Shareholders are increasingly using the mishaps of companies to argue for securities fraud.
The term ‘securities fraud,’ also called ‘stock fraud’ or just ‘fraud,’ encompasses many different activities.
According to the FBI, securities fraud usually entails deceiving investors of publicly traded companies to manipulate financial markets.
Chipotle Mexican Grill’s tainted burritos and BP’s oil-well accident in the Gulf of Mexico did not constitute securities fraud, as some would argue. Securities fraud stops companies from lying to shareholders about serious financial risks.
How Often do Shareholders Sue for Securities Fraud?
Last year, shareholders brought lawsuits against nearly 9% of U.S. public companies.
This percentage is three times higher than the yearly averages from 1996 to 2016.
Over 25% of the lawsuits were events-driven lawsuits, relatively rare before 2017.
Securities fraud lawsuits based on events are on the rise.
Events-driven security fraud lawsuits assert that calamities were known risks that the company should have disclosed.
In the case of Chipotle Mexican Grill, shareholders sued to argue that the tainted meat was a known risk that Chipotle should have shared with the shareholder.
Events-driven claims differ from traditional securities fraud cases, which usually involve allegations of fraudulent accounting in an attempt to mislead shareholders.
Financially-based securities lawsuits have dropped in prevalence for more than a dozen years in a row.
How Effective are Events-Based Security Fraud Lawsuits?
A U.S. Supreme Court ruling made in 2011 opened the door for more shareholders to file events-based security fraud.
The court ruled that the drug maker Matrixx Initiatives should have warned investors about people who claimed to lose their sense of smell after using the company’s nose spray.
The number of people who claimed to have lost their sense of smell was statistically insignificant.
This case set a precedent for shareholders to sue for securities fraud for events about which the company should have warned them.
About 60% of events-based cases are dismissed.
In March 2019, a Colorado federal judge dismissed a shareholder’s lawsuit against Chipotle.
Shareholders argued that Chipotle should have told them about diseased food outbreaks that happened in Virginia.
Similarly, a federal judge in New York dismissed a securities fraud case against Tempur Sealy, a mattress company.
Shareholders argued that the company should have disclosed that Mattress Firm, one of its retailers, might terminate its contract with Tempur Sealy.
The judge who dismissed the case wrote that Tempur Sealy did not commit securities fraud because it could not prove that the company knew about the contract.
Should Companies File Events-Based Securities Fraud Claims?
Some argue that shareholder lawsuits should occur when companies lie to shareholders about foreseeable risks.
Others note that there are better ways to punish companies for the horrific consequences of their negligence.
Personal injury lawsuits, criminal charges, and other laws may be better tools to punish businesses for their negligent conduct.
Frivolous events-based securities fraud lawsuits cost the company and shareholders money.
When judges dismiss these cases, only the lawyers win.
