Securities fraud cases in Europe

February 2016 | LEGAL & REGULATORY | LITIGATION & DISPUTE RESOLUTION

Financier Worldwide Magazine

Legal claims by shareholders against publicly-listed companies, commonly referred to as ‘securities fraud’ cases, have for a number of decades now been commonplace in the United States. Within the UK and across Europe, however, they are a more recent phenomena, having only emerged within the civil litigation landscape over the last few years.

In securities fraud cases, shareholders typically seek to pursue redress in a collective manner, as part of a ‘class’ or a group. A benefit of acting in this way is that the shareholders, who may number in the hundreds or even thousands and will include large global fund managers down to ‘mum and dad’ investors, are able to share the financial cost of taking the claim.

The group of shareholders will allege that they are collectively eligible for compensation in the form of damages payable by the company that they are suing, on the basis that they have invested in the company by purchasing its shares at a time that, they allege, the company was in some way misleading or deceiving the investing public, or ‘the market’. The target company may have misled the market by failing to disclose information which was adverse to its financial position, or misled the market by making fraudulent statements regarding its financial position, operations or trading outlook. Inevitably, when that information becomes public, either through the company itself or via a third party, the market typically reacts in a negative fashion and investors sell out of the company – and as a consequence the company’s share price falls significantly. The investors will thus allege they have bought the company’s shares at an inflated price.

When a class action is launched, investment or asset managers who hold or held the company in question’s stock will have to consider whether to join the case. Where that manager is managing other people’s money, this decision is an important one. A similar situation is faced by pension fund trustees, entrusted with managing the pension pots of its constituent clients. On the one hand, it has been said that there is a fiduciary obligation on the manager or trustee to his underlying clients to participate in the case – if he or she doesn’t, they will not be able to recover anything on their client’s behalf resulting from the misconduct by the company.

On the other hand, critics of class actions point out that the manager or trustee is in fact participating in a case which will further damage the target company, or merely involving itself in a case whereby one group of shareholders will pay out moneys to another.

Neither criticism is entirely correct, for a number of reasons. Firstly, it may be that the company is in fact insured for these types of cases, which is typical in the US, and hence the payout it makes is in fact an insurer’s money. Analysis suggests also that class action settlements actually benefit a target company’s share price, on the basis that the settlement allows the company to put the case and the bad news behind it. Regarding the argument that these cases merely represent one shareholder group paying out funds to another, this misses a larger point. Many investors, managers or trustees will have sold out of the stock, and if they were defrauded by the company, why should they not have a venue to seek redress on their clients’ behalf?

One aspect of these cases not yet covered is the cost of pursuing them. Most fund managers and the like will be alive to the fact that these cases cost a lot of money to pursue. Securities fraud cases are notoriously expensive to run, even where a large group of shareholders is footing the bill – and, of course, in England adverse costs are also payable, meaning that if you or your group lose your case, you are liable to pay for the defendant’s legal costs incurred as well (known as ‘adverse costs’).

This cost-risk the shareholder group faces can be ameliorated by seeking finance from a litigation funding company. Litigation funding companies within Europe are now prepared to back these shareholder groups (or at least those with good claims) on a ‘no win, no fee’ basis, whereby they pay for all of the class’s legal fees and costs and provide cover for adverse costs, and in turn receive a percentage of any sum recovered from the target company (if the case succeeds, the funder will take around 25-35 percent of the amount recovered). If the class loses, the funder loses what it has invested in the case. Where they are backed by a litigation funder, it is hard to see why fund managers would not join securities fraud cases.

There are also the general or wider benefits of securities cases to consider. There are obvious benefits from a general corporate governance perspective of shareholders taking such affirmative action. By participating in securities fraud cases, shareholders are able to assist in the ‘private enforcement’ of corporate laws, in the process assisting in the wider enhancement of market transparency and the development of proper disclosure practice by large publicly listed companies.

Within Europe, there are currently a number of shareholder cases underway against high-profile targets – for example, against large financial institutions The Royal Bank of Scotland PLC (RBS) and Lloyds Banking Group PLC in London, and against Fortis NV in the Netherlands. In these cases, shareholders number in the hundreds and include some of the world’s largest fund managers.

This year, it is likely that a number of shareholder groups will initiate claims in Germany and the US against Volkswagen AG, relating to last year’s ‘emissions scandal’ and the detrimental effect the disclosure of that had on the company’s share price.

It is likely that as corporate governance initiatives increase across Europe, we will see more of these shareholder claims occur. For fund managers and the wider investing public, this brings some obvious benefits as outlined above.

Simon Dluzniak is an investment manager at Bentham Europe Limited. He can be contacted on +44 (0)203 750 1300 or by email: sdluzniak@benthameurope.com.

Simon Dluzniak

Bentham Europe Limited