By Dominic Auld
The world’s institutional investors have become more and more globally diversified as they seek the returns necessary to satisfy clients and beneficiaries. This opens up many areas of risk, one of which is effectively tracking securities and investment-related litigation — from which monetary
recoveries can potentially have a material effect on the bottom line.
Historically the vast majority of these cases have been filed in the United States; and this is still true, as the country has a long history of strong and well-established securities laws and a class-action regime for prosecuting such actions firmly in place. But things are changing, and an increasing number of securities-fraud related cases are being filed in other countries.
Unlike the US, where investors are typically deemed to be part of the protected class of damaged investors, many of these non-US actions require an affirmative decision to participate. Shareholders with global exposure must therefore navigate unfamiliar waters in deciding whether involvement in these actions is warranted.
There are two main reasons for the uptick in non-US securities litigation;
One: active and passive participation in US legal actions has made large investors more aware of their rights and the potential for significant loss recovery elsewhere. In non-US jurisdictions they are starting to file cases, join actions, and push regulators and law-makers to similarly provide them legal recourse from corporate misconduct. Two: in June 2010, the US Supreme Court effectively abandoned decades of jurisprudence when, in the Morrison v. NAB case, it ruled that regardless of whether fraudulent corporate conduct took place in the US, the securities laws do not apply extraterritorially. This effectively restricted the reach and protections of US laws to securities traded on US exchanges.
Investors who have purchased shares on non-US exchanges of companies that list both in the US and elsewhere are now forced to look to the jurisdictions of their trading to recover losses stemming from fraud and misconduct. Although the Morrison decision will likely accelerate the changes in foreign and international law, these changes will take time. That said, some jurisdictions have already moved in this direction.
In the wake of the major corporate scandals of the early part of the millennium such as Enron, WorldCom, and Tyco, and the resulting enactment of Sarbanes-Oxley in the US, several countries began to re-examine their own securities laws. Canada, Australia and Japan have all pursued similar legislation.
Most notably, Canada is now one of the few countries in the world that will hear ‘US-style’ class action securities cases and currently seems able to certify global classes of damaged investors. In Australia, there have been a decade’s worth of securities cases, typically structured as collective actions funded by third parties, some of which have resulted in large recoveries for damaged shareholders. The Japanese system has a long way to go, but there have recently been successful suits against companies such as Livedoor and Seibu Railway found guilty of “misstatements”. That said, despite the recent arrest by Japanese authorities of seven high-level executives, there is little current evidence that Olympus investors damaged by the accounting fraud scandal will be able to effectively seek recovery for their losses in Japanese courts.
Within the European Union, the securities litigation landscape is a mixed bag. Perhaps most encouragingly, in 2005 the Netherlands passed the Collective Settlement of Mass Damages Act, which permits parties to a settlement to request a court declaration that the settlement agreement is binding on all persons to which it applies according to its terms. This framework effectively provides an opt-out system similar to the US, allowing for passive class members. Additionally, in January of this year, the Amsterdam Court of Appeals held for the first time that a collective securities settlement was binding on all parties.
Investors who originally sued Vivendi Universal in the US in 2002 – and achieved a $9 billion (£5.68 billion) jury verdict – have been forced, due to retroactive application of the Morrison decision, to pursue their claims in France.
However, the absence of a fixed class action structure in this jurisdiction has required the parties to actively join the matter and work as a collective in their attempts to recover their losses. Recently proposed cases in Switzerland, Denmark, and Germany will also follow this framework and it can be safely assumed that this will be the norm across Europe and likely the rest of the world.
It is clear there are still a number of complexities associated with non-US avenues of redress for securities fraud. Potential foreign litigation is dogged by inefficient and overly complicated legal frameworks. Even countries with similar frameworks to that of the US lack the history necessary for both perfecting the law and training jurists. One crucial element of the US system – generally lacking abroad – is the threat of a jury trial. This absence reduces the litigation risk for defendants and therefore also the potential size of settlements. The result of all of these factors is a great deal of uncertainty for participants. It is difficult to accurately estimate the potential recoveries available in any non-US jurisdiction.
It is clear that investors do not put money into companies assuming they are engaged in fraud (unless of course they are actively shorting them) and that they will need to litigate against them at some point later. But, when fraud does occur and cause damage it is important to determine the most effective pathway to mitigation, and pros and cons need to be examined.
One of the reasons for high levels of active prosecution in the US, is the absence of downside risk for participating investors. Attorneys are able to work on contingency, there are no statutory cost-shifting provisions, and the class action structure is ideal for securities cases as it can cover literally thousands of damaged shareholders in one action. Passive class members can simply “ride on the securities class action bus” and participate in any recovery achieved.
The same seems to be basically true in Canada, Australia and Europe however, require an affirmative decision to participate if an investor wished to join an action to recover losses taken due to fraud.
Accordingly, investors considering pursuing securities litigation in these
jurisdictions will need to consider a number of factors in addition to the scale of their losses and the potential for recovery. Most important will be determining that the proposed structure fully eliminates or indemnifies downside risk such as cost-shifting or reputational concerns or significant resource drain such as discovery obligations. It is also important to analyse the parties responsible for bringing the action - is the group made up of reputable law firms, funding companies, shareholder organisations? Any agreements that govern the participation will need to be fully reviewed by independent legal counsel to ensure they are equitable and fair.
Finally, it is important to understand the history of the jurisdiction - there is no point in expecting too much when the efforts take place in a highly unpredictable environment.