Securities Litigation in the Utility Sector
Bohn, James G., Energy Law Journal
Federal and state laws provide owners of securities issued by public corporations the right to file suit against perceived wrongdoing. In recent years, utilities have seen an increase in the number of actions filed against management and board members. In 2002, almost ten percent of new federal securities fraud class actions involved an electric utility or a firm heavily involved in gas and electricity trading. This increase in litigation has followed a period of deregulation and restructuring among electric utilities and an accompanying rise in wholesale energy trading activities. Changes such as these alter the nature of a firm's risk exposures, as well as, generally increasing its overall risk. I find that the recent rise in securities litigation is one consequence of the fallout from electricity deregulation and restructuring. I also address the implications of securities litigation for utility managers and board members.
Litigation affects corporate conduct by providing a means for owners to sanction wrongdoing. The threat of involvement in an action may serve to create incentives for corporate officers and board members to better serve the interests of owners.1 A change in industry structure may affect the importance of litigation as a means of control. Deregulation increases the amount of discretion afforded management. While an increase in discretion may allow for better use of corporate resources, it also provides insiders increased latitude to serve their own interests, rather than the best interests of the corporation.
But agency problems are not the only factor influencing the propensity of firms to become involved in some form of securities litigation. securities actions are usually filed after a revelation of unfavorable news concerning the firm. Greater risk increases the likelihood that actual financial results will materially differ, on the minus side of the ledger, from expectations. Such an outcome may result from misleading disclosures or from a dereliction of management and board duties. But such developments may also result from unforeseen events. Given the difficulty in sorting out actual malfeasance from bad luck, an increase in the probability of bad outcomes by itself increases the litigation-risk exposure of officers and directors.
This article develops stylized facts concerning the recent experience of the utilities sector rather than constructing a formal model of the litigation process. I find that the incidence of litigation involving firms in the utility sector increased dramatically over the period between 1996 and 2003 (the sample period). I also find that most of the litigation involves companies in the electric power sector and firms with substantial unregulated energy trading activities or non-utility investments. Relatively few actions allege some form of fraud or dereliction arising from traditionally regulated operations. Rather, most actions emerge from unregulated operations or investments outside of the utility business. I also find that these actions have been costly. As of April 2005, the total amount that utilities and their insurers have agreed to pay to settle securities class actions is almost $1.4 billion.2 Many actions remain ongoing. The experience of the utilities sector provides a useful case study for managers and directors of firms in industries that are about to undergo, or are currently undergoing, structural change. I suggest steps that managers and directors of such firms may take to reduce their exposure to the risk of a securities action.
Section II provides a thumbnail sketch of the four most common types of securities actions involving public corporations. This includes both actions filed under federal securities law and state corporation law. section III provides an overview of the reasons that changes in the industry may have caused an increase in the level of litigation risk. This section also reviews the relationship between risk and the incidence of securities litigation. …