More and more companies are being attacked by shareholders in class-action lawsuits that cost an arm and a leg.

They're back. Shark fins once again are roiling the corporate waters as the number of lawsuits filed against corporations on behalf of shareholders increases. We're on track for a record 316 class-action shareholder suits to be filed in 2001. The Wall Street Journal in July put the cost of defending such suits at $100 million — and that's just for legal fees for one subset of them (those related to IPOs from 1998 to 2000). Settlements are going through the roof, having crossed the line from millions to billions in one case (see The Biggest Bites).

It wasn't supposed to be this way. When Congress passed the Private Securities Litigation Reform Act of 1995, finance executives heaved a sigh of relief. The standards had been raised, and frivolous suits no longer could be filed. Indeed, the number of filings dropped sharply from 231 in 1994 to 110 in 1996 (see Shark Attacks). "Before 1995, when a stock price plummeted, lawyers would race to the courthouse to file suits, even when there was no hint of fraud," recalls Steven L. White, first vice president for claims at Hartford Financial Products, New York City. "A falling stock price created an assumption of fraud. Attorneys spent very little time and money investigating before they filed suits."

But the 1995 drop in suits came with a downside: Plaintiff attorneys who had to work harder and file stronger cases began demanding larger settlements. The average settlement jumped from $14.6 million in 1998 to $23.8 million in 2000. "The Reform Act raised the bar, but it also raised the stakes," White observes.

And that brought in the lawyers. "Everybody hates lawyers until they need one. Then they want their own shark," notes Jeffrey Kodroff, partner of the Philadelphia law firm Spector, Roseman & Kodroff, who makes his living suing corporations. Now with both the size of settlements and the number of claims rising, businesses are scrambling for safe waters.

Shark Logic

If plaintiff attorneys are the sharks that put businesses in peril, executives need to understand how they think. For one thing, they are attracted to cases they think they can win, and win large settlements in. "As a contingent-fee attorney, I only get paid from what I recover for plaintiffs, so I won't waste time on a case unless I believe that the company did something wrong," Kodroff says.

Trading volume is also a factor, notes Kevin P. Muck, partner in the San Francisco office of Brobeck, Phleger & Harrison LLP, who sometimes defends corporations in these suits. "Plaintiffs like to calculate damages by multiplying the size of the share decline by the number of shares traded during the period in question, so the greater the trading volume, the higher the damages they claim."

Frank H. Penski, partner in the New York City office of the law firm Nixon Peabody LLP, estimates that more than 90 percent of shareholder suits start with plaintiff attorneys looking for plaintiffs. Once lawyers have zeroed in on an organization for attack, senior management needs to prepare. They shouldn't pin their hopes on loyal shareholders; everyone who can will join the suit. "Most of them are delighted to learn that they might get some money without having to do anything," Penski reports.