Of The “Liars’ Discount” — And The Settlement Value, In Merck’s Cain v. Hassan Case


About three years ago, the expert whose opinions accompany the proposed Cain v. Hassan, et al. settlement co-authored a very highly regarded law review article. The article, as it happens, was all about assessing whether the merits matter, in securities class action settlements.

The view that they do not lead in large part to the PSLRA (a retrenching of civil securities class action rules), which made bringing such cases more difficult. In the invervening years, that view has been essentially discredited by some pretty persuasive empirical evidence, and Sarbanes-Oxley, and more recently, Dodd-Frank represent (in part) the “returning swing” of the legislative pendulum.

Back to the central part of our narrative, though now. The expert, in his 2009-era law review article, speaks of the rough algorithm used (by both plaintiffs’ lawyers, and D&O insurance claims staff) to assess the probable range of settlement values, in any given securities case.

Strictly speaking, this analysis applies more to the monetary damages cases that remain pending against New Merck, as the continuing party from the Merck/Schering-Plough merger. Remember here that Cain v. Hassan is more of a governance reform, not damages, case. So this bit of analysis will be most useful in assessing the fairness of the presumably coming settlements of Manson v. Schering-Plough, and the like.

Just the same, the expert estimates that the ENHANCE-delay loss — to New Merck/legacy Schering-Plough shareholders, in a “plaintiffs’ style” calculation — was about $7.5 billion (an NYSE market-price-drop calculation, times the outstanding shares).

He tells us — quite reliably, in my experience — that the D&O insurers then take this market-drop number, and determine that only 2 percent to 6 percent of that is directly attributable to the (alleged) “lying” of senior management.

Said another way, the insurers expect that there is only an around 5 percent chance that the $7.5 billion would be awarded by a jury. The expert, in his law review article, quotes an insurer (anonymously, for obvious reasons), thus — particularly apt, as it refers to another pharma securities fraud case:

. . . .Pfizer has — I’m talking off the top of my head — 3 billion shares outstanding, and the stock went down 10 bucks. That’s $30 billion of damages. 5% of that is $1.5 billion. Settlement.

And you go to a judge and say, “The damages are $30 billion. We are proposing a settlement that is 5%. How can you say that is unreasonable?” And we say, “It’s unreasonable because it doesn’t reflect the liability,” and they say, “Sure it does. It’s 5% of the total, but it could happen. So it is 5-to-95 chance to win. Yes, it’s a perfect discount. . . .”

And so sometimes the numbers will in and of themselves take over, and I have that on a number of the pharmaceutical companies or large, large, jumbo-cap companies. I have it with General Motors, General Electric. The stock ticks down $2, which isn’t enormous. It’s not a free fall[. It’s] based on some news that might be innocuous, and it’s enough because that creates a damage pool that is into the billions which immediately gets the plaintiffs’ lawyers out because there [are] damages, and the case has value irrespective of the merits. . . .

If you look at the numbers, the settlement compared to the damages, you are talking anywhere from 2% to 6% of [plaintiffs’-style damages]. . . .

So, applying this to the ENHANCE facts, at legacy Schering-Plough/New Merck, we multiply $7.5 billion times 2 percent to get $150 million. If it is 6 percent, we’d yield a settlement value of $450 million. So something between $200 million, and $500 million, is the likely rough value of the cases still pending, for damages — according to the parties’ own jointly selected settlement defense expert. And that’s before approaching the involved lead underwriters, in the Schering-Plough convertible securities offerings, back in August of 2007 (some $4 billion worth, in the aggregate).

Are you paying attention, here, Fred Hassan? This is what poor management and lax oversight costs a company, and its owners.

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