Study Shows Class Action Lawsuits Discourage Financial Misconduct
Allen Yesilevich | October 3, 2011
Results from a new study by finance and accounting professors at Rutgers and Emory universities’ business schools show that class action lawsuits deter companies from misrepresenting their financial results and in many cases class actions prevent more fraud than Securities and Exchange Commission (SEC) enforcement actions.
“Our research found statistically and economically significant deterrence associated with both SEC enforcement and class action lawsuits,” said Simi Kedia, Ph.D., MBA, associate professor of finance at Rutgers University School of Business in a September 29 press release issued by the Investor Advocate. “We looked at firms in the same industry as the enforcement target and found that the average peer firm subject to SEC action and/or litigation reduces discretionary accruals (i.e., reporting as sales transactions for which payment has not been received) equivalent to 14 percent to 22 percent of the media return on assets in the aftermath of such enforcement.”
Some of the more significant findings included in the report focus on the government’s lack of action compared to private litigation. In the paper entitled “The Deterrence Effects of SEC Enforcement and Class Action Litigation,” the researchers conclude that a class action lawsuit for accounting irregularities is more likely to occur against a firm than an SEC investigation. “The greater likelihood of class action litigation, combined with higher monetary sanctions, likely renders lawsuits as a potentially effective way to deter reporting irregularities at peer firms,” the report states.
Moreover, the new research found that, on average, private lawsuits are filed in advance of SEC actions by 297 days. However the report stated that the strongest deterrence to corporate fraud occurred when both SEC and private class actions are initiated.
A recent New York Times story on AIG’s lawsuit against Bank of America noted that private litigation is a crucial method for shareholders to recover losses. The article cited a letter from the general counsel of the California Public Employees’ Retirement System (CALPERS) which stated that “private litigants in the 100 largest securities class action settlements had recovered $46.7 billion for defrauded shareholders.”
