Trends In Security Litigation.

There has been a marked increase in securities class action litigation and Securities and Exchange Commission enforcement activity focused on problems with companies' publicly disclosed financial statements. In case after case, counsel for class action plaintiffs have cited accounting irregularities as evidence of "fraud on the market," in connection with earlier financial reporting. Not surprisingly, with many California companies making intriguing admissions of accounting irregularities (sometimes accompanied by re-stated financial statements) California continues to be one of the more popular venues for securities fraud claims. According to a recent study released by Pricewaterhouse Coopers, the industries most frequently subject to securities class action lawsuits are computer service firms, telecommunications companies, health care companies, banking and brokerage firms and pharmaceutical and electronics companies.

Many companies in these industries -- "start-up" companies, in particular -- are headquartered in California.

Class action filings have increased notwithstanding the passage of the Private Securities Litigation Reform Act of 1995, a statute that was specifically designed to prevent abuses in class action securities litigation. Stated in simplest terms, the Reform Act, among other things, requires plaintiffs to plead more specific facts in order to proceed with claims under the federal securities laws. While many believed that the passage of the Reform Act would decrease the number of securities class action filings, this has not occurred. In fact, the volume of class action filings continues to exceed historic levels. 1999 represented only the third year in the 1990's in which the number of such new cases exceeded 200.

This trend continued in 2000 with over 200 new cases. As of June, there already have been 154 new cases filed in 2001.

More than anything else, the Reform Act has had an impact on the type of securities class action cases filed. In the early 1990's, plaintiffs based many securities claims on assertions that companies released publicly misleading future earnings predictions, growth predictions or other "forward looking" statements. The Reform Act has largely eliminated these cases because of the protection it provides to certain "forward looking" statements made by companies and their officers and directors.

The newer cases predominately involve frontal assaults upon publicly disclosed financial statements and perceived misstatement of actual earnings. The perception that a company misstated its earnings is heightened when a company re-states its financial statements for previous periods. Although re-stated financials are sometimes unavoidable, they will almost certainly raise red flags and invite the scrutiny of potential plaintiffs' counsel. Indeed, slightly more than a third of the cases filed since 1998 and alleging purported accounting irregularities were filed after a company announced that it had or was about to re-state its financials.

The recent rise in private securities litigation focused on accounting irregularities has been accompanied by a rise in enforcement activity by the S.E.C. In 1999, for example, the S.E.C. brought 90 financial fraud cases, a 15 percent increase from 1998. About one-third of the S.E.C. actions brought in 1999 involved improper revenue recognition, mirroring the rise of civil litigation involving these issues. In 2000, the S.E.C. brought a record 100 financial fraud cases, over half of which involved revenue recognition issues.

Thomas L. Taylor III is head of the litigation section in the Los Angeles office of Morgan Lewis and a member of the firm's securities litigation practice group.