A class act?
10 November 2008, 2:07 pmA study by GOAL Group into unreclaimed funds resulting from the settlement of securities class actions in the US
Management Summary
- In the wake of the financial markets crisis, filings for securities class actions are on the rise again in the US
- Average settlement values are around $30 million. But average investor losses (a major factor determining settlement size) in ‘subprime’ cases are thought to be 10 times higher than other cases.
- Over 25% of claims that could be filed by entitled parties are left unprocessed and unrecovered, despite opinion that institutional investors are legally obliged to instigate such claims on behalf of their clients
- Between 2000 and 2007, almost $12bn in settlements, to which shareholders were entitled, was not reclaimed. Around $3.6bn of this total can be attributed to European investors, and almost $1.5bn to investors in the Far East.
- Participating in class actions is increasingly viewed as an essential element of responsible institutional investment. Astute managers are already using one of the outsourced, automated services available on the market to process class action claims without incurring high expense
Introduction
In the US, class actions – where many litigants combine to pursue a joint action against a single defendant for their collective claim for damages – have been used by groups of shareholders to recover losses stemming from fraud and misgovernance for decades. However, since the late 1990s, the picture has changed dramatically. The corporate governance scandals around the millennium – Enron is the prime example – and the bursting of the dotcom bubble ushered in a new era of class actions, where the issues of shareholder rights and corporate accountability rose to the fore. American corporations as well as foreign firms began to be called to account in the US courts and subsequently, foreign shareholders also began to seek redress for their losses. Part of the reason for this is without doubt the absence of class action procedures in most other countries (with the notable exceptions of Australia, Canada and South Korea) but various commentators now predict that similar legal frameworks – or equivalent – will be introduced in other legislatures. This paper seeks to quantify the level of redress being successfully claimed through the US courts by non-US shareholders – especially those in Europe and Asia – and briefly looks at the emergence of the joint legal process in respect of securities-oriented litigation in other geographies.
The Rising Tide
According to research body NERA Economic Consulting, the top ten Shareholder Class Action Settlements since 2000 have ranged from Enron Corp., at just over $7.2bn, to Lucent Technologies Inc., at just over half a billion dollars. In between this range come well-known US firms such as Worldcom and AOL Time Warner, as well as European companies including Royal Ahold. If mega-settlements such as these are included in the average class action securities settlement, then that average sits at some $54m. If settlements over $1bn are excluded, then the average remains at a staggering $33.2m.
Given that the first wave of these ‘mega-settlements’ was triggered by a specific period of corporate misconduct in the late nineties and around the turn of the millennium, a question often asked in the legal arena is whether these class action cases – and settlements – were a one-off affair, especially since this period gave birth to the Sarbanes-Oxley Act (SOXA) which was aimed at deterring such misdemeanours. In answering this question, it is firstly important to note that such class actions have a long tail. 235 federal actions were filed in 2000. To date over 90% have reached some form of resolution. 60% have been settled and 30% dismissed, broadly speaking. But some still have further to go, even eight years later. Secondly, a downturn in actions filed between mid-2005 and mid-2007 prompted many commentators to speculate on the demise of US class actions but figures from 2007 onwards give this the lie. We have seen renewed vigour in the courts, with the main authorities[1] on the subject telling us that securities class action lawsuits filed in 2007 are up between 43% and 58% (definitions vary) on 2006, with over 200 such actions instigated during the year. This upturn has continued into 2008, with 139 filings during the first six-months. If this pace is maintained, then 2008 could result in around 280 filings, a level not witnessed since the 2002 collapse of Enron and the “tech bubble”. It has been observed that just over half of these filings so far in 2008 involve allegations relating to the subprime collapse.
We may conclude, therefore, that although SOXA and its European equivalents are undoubtedly suppressing the possibility of further Enrons, the international financial markets crisis has already spawned a multitude of cases where class actions are being used to try and obtain compensation for shareholders and investors. Since we have evidence that the first wave of subprime-related filings is well under way, and that resolution can take 5-7 years, then the subprime crisis will undoubtedly remain the catalyst for at least another half a decade’s worth of class action cases.
