Class Inaction
9 October 2009, 12:50 pmInertia over the UK’s class action laws leaves pension funds with significant obstacles to gaining compensation
Fears of another major investment bank default have been receding for the last few months, but the activity for investors of all hues to disentangle themselves from some
of the beleaguered remaining institutions has increased. In the post mortem of the market crash and government bailouts, more investors are seeing yesterday’s losses as tomorrow’s potential compensation, and the emerging global phenomenon of class actions – a single lawsuit made by multiple claimants against the same entity – has seized headlines.
A class action, otherwise known as ‘representative action’, is a lawsuit in which a large group of investors or consumers collectively bring a claim to a court based on common injury over a certain time period. In the US, one of the world leaders for this type of litigation, class actions are overseen by the Federal Rules of Civil Procedure Rule 23 and 28. A suit is typically filed with a named ‘lead plaintiff ’ or multiple plaintiffs, to represent a ‘class’.
There are two types of action, explains Stephen Everard, managing partner at GOAL group, a class action specialist law firm. “You can do a class action where you go to court, as with the US system, and the judge decides there’s a case to answer. Then it would follow the usual pattern of the forensic accountants to work out the losses suffered by investors – to see if the company had made full disclosure, where the share price would have been versus where it was, using peer index, daily inflation tables, a whole raft of factors.” Sufficient damages and losses incurred from the first day the company should have disclosed through its did finally get round to disclosing would then be calculated.
“The alternative is that a group of shareholders get together, normally brought together by one of the specialist law firms, and form a foundation and take a direct action.”
Everard explains that a foundation approach benefits the defendant in the sense that the company can agree and negotiate on a settlement. “If it goes to court, that number is largely out of their hands.”
GOAL Group conducts detailed research to identify where a company’ share price might have been artificially raised on the back of fraud of lack of full company disclosure, as compared to an index of its peer group. On page 14, a chart displays the case of Enron, the energy group accused of fraud in 2001 due to years of mismanaged accounting and insider trading.
As with defaulting banks, specific class action cases have come to represent wider, encapsulating issues. Where Lehman Brothers and its collapse defined the perils
of sub-prime mortgage trading, Enron and the lawsuit against Royal Dutch Shell, the oil group, has summed up the ubiquitous talk of company opacity and responsible
governance.
On 29th May, the Amsterdam Court of Appeals approved issued a binding declaration ordering Royal Dutch Shell to begin payment of USD381 million to a foundation made up of more than 150 institutional investors from 17 European countries, plus Canada and Australia. It includes USD352.6 million in cash paid from Shell and an expected payment to non-US shareholders out of a USD120 million fine Shell paid to the US Securities and Exchange Commission.
The action against Royal Dutch Shell relates to the company’s misrepresentations concerning details of its oil and gas reserves between 1999 and early 2004. All non-US investors who
bought Shell shares during this period technically had a claim against the fi rm. A leaked email from Walter van der Vijver, then head of oil and gas exploration at the firm, to the chairman, bemoaning the need to lie about its reserves, sealed the case for a class action, and a suit was fi led in a US district court.
Two years later, the oil company sought settlement for the non-US investors, and the scene moved to the Netherlands. The foundation structure of the combined claimants – which lawyers say is easier to facilitate out of court settlements – is slightly different to a class action. Dutch law does not allow aggrieved individuals to petition the court for a class-wide settlement.
Nevertheless, it was a situation whereby institutional investors smelled blood from a company and sought recompense.
An increasing number of countries have been amending laws to facilitate class actions, which have been credited with improving the efficiency of cases and reducing legal costs. On 1st June the Securities and Exchange Board of India (Sebi) decided to pledge financial aid to collective lawsuits, leading to expectation of more cases that seek to take advantage.
The regulator has restricted the funds to 25 Sebi investor associations and requires the collective claimants to prove that each case has affected more than 1,000 investors. Further, the Sebi funding will not exceed three-quarters of the total costs of the case.
The decision follows an increased awareness and culture change towards investor compensation, a stark sign of the times from a country that has traditionally disincitivised such lawsuits. Australia, too, has seen an increase in corporate class action, spurred by strong legislation against misleading and deceptive conduct. In the UK, the inability to fi le class actions has produced the unorthodox situation in which UK investors can sue a UK company in a US court. Most recently and pertinently this year, two pension funds – based in Merseyside and North Yorkshire – filed a class action against Royal Bank of Scotland.
Like the Royal Dutch Shell, the funds claimed the bank had withheld information concerning the state of its finances prior to its nationalisation by the UK government in November 2008. Four months previously, the bank had undertaken a rights issue, raising GBP12 billion to shore up its balance sheet, the first of the UK banks during that period to do so, before accepting a GBP20 billion rescue by the government.
