It is no secret that the costs of settling securities class actions are high and continue to rise. The numbers are clear: prior to the adoption of the Private Securities Reform Act by Congress in 1995, the average class action settlement was under $7 million; by 2003 the average exceeded $25 million.
But these monetary costs represent only part of the equation. For many companies, another aspect of the class action settlement may be equally or more disruptive – mandated changes in the board of directors, executive team, company rules, procedures or all of the above.
Although non-monetary relief to settle securities cases is not unprecedented, some recent settlements demonstrate a desire on the part of the plaintiffs' bar to expand the scope of reform and actually participate in corporate governance long after the settlement.
This boardroom activism by the plaintiffs' bar runs in parallel with (and sometimes runs past) the SEC's growing tendency to seek remedial measures in the settlement of enforcement cases against public companies. Case in point: in late 2003 a securities class action against the Hanover Compressor Company was settled for $80 million. The settlement terms (totaling eleven pages) also included requirements to adopt governance reforms faster than required by the SEC in the wake of Sarbanes-Oxley, plus more frequent rotation of audit firms; restrictions on insider selling when the company is buying stock in the market; additional shareholder approvals for option repricing; and prohibitions on insider use of derivatives in connection with company stock. The reforms did not stop there. The settlement also allows lead plaintiff's counsel to contact shareholders for the purpose of soliciting candidates for the board of directors and submitting nominations to the board, and to do so for some time into the future.
The Hanover settlement is not an isolated event. The recent settlement of the class action launched against Sprint PCS, Inc. (following its failed attempt to merge with WorldCom) resulted in a $50 million settlement and, according to the lead plaintiff's counsel in the case, "the most sweeping reforms of the corporate boardroom ever produced through shareholder litigation." Surpassing the requirements of Sarbanes, the settlement requires the company to replace a number of board members when their current terms expire. The settlement further mandates that the board must be independent and meet at least twice a year without management present. Going forward, the company will define "independence" in accordance with the terms of the settlement, which surpass the criteria adopted by regulators and courts. For example board members who have been affiliated with any present or former auditing firm used by Sprint in the prior three years will not be considered independent. Lastly, salary, bonuses and other compensation awarded to executives must be in line with "industry standards" as defined in the settlement.
In another recent settlement, Applied MicroCircuits Corporation accepted, among other reforms, that the positions of chairman of the board and chief executive officer must be held by different individuals.
Perhaps this courtroom activism is an inevitable response to post-Enron-Tyco-Adelphia research that finds a majority of Americans consider CEOs dishonest and believe executives will lie to increase profits. Perhaps it is a power play by the plaintiffs' bar, seeking business influence in addition to fees. (Indeed, one plaintiff now lists "Reforming Business" as part of its motto.)
Whatever its cause, this new brand of settlement clearly seeks not only to compensate members of the class for the company's past actions, but also define how the company will operate going forward. When this reformist wave will crest is anyone's guess. Equally uncertain is the long-term impact this trend will have on how companies are managed, and how they perform. But one immediate effect is clear – being a public company director is more demanding than ever. The New York Times recently reported that an annual corporate governance training conference run by a Stanford law school professor used to attract approximately 60 directors in a good year, but now sells out all 200 spots months before the conference takes place. Moreover, the average compensation of directors of public companies has increased approximately 40% in the last five years.
The result of these new governance focused settlements may be that the costs associated with class action settlements – long perceived as exhorbitant in and of themselves will be only part of the overall expense for companies that get sued in securities class actions.
Rudolph Pierce and Richard Rosensweig are members of the litigation group who specialize in securities law. They can be reached at rpierce@goulstonstorrs.com or rrosensweig@goulstonstorrs.com.