Effects of litigation on investment returns: what were the effects on the stock prices of, first, the announcement of an investigation and, second, the announcement of a settlement?

Publication: Bank Accounting & Finance

Publication Date: 01-JUN-06

Bookmark this article Print this article Link to this article Email this article Digg It! Add to del.icio.us RSS

COPYRIGHT 2006 Institutional Investor, Inc.

In 2002, the New York State's Attorney General charged the world's 10 largest brokerage houses using the state s tough antifraud law, the Martin Act. New York State alleged the 10 brokerage houses for deceptively touting the quality of the firms in analyst reports in exchange for lucrative underwriting or investment-banking businesses.

On December 20, 2002, the state and the investment banks reached a settlement that amounted to $1.435 billion. The settlement payments were in three different categories: retrospective relief, independent research and investor education. Exhibit 1 shows settlement categories and amounts for the 10 banks.

In additional to these financial settlements, the investment banks agreed to make other changes, which are outside the scope of this article.

Hypotheses

In an efficient financial market, relevant information affects firms' stock price and, hence, return almost instantaneously. Positive relevant information incurs positive returns via price appreciation, whereas negative relevant information incurs negative returns via price decline.

In the extant finance literature, the reaction to the relevant news or information has been studied at two chronological points of interest, namely, the announcement day and the event day. In a seasoned equity issue, for example, the majority of the empirical findings seem to concur that statistically significant negative returns are realized on the announcement day, but no statistically significant returns manifest on the offer, or event day, itself.

In this article, I examine the returns of the world's 10 largest investment banks in conjunction with the litigation under the Martin Act. I examine two chronological windows, one centered on the announcement day of the litigation (April 9, 2002, afterwards called the "announcement day"), and another on the announcement day of the settlement (December 23, 2002, afterwards...

Read the full article for free courtesy of your local library.