Foreign Involvement
As we have already observed, several high-profile non-US firms have come before the Federal courts. These include Parmalat, Royal Dutch Shell, Vivendi and Daimler Chrysler. Leading commentators tell us that between 2000 and 2003, 68 foreign companies were sued by their shareholders in US class actions, of which 24 were European[2]. However, the number of securities class action lawsuits filed against foreign issuers fell from 19 in 2005 to 13 in 20062, which represents the lowest number filed against foreign issuers in the last seven years. Despite this, there remains substantial motivation for aggrieved foreign institutional investors to become actively involved in class actions, whether it is a US or foreign firm being sued. This is especially the case for European investors, as the typical European share portfolio is strongly international. The average balance is in the order of 75% domestic shares, 25% foreign shares. Moreover, the US is one of the most attractive markets for European investors, with its transparent reporting rules, and its cultural similarity for investors operating out of London, Europe’s largest financial centre. But for other non-US investors who have shareholdings in US-listed firms, the imperative to participate in securities litigation is just as strong. Many commentators have noted the huge losses incurred by funds due to the subprime crisis. The Financial Times, for instance, notes: “Pension funds across Europe, Asia and North America stand to lose hundreds of billions of dollars from investment in so-called ‘toxic’ assets.”[3]
The involvement of foreign investors in US litigation is not a given, though. It is a sensitive matter and largely depends on case-by-case decisions by US courts[4]. The likelihood of successful participation is greater if the non-US firm becomes a lead plaintiff. It is widely felt that if an American investor controls the class action, there is a twofold temptation to exclude foreign investors. First, arguments around the jurisdiction of the US courts regarding foreign shareholders are avoided, making the legal process potentially quicker and less expensive. Secondly, the fewer the claimants, the greater the proportion each will receive from any settlement. Therefore there are already been several precedents of non-US firms becoming lead plaintiffs, in some cases encouraged to do so by US legal firms who have started to actively market their services overseas. In the Parmalat case, for instance, all the lead plaintiffs are European. In 2007 the first UK local authority pension fund, Avon, was appointed lead plaintiff in the case against GlaxoSmithKline. It has been reported that in each year since 2002, international institutional investors have filed lead plaintiff motions in around 5% of all US class actions, with German and Austrian funds being the most active.
Eastern Promise?
Until recently, comment on the subject of US class actions in the Far East seemed to focus rather more on the implications for issuers than investors. In particular, there is much discussion about the possibility (or danger) that as more firms in the Far East list their shares on US stock exchanges, they could become the subject of class action litigation themselves. It has been reported that cases such as China Life – a state-owned insurance enterprise that listed on the New York Stock Exchange in 2003 and had a legal claims brought against it for alleged financial irregularities – have the effect of deterring local firms from seeking a US listing, despite the case having been dismissed by the US court. One report notes: “American investors are demanding better corporate governance practices from foreign companies.” [5] But it is not only American investors that are doing so – there is an increasing movement in various Far East legislatures towards improved corporate governance and shareholder rights, which we will come back to later in this paper.
When it comes to US class actions participation, the Far East investors’ perspective merits as much attention as that of European investors, but there has been little talk of their involvement. Overall, 12.5% of all foreign investment in US equities can be attributed to Far East investors, the majority based in the three largest markets (by market capitalisation) of Japan, Hong Kong and Korea. Cultural reasons certainly play a role in explaining why Far East investors are not known for becoming active litigants in the US. There is scant history of shareholder activism although this is gradually changing. As the OECD states, “Asian business cultures often prefer quiet, informal dispute resolution as a way for all parties involved to “save face” and to keep their business affairs out of the public eye”[6]. Other commentators observe the “Japanese predilection against litigation”[7] and that “Investors in Hong Kong are quiet, meek…”[8]. Although these comments relate to the attitude of investors in the domestic market, the culture of shareholder pacifism must go some way to explaining the reticence of Far East institutional investors in US litigation. Conservatism is also reflected in other areas of investment strategy – a recent report highlighted that “the bulk of the $1.5 trillion in [Japanese] public pensions is languishing in ultraconservative investments such as government bonds instead of being in a more balanced portfolio with medium-risk-medium-return securities”[9]. However, as the trend towards globalisation begins to have a greater impact on investment strategy in the Far East, interest in the international element of securities holdings is likely to increase. Even at the present stage, there is much potential for investors to recoup investment losses through the US courts. The Financial Times corroborates this sentiment with specific relation to China - “Pressure on trustees and fund managers is likely to increase as securities class actions become a global phenomenon.”[10]
Class Actions Globally?
