Securities Litigation: The Importance of Monitoring and Staying Informed

By McNair, Mark; Cooke, Jim | Government Finance Review, April 2007 | Go to article overview

Securities Litigation: The Importance of Monitoring and Staying Informed


McNair, Mark, Cooke, Jim, Government Finance Review


Corporate fraud--from Enron and WorldCom to recent instances of options backdating--has become an unfortunate part of the investment equation for public pension funds. Many institutional investors' portfolios have suffered large losses as a direct result of false financial reporting and the failure of corporate officers to live up to their fiduciary responsibilities.

The primary tool for investors to redress corporate fraud is securities class action litigation. Through litigation, billions of dollars have been recovered for investors. Certain large public plans take a prominent role in such litigation, and many smaller plans have been active as well. Because significant sums have been recovered each year, it is increasingly important that public funds monitor their portfolios to ensure that they recover the funds to which they are entitled and do not"leave money on the table "The GFOA recently adopted a Recommended Practice (RP),"Developing a Policy to Participate in Securities Litigation Class Actions," designed to highlight the fiduciary obligation of public pension plan governing bodies to recover funds lost through investments in public securities as a result of corporate mismanagement and/or fraud.

This article addresses securities litigation--what it is, how the process works, the benefits of securities class action litigation, and why some criticize such litigation. More importantly, this article considers securities litigation from the perspective of medium-and small-size public pension plans, including what such public plans definitely should do and what they might consider doing to implement the GFONs RP. Specifically, this article addresses what is involved in monitoring a public plan's portfolio, including:

* What should be considered in developing a securities litigation policy;

* How to ensure a plan's participation in settlements;

* What it entails to get involved in class action cases; and

* The advantages and disadvantages of participating in a case as lead plaintiff.

WHAT IS SECURITIES LITIGATION?

A securities class action complaint is a collective legal action to recover the losses of all individuals and institutions that lost money because of a company's fraud or mismanagement. In most situations, except for a few large institutional investors that may have losses in the millions, it is not practical or economically feasible for public pension plans or individuals to sue a company individually.

In most situations, a case is filed after corporate irregularity that negatively affected investors is uncovered. In such a case, some investors would have purchased the stock at "an artificially inflated price" because its market price was based on false financial data disseminated by the company at that time. In any securities class action lawsuit, the time period during which the stock price was artificially inflated is called the "class period." The class period is established by the plaintiff subject to approval by the courts. Investors who purchased stock during the class period may initiate or participate in a class action lawsuit as long as they did not sell their stock during the period for a profit.

How the Securities Litigation Process Works

In 1995, Congress adopted the Private Securities Litigation Reform Act (PSLRA) to address certain perceived abuses of securities class action litigation. PSLRA requires federal courts to appoint one or more lead plaintiffs. Congress believed that the individuals or institutions with the largest losses would take a more active role in securities litigation and therefore be preferable lead plaintiffs to individual investors with comparatively modest losses.

Under the PSLRA, notice of a case filing must be published within 20 days of the filing date to notify potentially affected investors. This publication starts a 60-day window for potential lead plaintiffs. …

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