Securities Class Actions and Bankrupt Companies
Abstract: Securities class actions are criticized as wasteful suits that target temporary fluctuations in the stock prices of otherwise healthy companies. The securities class actions against Enron and Worldcom, companies that fell into bankruptcy in the wake of fraud, resulted in multi-billion dollar recoveries for permanent shareholder losses and provide a powerful counter-example to this critique. The context of bankruptcy may affect our perception of securities class actions and their merits, yet little is known about this subset of cases. This is the first extensive empirical study of securities class actions involving bankrupt companies. It examines 1466 securities class actions filed from 1996 to 2004, of which 234 (16%) involved companies that were in bankruptcy proceedings while the securities class action was pending. The study tests two hypotheses. First, securities class actions involving bankrupt companies (“bankruptcy cases”) are more likely to have actual merit than securities class actions involving companies that are not in bankruptcy (“non-bankruptcy cases”) Second, bankruptcy cases are more likely to be perceived as having more merit than non-bankruptcy cases, even when they are not more meritorious. The study finds stronger support for the second hypothesis than the first, suggesting that some form of hindsight bias affects the decisions of judges and parties with respect to bankruptcy cases. Even when controlling for various indicia of merit, bankruptcy cases are more likely to be successful in terms of dismissal rates, significant settlements, and third party settlements than non-bankruptcy cases. These results demonstrate that judges use heuristics not only to dismiss cases, but to avoid dismissing cases.