The introduction of securities-related class action legislation is generally viewed as a key step towards improving corporate governance, protecting investor rights and bolstering market credibility. Impetus for investor legislation often intensifies in the wake of major corporate scandals, such as the Sarbanes-Oxley Act in the US after Enron; the Class Action Act of South Korea instigated by mismanagement and fraud in the economic crash of 1997; and class action legislation in Australia following the collapse of HIH Insurance. That said, there is now an inexorable global movement towards corporate governance reform, with increasing numbers of legislatures adopting mechanisms similar to the US model or currently considering their own approach.
The European Picture
Class actions in the different European legislatures is much discussed, but is not yet implemented. In the UK, US-style class actions are not allowed, but two other instruments – group litigation orders and representative claims – are available, even though they do not ensure the finality of claims. In Spanish law, various consumer associations and bodies are legally constituted to defend the collective interest of injured groups. In France, securities investors have been able to act jointly through authorised, non-profit investor organisations since 1994 (under article L. 452-2 of the French Financial and Monetary Code) but debate continues regarding the introduction of class actions in French law (albeit focused on protecting consumers rather than investors). Germany has introduced legislation, called the capital markets sample proceedings act (KapMuG) which refers to a highly restricted number of capital markets transactions. This is effectively a legal experiment, and will be monitored until 2010 to examine how effectively the legislation works. An Italian-style class action law was passed in December 2007 and it seems that investors, as a class, are eligible to use this[11]. The Dutch Civil Code allows representative organisations to bring actions to protect the interests of others, and in 2005 a new Act came into force facilitating the collective settlement of mass damages.
Despite the fact that European implementation of collective litigation is mixed, expectation amongst European corporates is that class actions on their home turf is just around the corner. A survey from October 2007[12], amongst 240 European executives and lawyers, found that around half of them (49%) expect their domestic courts to expand access for groups of individuals acting collectively in the next three years. 59% said they expected to see collective litigation take root in the UK over the next three years.
Canada and Australia Lead the Way
Interestingly, class actions are far more straightforward to pursue – and have taken hold – in Australia and Canada. The legislative basis for class actions was introduced into Australian law since 1992, with the introduction of Part IVA of the Federal Court Australia Act of 1976. In recent years, it has been regularly suggested that Australia is the most likely geography outside of the USA in which corporations will face a rising tide of class action lawsuits. In parallel to the American experience, the largest corporate collapse in Australian history – that of HIH Insurance in 2001 – has helped to accelerate class actions being employed as a vehicle for prosecuting claims for shareholder damages. More recent examples include the settlement by Telstra of shareholder class action for breaching continuous disclosure obligations, although this was for $5m rather than the action’s original $300m. Most provinces of Canada and the Federal Court had successfully achieved widespread reform of class actions by the early 2000s, which represented the culmination of several decades of reform efforts.
The Far East Joins the Fray
We noted earlier in this paper that, historically speaking, shareholder activism has not been widespread amongst Far East investors. However, in recent years various associations and investor rights groups have increasingly managed to get their voice heard, such as the Securities Investors’ Association of Singapore (SIAS) and the Asian Roundtable on Corporate Governance, organised by the Organisation for Economic Co-operation and Development (OECD). The latter met in 2006 in Singapore and delegates pledged themselves to further corporate governance reforms in the region.
