Bondholders Playing Larger Role in Securities Class Actions According to Study

Class actions brought on behalf of bondholders of public companies are playing a larger role in the overall landscape of securities class actions, an article recently published in the Minnesota Law Review says. Bondholders, often considered an afterthought in the securities fraud context due to claims by equity holders predominating, have been generating more recoveries, warranting a reconsideration of the prospects of bondholder claims in public company securities fraud cases.

The article titled “Bondholders and Securities Class Action” by James J. Park, a professor at UCLA Law School, reports that class action recoveries by bondholders, as a percentage of all securities class actions, more than doubled from 2001-2005 over 1996-2000. From 1996-2000, there were only 16 bondholder recoveries comprising 3% of all securities class action settlements. However, in the five-year period of 2001-2005, there were 48 bondholder recoveries comprising 7.9% of all securities class action settlements.

Bonds, unlike equities, do not function like a claim on the overall earning power of the corporation and, as a result, do not suffer from as dramatic of price swings when securities fraud is discovered. Bonds largely trade on the creditworthiness of the corporation and on their yield versus other assets in the marketplace. Nonetheless, this article identifies a broad swathe of situations in which bondholders would likely have claims for damages, primarily when the misrepresentations pertain to the creditworthiness of the corporation:

“A bond investor who purchases the bond on the assumption that the company had a certain credit risk will see the value of the investment decline. The bondholders would have to discount the price of the bond to sell it to another investor. In some cases, a company may find that its credibility is so damaged that it cannot access capital markets.”

Park also argues that bondholder claims are uniquely facilitated by the strict liability of Section 11 of the Securities Exchange Act of 1933. Section 11 liability pertains to material misrepresentations in a registration statement. To have standing under Section 11, a plaintiff must trace the purchase of the security to the registration statement at issue. This is typically easy for investors in a primary offering, but not so easy for holders of common stock purchased in the secondary market where several issuances of common stock under different registration statements may have been commingled over the years. It is easier for bondholders to meet this tracing requirement since all bonds generally bear a CUSIP identification number that can help relate them back to the primary offering and the relevant registration statement.

The article also suggests that bondholders may not be adequately represented in most class action settings, resulting in disproportionately favorable recoveries for equity holders. The article recommends greater scrutiny on whether separate classes should be certified for bondholders with their own counsel to improve the size of bondholder recoveries.

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