There are over 200 securities fraud class actions filed each year in the United States (excluding mergers & acquisition cases). When a new securities class action is filed and announced, shareholders who are part of the class have 60-days to file paperwork with the court seeking a leadership role in the litigation. During the 60-day period, numerous law firms from around the country may file their own cases against the same publicly traded company, and at the end of the period when petitions for lead appointment are due, numerous law firms may petition on behalf of shareholders with varying degrees of financial loss.
According to the Private Securities Litigation Reform Act of 1995 (“PSLRA”), the most adequate plaintiff to serve as lead plaintiff is the “person or group of persons” that, in part, “has the largest financial interest in the relief sought by the class.” In other words, the main factor for selection of lead plaintiff is how much money the shareholder has lost on his stock investment during the time of the alleged fraud. It is for this reason why disclosure of losses is critical when petitioning for lead plaintiff.
While the PSLRA requires petitioning shareholders to file a certification containing specific stock transaction detail, it provides no required method for calculating financial loss. Two competing methodologies are commonly used in lead plaintiff petitions as the principle loss calculation methodologies:
- THE FIFO METHOD (First-In / First-Out)
- THE LIFO METHOD (Last-In / First-Out)
Below is a hypothetical demonstrating how use of the two methods can lead to drastically different results in loss calculations.
THE FIFO METHOD
Assume Shareholder A holds 20,000 shares of ABC Corp. at the beginning of the Class Period. During the Class Period, Shareholder A buys and sells as follows:
Sale of 20,000 shares at $50/share, with total proceeds of $1,000,000.
Purchase of 20,000 shares at $45/share, for a total cost of $900,000.
In calculating losses under the FIFO method, Shareholder A’s sale of 20,000 shares of ABC stock during the Class Period will be offset or matched against its pre-Class Period holdings, and, in effect, these sales will be “zeroed out”. Next, assuming that the post-Class Period 90-day average price of a share of ABC Corp. stock is $35, Shareholder A’s loss would be $200,000, calculated as follows:
Purchase Price ($45) minus the 90-day average price ($35) multiplied by the number of share purchased (20,000) = $200,000 LOSS.
THE LIFO METHOD
In the LIFO methodology, sales within the Class Period would not be offset against pre-Class Period holdings (like in the FIFO example where the sales were “zeroed out”). Instead, Shareholder A would match the last purchase it made during the Class Period with the first sale it made during the Class Period. Using the same facts we used above in the FIFO example, the calculation therefore under the LIFO approach would be as follows:
Sale proceeds ($1,000,000) minus the cost of shares purchased ($900,000) = $100,000 GAIN.
As can be seen in the above hypothetical, utilizing different methodologies will result in different loss calculations, but the LIFO methodology seems to be a more accurate approach in determining losses.
The Supreme Court of the United States has not weighed in on the appropriate methodology; however, the Ninth Circuit, for example, has stated that a court may select accounting methods that are rational and consistently applied. See In re Cavanaugh, 306 F.3d 726, 730 n.4 (9th Cir. 2002). Unfortunately, both the FIFO and LIFO methods have historically been rationally and consistently applied.
Nevertheless, the recent trend in determining the largest financial interest at the lead plaintiff stage is to use the LIFO methodology. “The overwhelming majority position and the trend among courts is in favor of LIFO over FIFO for purposes of this lead plaintiff analysis. See, e.g., Mariconda v. Farmland Partners Inc. (D. Colo. Dec 3. 2018). As the Court in Cha v. Kinross Gold Corp. (S.D.N.Y. May 31, 2012) pointed out, some courts have used FIFO only reluctantly because of a lack of data with which to perform a LIFO analysis. Further, in In re Veeco Instruments, Inc. (S.D.N.Y. 2005), the court used FIFO at the lead plaintiff stage; however, ten years later, the same Judge (Judge McMahon) chose LIFO over FIFO, noting the advantage of using LIFO over FIFO and the fact that most courts use LIFO at this stage. See Khunt v. Alibaba Group Holdings Ltd (S.D.N.Y. 2015).
The primary reason for using the LIFO method is that LIFO is thought to be more accurate in determining a class member’s actual loss resulting from the alleged nondisclosures because “FIFO has the potential to exaggerate losses, by failing to take into account gains that an investor might have made on the stock that were attributable to its artificial inflation as a result of the alleged fraud; LIFO, on the other hand, takes into account such gains.” See Cha v. Kinross Gold Corp. (S.D.N.Y. May 31, 2012).
Nevertheless, in today’s practice, when making loss disclosures in lead plaintiff petitions, it is not uncommon for both calculations to be disclosed, and depending upon the losses and trade details of other petitioning shareholders, the court will evaluate the damage calculations and methodologies used on a case by case basis, determining which methodology is most appropriate to the facts at hand.
Once the court determines the most adequate plaintiff with the largest financial interest in the relief sought by the class, the lead plaintiff or plaintiffs will be chosen, and the various cases filed will be consolidated.