The Financial Times observes: “But after a decade of reforms, Asia’s company law frameworks and corporate governance codes are close to global best practice. The flaws are largely in implementation and enforcement.”[13] Indeed several legislatures have had a legal framework for class actions for years but there is a significant gap between theory and practice, with the prevailing sentiment that filings were hindered by high minimum share requirements, high court filing fees or other mechanisms to actively discourage litigation. In China, several types of “collective suits” were unexpectedly introduced into the 1991 Civil Procedure Code, following growth in the volume and scope of multiparty disputes. But it was not until 2002 that the authorities “lifted the litigation floodgates”[14] by addressing procedural issues that had previously hampered the filing of joint suits. Even so, the culture of shareholder silence will take many years to change. One operational aspect of filing class actions that may encourage Far East investors to become more involved is that shareholders’ names remain anonymous unless they choose to put themselves forward as lead plaintiff.
Following years of discussion, South Korea passed a Class Action Act in 2005, as part of a wider initiative to ‘clean up’ the accounts of its listed corporations. It was introduced in two phases – initially limited to the largest listed companies (with assets of over 2 trillion won) and then allowing suits to be filed against listed companies of all sizes from 2007. Currently there is no specific securities-related class action legislation in Japan or Hong Kong.
We have established that global shareholders have got wise to the possibility they could be left out of securities class actions in the US unless they take an active role in a lawsuit. Now, we come to the question of how efficiently and effectively the interests of the totality of affected shareholders are being represented in securities class actions in the US.
Unclaimed Funds
The findings of various parties – both within the legal profession and academic studies – have revealed that non-claims are estimated to amount to anywhere between 25% and 35% of total settlements[15]. To quote one authoritative source, it appears that, “some institutional investors are not filing claims in securities fraud class action settlements, and are therefore leaving potentially large sums of money on the table…. We have attempted to answer the question of whether institutional investors are leaving money on the table by failing to file claims in securities fraud class actions. We think that their fiduciary duties to file such claims are clearly established by existing law, and that the costs of filing such claims are likely to be trivial. Thus, even if the benefits from filing are small, institutional investors should be filing claims in these settlements. We conclude that it appears that many of these investors are failing to file such claims[16].”
This view now prevails in many areas of institutional investment. In 2007, the body governing Britain’s biggest pension funds, the UK National Association of Pension Funds (NAPF), spoke out about the importance of its members participating in US class actions. David Paterson, the NAPF’s head of corporate governance, was quoted as saying: “Pension trustees have a duty to protect the assets in their scheme. At the very least they shouldn’t neglect opportunities to recoup losses, especially where the cost and effort of doing so are commensurate with the expected return.”
In order to quantify the scale of losses to investors through non-registration in securities class action lawsuits, Goal Group combined its historical records of registration and settlement claims, with market data sources. The results were stark. Almost $12bn has not been claimed on behalf of entitled investors between 2000 and 2007. $3.6bn of this total can be attributed to European investors, and $1.5bn to those in the Far East. A huge spike of losses was experienced in 2006, the year when the bulk of the mammoth Enron settlement was finally authorised by the courts. However, 2007 also saw a strong throughput of mega-settlements, as well as an overall increase in filings due to the emerging wave of litigation relating to the subprime crisis.
Keeping track of the opportunities to make a claim, and the actions required to do so successfully, can be a complicated and daunting task. Such an undertaking requires timely and accurate information about the relative merits and procedural processes of the actions. It also requires the time and resources to review and evaluate relevant settlement provisions. Investors must then cross-reference these outputs against extensive individual trading activity data and then compile and submit the often complex paperwork necessary to make a valid claim.
Automated and Outsourced Claim Management
A majority of institutional investors seem to believe that the cost and time taken to undertake these tasks is likely to outweigh the benefits from potential settlement recoveries. This is often not the case.
The demand for efficient and affordable means of participating in securities class actions and recoveries has inspired the development of outsourced services that overcome the claim processing complexities. These services combine legal and procedural expertise, with a shared knowledge-bank and alert facility. The key processes comprise:-
- Pinpointing and informing investors of portfolio losses suffered allegedly due to corporate fraud or malfeasance
- Delivering accurate and appropriate legal advice concerning US law, investors’ legal rights and their legal options
- Tracking and monitoring securities class actions both in the US legal system and globally
- Putting strategies and procedures into action for investors’ to submit valid claims and recover settled funds.
