A class act?
February 10 2009, 2:01 pmA study by GOAL Group into unreclaimed funds resulting from the settlement of securities class actions in the US.
Management Summary
- Filings for securities class actions are on the rise again in the US
- Total securities class action settlements in 2007 are down on 2006, but the average settlement rate is up
- 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. Some $3.6bn of this total can be attributed to European investors
- Astute and responsible institutional investors are already using one of the outsourced, automated services available on the market to process class action claims without incurring high expense
Introduction
Class actions – where many litigants combine to pursue a joint action against a single defendant for their collective claim for damages – used to be a purely US phenomenon. Other countries’ legislatures had mechanisms for joint actions, but these were rarely employed. Now the world is changing. Since the corporate governance scandals around the millennium – Enron is the prime example – class actions in the US courts have been used by non-US shareholders to seek redress for their losses. And this is now spreading to other legislatures. The legislature in Australia is already well developed, and various pundits now predict an escalating level of class action – or equivalent – in Europe. This paper seeks to quantify the level of redress being successfully claimed through the US courts, as well as painting a picture of the emergence of the joint legal process in respect of securities-oriented litigation in other geographies.
Let us first deal with the situation in North America. In the United States, the securities markets are regulated and policed by bodies such as the Securities Exchange Commission and by investor representative bodies. Class action litigation has been used by groups of shareholders to recover losses stemming from fraud and misgovernance for decades. However, since the late 1990s, a number of major frauds have come to light, which largely contributed to the bursting of the dotcom bubble and the subsequent economic trough that followed in most of the Western world. Nor were these corporate frauds confined to the United States. 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 and Parmalat. 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.
One-off, or With Us For Good?
There is a question often asked in the legal arena as to whether these class action cases – and settlements – were a one-off affair; whether the gross misconduct of the late nineties and early noughties would perpetuate, especially since the misbehaviour of this period gave birth to the Sarbanes-Oxley Act (SOXA) which was aimed at deterring such misdemeanours. In answer to this question, to date, there are two factors to consider. First, 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 in 2006 raised the possibility that shareholder class actions – in the US at least – were on the wane. The figures from 2007, however, give this the lie, as we have seen renewed vigour in the courts. The main authorities[1] on the subject tell us that securities class action lawsuits filed in 2007 are up between 43% and 58% (definitions vary) on 2006, with up to 207 such actions instigated during the year. Evidently preventative legislation, in the form of SOXA have opened the door to more class actions as a result of the very transparency and reporting which the Act requires. The same is true of transparency regulation and legislation in Europe – a situation that is likely to accelerate on the Eastern side of the Atlantic as the EU moves towards implementing its own SOXA equivalent in the form of the 8th Company Law Directive on Statutory Audit.
Part of the reason for the upturn has been the recent crisis in the subprime mortgage market, inspiring a surge of class action lawsuits. To the end of the year, 32 subprime class actions had been filed in the United States, in the main against mortgage companies and lenders who had allegedly improperly inflated the value of their mortgage books and were being accused of failing to disclose that loans may have been based on substandard appraisals. We may conclude, therefore, that although SOXA and its European equivalents are undoubtedly suppressing the possibility of further Enrons and Parmalats, new factors have arisen in the financial and corporate markets where class actions are being used to try and claim compensation for shareholders and investors. Moreover, most pundits are predicting that the credit crisis will affect corporate, as well as financial, organisations, and that the results of its contagion will be felt worldwide in 2008. Since we have evidence that resolution of the cases can take 5-7 years, then the subprime crisis will undoubtedly spawn another half a decade’s worth of business for class action lawyers, their clients and the courts.
European Claims Abroad
What happens in the USA is of no small interest to European investors. The typical European share portfolio, especially amongst institutional investors, is strongly international. The average balance is in the order of 75% domestic shares, 25% foreign shares. And 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. Since the millennium, there has been a noticeable shift in the US courts, as an increased number of European investors have sought to lead shareholder class actions against both US and European companies. Between 2000 and 2003, 68 foreign companies were sued by their shareholders in US class actions, of which 24 were European[2]. Well known European firms that have come before the US courts are Parmalat, Shell Transport, Vivendi, Daimler Chrysler and Cable & Wireless, to name just a small sample. However, when a European firm is being sued in a class action in the US, European investors need to be particularly alert, and ensure that they are included in the list of litigants. Where 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. These two dangers have inspired European companies to become active litigants in US class actions – for instance in the Parmalat case, where all of the lead plaintiffs are European.
Class Actions in Europe
Class action 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. French legislation only allows only individual actions, although in recent years, the introduction of class action legislation has been seriously considered. 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. Finally, Italy and the Netherlands both have laws which allow collective action to compel certain types of corporate behaviour, but damages claims still have to be largely pursued through separate action. The introduction of class actions in Italy is currently on the political agenda. Despite these hurdles, expectation amongst European corporates is that class actions on their home turf is just around the corner. A survey from last October[3], 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.
Interestingly, it is not Europe but Australia where shareholder class actions are straightforward to pursue, and have taken hold. The legislative basis for class actions was introduced into Australian law has existed at the federal level 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.
We have established that European 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 interested 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[4]. 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[5].”
In order to quantify the scale of losses to investor 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. 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 over 2006.
Keeping track of the opportunities to make a claim, and the actions required to do so successfully, can be a complicated and daunting task, particularly for European investors. 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 development of outsourced services that overcome the claim processing complexities. These services combined 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, based on the continued growth of mega-settlements, as well as the upward trend in class actions filed. 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.
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). There is an urgent need (indeed, legal obligation) for institutional investors to make claims on behalf of their clients where a class action is involved. And 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 client responsibility.
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] Source: PriceWaterhouseCoopers
[3] Economist Intelligence Unit/Bryan Cave LLP, Collective Litigation in Europe, October 2007
[4] 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
[5] Ditto