Stephen Everard explains that case meets the criteria for a US based case. “You typically need to have a place of business in the US, which the bank has; your shares need to be tradeable in the US too,” he says. Everard adds that if the case is successful it will have ramifications for further lawsuits against British banks, including Lloyds TSB and Northern Rock, two banks part- and fully-owned respectively by the UK government.
“Although we don’t have class action legislation [in the UK] in cases against Lloyds TSB, Northern Rock, you’d be effectively be suing the government. That would be interesting.”
The lawsuit ran parallel with another UK pension fund seeking compensation in the US, when the GBP1 billion Avon Pension Fund was appointed “lead plaintiff” — the institution fronting a group lawsuit on behalf of others, including the North Yorkshire Pension Fund — in a case against GlaxoSmithKline, the drugs giant on grounds of deceit and fraud.
Despite this precedent, Everard and researchers at GOAL Group are also well aware that the UK should not expect a stampede of institutional investors seeking compensation any time soon. A recent report from the firm found that UK local pension authorities lost out on around GBP200 million from unclaimed compensation between 2000 and 2007. The report summarises that the emphasis of class action suits has shifted in the last two years from corporate governance scandals such as Enron – the US energy group whose accounting fraud led to multi-billion dollar settlements since its bankruptcy in 2001 – to losses related to the sub-prime mortgage lending fallout.
Though Everard says there has been an increase in claims overall, organising and filing class actions among UK institutions is still far from automatic. Inertia and a lack of understanding have been two critical reasons.
“There is a huge inertia, even to this day,” he says. “We do quite a lot of work for local government authorities, like West Midlands, and they’ve been very vocal and supportive to say they’ve received over USD500,000 in compensation for their fund. That’s a big fund, around GBP7-plus billion. I try to work with lots of other local authorities and they will recognise yes, we need to do class actions, yes, we know we should be doing more, we think our custodian does it but we’re not sure, or ‘we’ll get round to it’. Some I’ve talked to
for about two years and they haven’t done anything.”
However, class action lawsuits are likely to increase as governments and the exchanges want to be perceived as pursuing good corporate governance: “If something goes wrong, they [investors want to] know there is the wherewithal to recoup losses.”
For the UK, others agree with Everard as to the state of inaction. David Paterson, head of corporate governance at the National Association of Pension Funds, sees little appetite for increased litigation. “It’s not to say they [pension funds] are not concerned about RBS and the others, but the UK structure of governance – where a lot depends on an openness between companies and shareholders – is not a particularly good one to in which to have a litigation backdrop,” he says.
Paterson identifies additional problems to the pursuit of class actions and achieving a worthwhile settlement. Class actions often take a long time to get to court; when they do, the period of time in which the class action is seeking compensation may be a few years in the past. Many things could have happened or changed since then to affect the clarity of the claim.
“In the course of the five years since the fraud, the fund manager might have been changed, perhaps you’ve changed your custodian. There are quite a few things that make it a bit more difficult to launch a claim.”
He adds that pension funds also face a crucial cost-reward decision. “You’ve got to look at the potential value to the fund. We’re talking about small amounts of money sometimes; is it cost effective to pursue the claim?”
Everard echoes this concern, and reveals that only around 12% of the total loss within the class action period is typically recovered. But there are success stories out there, and GOAL Group has helped the West Midlands Pension Fund to recover around USD500,000. The fund, in turn, has been a vocal supporter of the class action process
Pension funds must keep up to speed with the relevant bodies responsible for identifying claims on their behalf. This can be a mixture of the fund’s custodian and external law firms. Bedford Pension Fund, for example, uses Northern Trust and the US-based law firm Barrack, Rodos & Bacine to monitor developments. Geoff Reader, head of pension fund management at the fund, revealed to ISJ that the organisation has 11 outstanding cases seeking cash reimbursement.
“Claims have been just on the back of our holdings,” he says. “So a manager has bought stock X and then that’s gone down in value – then more information comes into the public domain that questions it should have been sold at a different price. That forms the basis of the class action.”
He adds that domestic lawyers would be understandably keen for UK laws to change so they could “get a piece of the pie”. Reader has reservations, however, as to the overall benefits of increased class actions, particularly during more fragile economic circumstances. “There’s only a certain amount of money in the world; if you take money away from companies for class actions – which affects shareholders – then personally, I’m not convinced that ultimately it might not be the best solution for the whole economy. So it may not be the best thing for everybody to be doing.”
Everard at GOAL Group says: “Class actions is becoming a global phenomenon, not just the US. If the UK government doesn’t put it in then people will have to go through direct action through foundation.
If the government doesn’t allow class action legislation, then it doesn’t give the shareholders a lot of choice. There’s only one route to take, so they will try to drive a direct action, a one-to-one or one-to-many arrangement.”
Source: Ben Roberts, Investor Services Journal | Published: 11 August 2009
