk of a firm. Park points out that complaints in the Adelphia, Delphi, and Williams Companies class actions all claimed that the fraud involved hiding debt from the markets and rating agencies. It turns out that more than half of all cases ending with a bondholder settlement related to a credit downgrade.
Bondholder class action lawsuits not infrequently relate to bond sales where the risks were not adequately disclosed to buyers. The HealthSouth complaint claimed that the bond offerings made by the company were fraud as they were designed to raise fresh capital to keep the firm operating. The General Motors case alleged the firm issued bonds fraudulently simply to save $520 million in interest.
Trend likely to continue
In closing, Park notes that the increasing involvement of bondholders in securities litigation is likely to continue given the clear trend over time. In the first year of the data, 1996, less than 10% of securities class litigations involved any recovery for non-shareholder plaintiffs. However, over the rest of the 10-year period, plaintiffs began to certify wider classes including bondholders. In fact, it is now commonplace for a securities class action lawsuit to allege claims on behalf of all investors. Of note, almost half of class actions brought claims on behalf of such a broader class in 2005.
See full PDF below.