The Screening Effect of the Private Securities Litigation Reform Act

Journal of Empirical Legal Studies,Vol. 6, No. 1 (2009): 35-68

U of Michigan Law & Economics, Olin Working Paper No. 07-008

44 Pages Posted: 26 Mar 2007 Last revised: 23 Jul 2013

Stephen J. Choi

New York University School of Law

Karen K. Nelson

Texas Christian University - Department of Accounting

Adam C. Pritchard

University of Michigan Law School

Date Written: February 1, 2007

Abstract

Prior research shows that the PSLRA increased the significance of merit-related factors, such as the presence of an accounting restatement or insider selling, in determining the incidence and outcomes of securities fraud class actions. (Johnson, Nelson, and Pritchard, 2007). This result, however, is consistent with two possible hypotheses. First, the PSLRA may have reduced solely the incidence of non-meritorious litigation. Second, the PSLRA may have changed the definition of merit, effectively precluding claims that would have survived and produced a settlement pre-PSLRA. This paper tests these alternative hypotheses. We find that pre-PSLRA claims that settled for nuisance value would be less likely to be filed under the PSLRA regime. We also find, however, that pre-PSLRA non-nuisance claims would be less likely to be filed post-PSLRA period. The latter result, which we refer to as the screening effect, is particularly pronounced for claims lacking obvious hard evidence indicia of fraud (an accounting restatement or an SEC investigation). This screening effect is stronger if the claims also lacked evidence of abnormal insider trading. By contrast, we find that pre-PSLRA claims with hard evidence or abnormal insider trading would be no less likely to be filed in the post-PSLRA period. We also examine the likelihood of settlement for pre-PSRLA claims if they had been filed in the post-PSLRA period, and find a similar screening effect for case outcomes. We conclude that Congress effectively changed the definition of merit in adopting the PSLRA, discouraging suits that would have produced a non-nuisance outcome prior to the law's enactment.

Keywords: Stockholder litigation, accounting restatements, earnings forecasts, insider trading

JEL Classification: K41, M49

Suggested Citation

Choi, Stephen J. and Nelson, Karen K. and Pritchard, Adam C., The Screening Effect of the Private Securities Litigation Reform Act (February 1, 2007). Journal of Empirical Legal Studies,Vol. 6, No. 1 (2009): 35-68; U of Michigan Law & Economics, Olin Working Paper No. 07-008. Available at SSRN: https://ssrn.com/abstract=975301 or http://dx.doi.org/10.2139/ssrn.975301

Stephen J. Choi (Contact Author)

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States

Karen K. Nelson

Texas Christian University - Department of Accounting ( email )

M.J. Neeley School of Business
TCU Box 298530
Fort Worth, TX 76129
United States
817-257-7567 (Phone)

Adam C. Pritchard

University of Michigan Law School ( email )

625 South State Street
Ann Arbor, MI 48109-1215
United States
734-647-4048 (Phone)
734-647-7349 (Fax)

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