Two new reports, including one published yesterday, delivered discouraging news for directors and officers insurers, revealing that the number of securities class actions started climbing again in 2007 after dropping in 2006.

Both reports said subprime mortgage problems are partially responsible for the uptick.

Stanford Law School in Palo Alto, Calif., and Cornerstone Research in Boston jointly released an annual report yesterday, finding that federal securities fraud class actions soared 43 percent to 166 in 2007 from 116 in 2006, attributing the jump to subprime issues and stock market volatility.

Offering a different count in late December, New York-based NERA Economic Consulting projected a 58 percent increase in these federal filings--to 207 in 2007 from 131 in 2006.

Along with the numerical differences, the reports offered different perspectives on what lies ahead for defendants in securities class actions and insurers of directors and officers.

"The 18-month decline in shareholder class-action filings has definitively reversed course," NERA said, going on to cite a fourfold increase in litigation related to subprime lending in the second half of 2007 compared to the first half.

According to NERA, 38 subprime shareholder class actions were filed last year by Dec. 15, and looking ahead to 2008, market conditions suggest such filings will likely remain high, the report said.

Subprime lending cases have already emerged in seven of 11 federal circuits, according to NERA, a unit of the Oliver Wyman Group, an MMC company.

"As the crisis in the credit markets continues to deepen and the market for subprime mortgages continues to suffer accordingly, more litigation is likely to follow," the Wyman report authors said in a statement.

The December 2007 NERA report predated yesterday's announcement by Boston-based State Street Corp. that it will reserve $618 million before taxes ($279 million after taxes) to address litigation arising out its investment management activities that put some customers in securities backed by subprime mortgages.

Such litigation against investment advisers threatens to impact both D&O and E&O ("errors and omissions" or professional liability) insurers.

With respect to 2007, the NERA report noted that subprime litigation was not the sole driver of the surge in class actions, adding that "standard" federal filings by themselves--filings other than those related to subprime and options backdating issues which had fueled 2006 and early 2007 figures--increased nearly 40 percent to 151 in 2007 from 109 in 2006.

While the Stanford/Cornerstone analysis reported a similar jump in the "core litigation rate"--defined as the litigation excluding the impact of "one-time systematic shocks" like backdating and subprime issues--Professor Joseph Grundfest, director of the Stanford Law School Securities Class Action Clearinghouse, read some positive signals into the data.

Citing Stanford's figures of 126 "core" filings in 2007 and 92 in 2006, he said that despite the 37 percent increase, litigation activity for 2007 remained well below historical norms.

With the report indicating a 10-year historical average covering 1997-2006 was 192 companies sued per year, Mr. Grundfest suggested that recent levels of class-action filings continue to bear out a hypothesis that lower filing rates can be attributed to a reduction in the incidence of fraud on the part of public companies. This reduction, in turn, reflects the fact that companies are being more carefully scrutinized by federal regulators and more actively engaged boards and auditors.

The Stanford/Cornerstone report noted that a strong stock market offers another explanation for the lower incidence of class-action filings in recent years, adding that an increase in stock market price volatility in the second half of 2007 helped fuel the jump in filing activity that also came about because subprime disclosures heated up.

One hundred companies were sued in the second half of the year, a litigation rate that reversed a trend of eight consecutive quarters with below-average litigation activity, according to the report, which counted 31 filings related to subprime issues.

The Stanford/Cornerstone report said that while the finance sector led the way in securities class-action activity with 47 companies sued in 2007--more than quadrupling 2006's 11 filings--the consumer noncyclical and communications industry sectors had the second- and third-highest levels of litigation activity with 36 and 33 companies sued, respectively.

The report is online at http://securities.stanford.edu/clearinghouse_research/2007_YIR/20080103-01.pdf. The NERA report can be found online at www.nera.com/recenttrends.

Special Reports /

Securities Class Actions Up, Reversing Prior Trend

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