One of the most interesting findings in my study of the SEC's fair fund distributions is the surprisingly limited overlap between fair fund distributions and class action settlements. Class actions overwhelmingly compensate investors for accounting fraud (more than 60% of settlements and 90% of settlement dollars). By contrast, a large majority of fair fund distributions by number and by amount compensate investors for misconduct that can best be described as consumer fraud or anticompetitive behavior by financial intermediaries. For example, fair funds have compensated investors for interest rate fixing, undisclosed fees and false advertising, collusive arrangements between broker-dealers and investment advisors, bribing brokers for selling overpriced investment products to municipalities, market timing and late trading, and cherry picking.
Class actions are filed in 65.4% of cases in which the SEC established a fair fund, and settle for non-zero monetary damages in 45.6% of cases (104 of 228). Fair funds without parallel private lawsuits are smaller on average than those with parallel litigation: the mean fair fund without a parallel lawsuit distributed $11.1 million ($2.5 million median), compared with a mean of $60.7 million for all fair funds ($17.0 million median). These fair funds tend to be smaller, predominantly against individual defendants, sanctioning insider trading, market manipulation, and certain broker-dealer and investment advisor violations (e.g., failure to supervise). The common element in these cases is that it is not cost-effective for private litigants to bring a lawsuit.
By contrast, 149 fair fund distributions were accompanied by a parallel class action. Of those, 104 settled for non-zero monetary damages, 31 were dismissed, and the remainder settled for non-monetary relief or are still ongoing.
In cases where investors receive compensation from both, a fair fund and a class action, the average share of total compensation that comes from the fair fund is 41.1% (median 33.4%). (In all other fair fund cases, investors receive all of their compensation from the fair fund.) But the aggregate numbers conceal real diversity in the underlying cases. A parallel class action was filed in 68 of 69 accounting fraud fair funds, and, of those, 59 settled for the aggregate $35.4 billion, while 6 were dismissed and the rest are still ongoing. In comparison, all accounting fraud fair funds combined distributed $6.3 billion.
By contrast, parallel private litigation is less likely to be filed and to prevail in all other categories of securities violations: 79 of 157 such fair funds were accompanied by private litigation and only 45 yielded monetary damages. For example, 2 of 15 insider trading fair funds were accompanied by private litigation, and both class actions were dismissed; 7 of 19 securities offering cases were accompanied by private litigation and 4 prevailed, settling for the aggregate $416 million (whereas fair funds in securities offering cases distributed $1.45 billion).
As the table illustrates, when it comes to enforcement and compensation, there are really two types of securities violations: accounting fraud and everything else. The SEC's contribution to investor compensation is small in accounting fraud cases, 15.5% of aggregate recoveries. By contrast, in all other cases, private litigation fails as a means of compensation. Small potential damages reduce the economic incentive to file a class action for these securities violations. More importantly, filed class actions that do not allege accounting fraud are much more likely to be dismissed, even though the allegations of misconduct are no less serious (as the SEC's enforcement actions indicate). As a result, the SEC's enforcement is now the dominant source of deterrence as well as compensation for securities violations, except for issuer reporting and disclosure violations.
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