IPO Litigation Risks
This morning I read an interesting article on IPO litigation risks, from Kevin LaCroix who has a daily D&O newsletter called the D&O Diary – I know, I can hear the chuckling in the back of the room already making fun of my morning reading habits, but there’s often great information here.
In today’s article, Kevin publishes a guest post from Stanford Law School and the Stanford Securities Litigation Analytics on the topic of IPO Litigation Risks. That post can be found in its entirety here: https://www.dandodiary.com/2021/06/articles/securities-litigation/guest-post-ipo-litigation-risk/
It was an interesting deep and analytic dive into IPO and securities class action litigation that I’ll try and summarize here.
In a nutshell, the authors have demonstrated that there has been an increase in litigation targeting IPOs. This is probably not a surprise for the variety of professionals that revolve around the IPO marketplace or those firms planning on going public.
It also bears out the current market conditions and pricing for D&O insurance for those firms which are planning an IPO or who have recently gone public. One of our underwriters described the current market conditions for small public or almost public firms as the wild, wild West. Shrinking capacity for coverage and dramatic premium increases is making it a very challenging marketplace for sure.
Back to the study by Stanford.
The approach undertaken by Stanford was “to establish a direct link between an IPO and a securities class action.” The analysis differed from other studies which simply counted the number of IPOs and IPO-related lawsuits because there is generally a lag between the initial filing year and litigation since there is a three-year statute of limitations. The study also removed the distortion caused by parallel federal and state cases based on the same IPO and counted that incident as one case and not two.
The Stanford study attempted to provide evidence that was analytic and free from distortions.
“From 2010 to 2019, 14% of IPOs became the target of litigation.”
Between the years 2010 and 2016, the average ratio of litigation to IPO filings bounced between 10% and about 16%. Then in 2017, that average moved to 18%, and they projected that the ratio continued to increase in 2018 and 2019 reaching 21%. The study needed to project their findings in 2018 and 2019 because the full three-year statute on filing securities claims had not expired so a trend was applied. Again, the study anticipates that 21% of IPOs filed in 2019 will see litigation.
The Study then looked only at companies whose share price fell 20% or more within three years following their IPO for the 2010 to 2017 time frame since the 2018 and 2019 IPOs have not matured to that three-year time frame.
What this analysis yielded was that of those IPOs with a 20% stock price drop there was a dramatic increase in litigation since 2013. The percentage of firms facing litigation was about 14% in 2013 and by 2017 that figure rose to 22%
Here’s the summary of their findings.
There has been a statistical increase in litigation risks associated with IPOs.
“The incident of litigation for firms going public is substantially greater than the incident of Section 10(b) litigation for more mature companies. Case outcomes are less favorable for defendants in IPO cases than in Section 10(b) cases as well. IPO cases settle more often and are dismissed less often than Section 10(b) cases and controlling for company size, they typically settle for larger amounts and larger percentages of plaintiff’s estimated damages. In sum, the litigation landscape for companies going public is more treacherous than it is for mature companies, and that situation appears to have gotten worse over the past several years.”
Here’s the bottom line.
If you’re moving towards going public, you need to speak with your insurance broker sooner rather than later. There are two forces at play that are important to understand. The risks of D&O-related IPO lawsuits are increasing in both the incident rate and the settlement costs. On top of that, we’re in the middle of a very hard D&O insurance market. Premiums are increasing monthly and coverage is somewhat scarce.
This means two things:
First, you need to anticipate proper coverage levels to protect your firm’s decision-makers pre and post-IPO, and
Second, you should be building the costs of that protection into your budgets, and not be taken by surprise.
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