When a Legal Win is a Wall Street Loss

There is an old gypsy curse that i frequently remind clients about: “May you be in a lawsuit, and may you be right.” You can have absolutely no liability and ultimately achieve vindication, but often only after a legal battle that proves costly not only in terms of attorneys fees, but in terms of lost management time, damage to the company’s reputation, effect on stock price, and the potential for “coattail” lawsuits.

Consider, for example, Mannatech, Inc., a Coppell-based seller of supplements and other nutritional products with more than 500,000 sales associates. On July 5, 2007, Texas Attorney General Greg Abbott filed a lawsuit against Mannatech, accusing the company of deceptive practices and exaggerating the therapeutic benefits of its dietary supplements and wellness products. Within one day of the lawsuit’s filing, Mannatech’s stock plummeted more than 23 percent. Even after adopting new sales and marketing guidelines in an effort to quell the claims of deceptive practices, the damage was done. Mannatech announced an 82 percent drop in quarterly earnings, reporting a net income of 6 cents a share ($1.5 million), down from 31 cents a share ($8.6 million) for the same period the previous year. While former CEO Samuel Caster (he resigned August 21) identified a number of factors that contributed to increased operating expenses, the legal costs and overall impact of the attorney general’s lawsuit were at the forefront.

The list of companies that have found themselves in the unenviable position of seeing their stock price driven down by news of a lawsuit is long indeed. A 2007 study by the Pacific Research Institute’s Dr. Lawrence McQuillan estimated that the cost of litigation to shareholders every year amounts to a staggering $684 billion based on the number of tort lawsuits that are filed against publicly traded companies—177,166 to be exact—and a median loss in market value per company of $3.86 million.

Among the economists’ studies that McQuillan analyzed were several that examined the fall of stock prices just on the date that a lawsuit was announced. Two of these studies (one of which focused on product-liability cases, the other devoted to employment-discrimination lawsuits) calculated that a company’s stock prices fell 2.12 percent and 2.43 percent, respectively—as soon as the filing of the lawsuit was announced.

For companies that settle in for the long haul of defending themselves, the results are mixed. In 2005, pharmaceutical powerhouse Merck reacted to a study indicating that its FDA-approved pain reliever, Vioxx, could cause increased risk of a heart attack by taking the drug off the market. That succeeded in chumming the waters for plaintiffs’ lawyers, who began to file lawsuits nationwide. By mid-2007, Merck was facing 27,250 personal-injury lawsuits over Vioxx. The drug company decided early on a strategy of taking every lawsuit to court. And despite an early $250 million plaintiff’s verdict (in a damages award overturned on appeal), Merck has been winning the battles—at last count, 10 trial victories in the company’s favor compared to four plaintiff’s verdicts. The company even scored a major victory in Texas in late April 2007 when more than 1,000 pending lawsuits in the state were put on hold by a judge’s ruling that plaintiffs couldn’t assert claims of inadequate warnings against Merck (an appellate court is now considering whether Texas law does indeed prohibit such claims). Overall, as of the end of 2006, the suits of more than 4,000 Vioxx users nationwide had been dismissed for various reasons.

So Merck has won many battles, but will it lose the war? The pharmaceutical company, which once generated $2.5 billion annually in sales of Vioxx, has had billions of dollars in shareholder value wiped away—money that could have been used for research and development for other drugs. Merck’s annual report confesses that its insurance coverage is most likely inadequate to cover the potential exposure from the tidal wave of litigation. By the end of 2006, the company was dug in for the legal equivalent of trench warfare, having allocated $958 million in litigation reserves. While Merck’s stock has staged periodic rallies, Wall Street analysts estimate the ultimate cost to Merck to be in the billions of dollars. Even if Merck ultimately prevails, it is likely to be a Pyrrhic victory as the media focus and bitter, costly litigation will have taken their toll.

Taser International, Inc., the leading maker of stun guns, can certainly offer advice to companies on the price of victory. Taser is currently fighting a lawsuit filed in May 2007 in Fort Worth, brought by two mental health workers at John Peter Smith Hospital who claim to have been injured when a police officer using a Taser shocked a mentally ill patient they were holding down. The claimants maintain that they were shocked when the Taser’s electricity went through the patient with such force that they were injured, resulting in seizures, pain, and memory loss. Taser says the stun gun doesn’t work that way; while acknowledging that “Taser technology is not risk-free,” the Scottsdale, Ariz.-based company points out that the electricity goes from barb to barb and doesn’t run through a person’s entire body. Training videos provided by the company depict two people holding a subject, without any signs of being shocked.

Taser is no stranger to the courtroom. As of May 2007, the company has won all 45 of the product-liability lawsuits it has tried.  Doug Klint, Taser’s vice president and general counsel, said after the stun gun manufacturer’s most recent victory, “Our strategy of fighting this litigation with an aggressive defense continues to get results.” Of course, victory comes with a hefty price tag for the company that was founded in 1993 and went public in 2001. Putting aside legal costs, reports of safety concerns have jolted Taser like one of its own 50,000-volt barbed darts. From a high of over $33 per share in late 2004, Taser’s stock plummeted to under $6 a share by October 2005. Even after its most recent courtroom victory in May 2007, the company’s shares were hovering around $9.54 per share.

During that timeframe, Taser had to contend not just with product-liability lawsuits but with negative publicity from all directions on its purportedly non-lethal weapons. Amnesty International has claimed that more than 150 people have died since June 2001 after being shot with a Taser, and the Arizona Republic found 84 cases of death after a Taser strike, including 11 in which medical examiners either attributed the cause of death to a Taser or could not rule it out.

Locally, three people have died after being shocked by Fort Worth police, while one person in Dallas has died following a police Taser incident. In the Fort Worth cases, they were classified as accidents brought on by the suspects’ drug use and poor physical health, while the Dallas incident was attributed to both cocaine-induced delirium and the shock itself. After USA Today published an article in June 2005 that Taser claimed “sensationalized” and overstated the electrical output of its stun guns, the manufacturer sued for libel and business disparagement. Taser has even sued coroners who included the stun gun shock as a possible cause of death.

While such a “scorched earth” approach to defending its product may yet help turn the tide—Taser has boosted profits in each of the last four quarters—its stock remains flat and a far cry from its 2004 peak. 

What steps can a company take to reduce the toll that real or threatened litigation can exert? You don’t have to settle a false claim simply to end the bad press, but you should know how to fight fire with fire. The field of “litigation communications” is booming, as both the plaintiff’s and defense bars embrace the need for case-specific media plans.

One important caveat: Work with your counsel to determine what is and what is not discoverable, so that such communications with public relations professionals remain protected from disclosure. Few things will anger jurors quicker, or tarnish a company’s credibility faster, than ill-timed revelations about plans for damage control or polishing the corporate image in the wake of a lawsuit’s allegations. Identify compelling spokespeople from within your organization, so that you can put a human face on the corporation. In addition, be prepared to brief the media before, during, and after a trial to ensure that reporters’ coverage won’t be one-sided. All too often, the pat answer of “no comment” forfeits an opportunity to be heard and equates to having something to hide.

And even companies with nothing to hide have plenty to be worried about.

John G. Browning is a partner in the Dallas law firm of Browning & Fleishman, PC, where his practice is devoted to civil litigation. He is also the published author of one book, a contributor to two others, and an award-winning legal journalist whose work has appeared in publications throughout Texas and the United States.