Such automated processes and services are now widely available for investors, fund managers and custodians to process all the necessary corporate actions to register and pursue a claim through a class action. This extends to the automatic alerts which prompt such claims in the first place. Costs vary between services, but all are minimal in relation to the settlement sums recovered. Since it is the judgement of academic legal commentators that there is a clear duty of care for institutional investors to register claims on behalf of their clients, it would seem that there is dangerous gap in the reclamation process, and one that (according to GOAL’s data) has narrowed little in recent years.
Conclusion
In conclusion, it seems that securities class actions in the US are once again on the increase.
Not only is the volume of lawsuits increasing, but the average filing loss (and therefore settlement size) is also on the rise. In the early 2000s, corporate fraud was the main instigator of class actions; the mantle now seems to be passing to cases born out of the recent international credit crisis. With subprime cases, investor losses are 10 times higher than in other cases, according to NERA Consulting.
Around one quarter of all entitled parties still do not seem to be claiming their share of settlement payouts resulting from the class actions. The result is that since the millennium, just short of $12bn that could have been claimed, was ‘left on the table’ (as one commentator put it). Furthermore, as we move into the next decade, it seems likely that the spread of geographies and legislatures in which class actions are gaining traction will continue to widen. For institutional investors across the globe, there is an urgent need (indeed, legal obligation) to make claims on behalf of their clients where a class action is involved. Moreover, since there are now low-cost services which are already enabling many financial organisations to do so, there remains no excuse for ignoring this important areas of client responsibility.
Global (non-US) Investor losses through class action non-participation 2000-2007
Far East Investor losses through class action non-participation 2000-2007
Methodology
Publicly available data sources on class action settlements were combined with GOAL Group’s own proprietary datasets in order to quantify the levels of unclaimed damages in securities class actions in the US between 2000 and 2007.
Third party sources consulted include:-
- The Securities and Exchange Commission
- World Federation of Stock Exchanges
- International Monetary Fund
- Vanderbilt Law School
- Duke Law School
- NERA Economic Consulting
- Cornerstone Research
- Stanford Law School
- Mallesons Stephen Jaques
- The 10b-5 Daily
- PriceWaterhouseCoopers
- The Financial Times
- Freshfields Bruckhaus Deringer
- Spector Roseman & Kodroff
[1] Sources: Stanford Law School/Cornerstone Research: NERA Economic Consulting
[2] PriceWaterhouseCoopers
[3] The Financial Times, Pensions have billions in toxic assets, 20 October 2008
[4] International Herald Tribune, U.S. firm seeks broad lawsuit against Société Générale, 30 July 2008
[5] For instance: CFO Asia, Liabilities’ Long Arm, July/Aug 2004
[6] OECD, Asian Roundtable on Corporate Governance, June 10 2003
[7] Japan Society (New York) and Harvard Law School’s Program on International Financial Systems, Enforcement in the U.S. & Japan, with Lessons from the UK, Feb 1 2008
[8] CFO Asia, Lack of Support, March 2003
[9] Business Week, Japan to Global Investors: Shareholder Activism Won’t Work Here, April 17 2008
[10] The Financial Times, Time to claim your slice of the pie, May 2005
[11] Legal Week, Italy: Class of its own, June 26 2008
[12] Economist Intelligence Unit/Bryan Cave LLP, Collective Litigation in Europe, October 2007
[13] The Financial Times, Wrong lessons from Asia’s crisis, July 01 2007
[14] The Globalization of Class Actions Conference, Collective and Representative Actions in China, Michael Palmer and Chao Xi, November 2007
[15] See, for instance:- James D Cox, Randall S Thomas, Leaving Money on the Table; Do Institutional Investors Fail to File Claims in Securities Class Actions, 2002; Pensions & Investment News, Should European institutions make the effort to see companies in court?, 26 September 2006
[16] As Footnote 16
