Number of Accounting Class Actions Steady Over Last Two Years

There was not much change in the number of accounting-related securities class-action lawsuits that were filed in 2013 over the previous year, but analysts recently found that accounting case settlements in which an auditor was named as a defendant reached a three-year high last year.

There were 47 accounting class actions filed against companies in 2013, up slightly from the 46 filed in 2012, according to a new report from economic and financial consulting firm Cornerstone Research. Still, those numbers are significantly lower than the yearly average of 72 accounting case filings over the last decade.

Of those 47 accounting cases in 2013, 44 resulted in settlements, compared to 38 settlements in 2012. Again, the number of settlements the past two years is lower than the 10-year average of nearly 58.

Cornerstone Research believes the low number of settlements since 2012 is due to a lack of new types of securities class actions, such as those involving Chinese reverse mergers.

According to Charles Lee, PhD, Joseph McDonald professor of accounting at the Stanford Graduate School of Business, many Chinese companies enter US capital markets through reverse mergers, in which a closely held firm buys a US shell company already public on an exchange, allowing them to list shares without the scrutiny of a public offering.

“While there were very few new Chinese reverse merger cases filed in 2013, over 30 percent of accounting case settlements were Chinese reverse merger cases,” Laura Simmons, PhD, a senior advisor at Cornerstone Research, said in a written statement. “The presence of these cases, which tend to involve smaller firms and lower shareholder losses, contributed to a drop in the total value of accounting case settlements. Chinese reverse merger cases are also different in that they more frequently name auditors as defendants.”

According to the report, six out of the 14 Chinese reverse merger settlements in 2013 involved auditors who were named as defendants. In addition, auditors were defendants in 12 out of the 44 accounting cases that settled in 2013, up from eight of the 38 cases settled in 2012 and four of the 33 cases settled in 2011.

Cornerstone Research also noted that a renewed emphasis by the US Securities and Exchange Commission (SEC) to crack down on accounting fraud could boost the number of accounting class-action cases in the future.

“It is conceivable that the SEC’s current focus could provide an opportunity for plaintiff counsel to make accounting-related cases a future wave in securities class actions,” Elaine Harwood, PhD, vice president of Cornerstone Research and head of the firm’s accounting practice, said in a written statement.

During a House Financial Services Committee hearing on Tuesday, SEC Chair Mary Jo White told lawmakers that the agency’s Enforcement Division continues to focus on identifying securities law violations relating to the preparation of financial statements, issuer reporting and disclosure, and audit failures.

“Last fall, the staff formed the Financial Reporting and Audit Task Force, which is working to identify areas susceptible to fraudulent financial reporting through an on-going review of financial statement restatements and revisions, analysis of performance trends by industry, and the use of technology-based tools,” White said during the hearing. “As a result of the work of the task force, a number of new investigations and inquiries are underway, including matters focused on both traditional and emerging financial fraud issues.”

She also noted that the Enforcement Division recently launched a risk-based initiative, called “Operation Broken Gate,” that identifies auditors who may have violated federal securities laws or failed to comply with US auditing standards during their audits and reviews of public company financial statements.

“Thus far, Operation Broken Gate’s efforts have led to actions against five auditors and their affiliated firms, resulting in suspensions from the ability to audit public companies,” White said.

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