Upfront: Sarbanes-Oxley Fails To Slow Fraud

Contrary to expectations, the tighter regulatory environment has not resulted in fewer securities class-action lawsuits.

CFOs hoping for a continuation of the current dip in directors and officers (D&O) insurance premiums have been keeping their fingers crossed that the tighter regulatory environment of the past few years might make accounting fraud less attractive to potential wrongdoers, thereby bringing the number of securities lawsuits tumbling down. But there's no relief from that quarter on the horizon, says Daniel V. Dooley, New York City-based partner in PricewaterhouseCoopers LLP and leader of the firm's securities litigation consulting practice. "Over the last 10 years there have been approximately 190 private securities class actions per year," he reports. "It looks like it'll be the same this year. Through the second quarter of the year, we're still on the same average.

"From the Private Securities Litigation Reform Act in 1995 through Sarbanes-Oxley in 2002 to the present, [legislation] hasn't really made a dent on the number of SEC investigations or private securities litigation," adds Dooley. "Even though criminal and civil penalties have increased, we still have the same number of cases. There's always the same number of fraudsters out there -- people who are willing to game the system, even though they know they'll go to jail for a long time if they get caught."

"In the future, Sarbanes-Oxley may work to deter financial frauds," notes a PwC report released in the first quarter of this year, "but this likely will take time and many more criminal prosecutions, regulatory enforcement actions and private securities litigation in order to be accomplished."

At the same time, damages claimed by plaintiffs in securities actions are trending upwards, driving average settlements higher, according to Cornerstone Research, a Washington D.C.- based organization that provides financial and economic analysis in civil litigation and regulatory proceedings. The total value of securities settlements hit $5.5 billion in 2004, sharply up from $2.1 billion in 2003, and topping the $4.5 billion in settlements approved in 2000, the previous record-setting year. The firm expects the upward trend to continue. "Based on the trends we observed last year as well as what we've seen so far for the year to date, I expect we're going to see an increase in overall settlement values for 2005," says Laura Simmons, principal with Cornerstone Research.

The PwC data confirms that settlements are on the rise. The median settlement value in securities class actions rose from $5.6 million in 2003 to $7 million in 2004.

Of securities cases filed in 2004, 59 percent contained one or more allegations of accounting irregularities, according to the report. The median settlement value in those lawsuits was $8 million, up from $6.9 million in 2003.