2011 May See Even More Litigation for Financials

| About: iShares U.S. (IYF)

"Securities Lawsuits Set New Record Despite Slowdown in Credit Crisis" (Insurance Journal, January 21, 2011), is a new study about securities litigation by Advisen, Ltd. and sponsored by Kaufman Dolowich Voluck & Gonzo LLP. According to the study, 2010 saw more action than the year before. While class action suits dropped "sharply" in 2010, a nevertheless higher number of filings consisted of securities fraud suits (35% of the total) and allegations of breach of fiduciary duties (33%). The study further asserts that plaintiff attorneys continue to "favor financial institution defendants" with nearly one-third of securities complaints naming "financial firms or their directors and officers."

Given a plethora of new rules and regulations that directly impact the financial sector, 2011 will likely see more complaints that involve at least one financial sector party. However, other industries are still vulnerable. As authors of "2010 A Record Year for Securities Litigation: An Advisen Quarterly Report - 2010 Review" suggest, the Dodd-Frank Act extends to a non-financial organization if it is deemed to be a "potentially significant threat to the financial system should it fail." Furthermore, questions about executive compensation, a shareholder's right to opine on pay and clawback provisions related to the filing of incorrect financial information could potentially create trouble for non-compliant businesses across the industry spectrum.

In a related commentary, uber-Director and Officer ("D&O") liability insurance blogger Kevin LaCroix provides insights as to how the Advisen report might be streamlined by starting with a separation of civil fraud complaints from regulatory enforcement actions. He further adds that securities class actions, should they occur, are often severe in nature and potentially impose a material burden on companies and their D&O insurers.

What's the potential impact on investors?

  • Litigation consumes time, money and energy on the part of senior management that might otherwise be spent on moving wealth creation projects to the next stage.

  • Litigation can impact a company's reputation, potentially causing sales to drop which in turn can impact stock price.

  • A spate of industry-centric litigation can lead to new regulations which in turn necessitate that resources be spent on compliance.

Investors need to assess litigation risk for every company they own. Even when a company wins in court or settles what it deems a nuisance suit, the cost to its shareholders and bondholders is far from zero.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.