Shareholder litigation has traditionally been seen as a defined benefit issue, but as the pensions landscape shifts to defined contribution, more trustees are considering the potential benefits of legal action.
The class action cases against the Royal Bank of Scotland (RBS) have brought the idea of pension schemes using the litigation process against securities firms into the spotlight in recent months.
The Massachusetts Pension Reserves Investment Management Board and the Mississippi Public Employees’ Retirement System have been chosen as lead plaintiffs for the class action brought by investors who bought RBS shares between June 6, 2007 and January 9, 2009.
The two pension funds are said to have lost £85m in RBS, which was bailed out by the British taxpayer in October after conducting a £12bn rights issue in April last year. They argue that RBS “falsely reassured” investors it was well capitalised.
But it’s not just the money. Increasingly, a number of US class action lawyers are using the courts to enforce the defending firms to not only pay compensation, but also change the governance structure to prevent similar mishaps occurring in the future. Corporate governance reforms that have been included in settlement agreements in the US range from altering the composition of the audit committee to revamping a corporation’s overall structure.
“Class actions are just a means of litigating torts efficiently,” says Robert Morfee, partner at UK law firm Clarke Willmott. “The definition of the purpose of the tort law in England was propounded by Glanville Williams in 1951 as appeasement, justice, deterrence and compensation. Note that two of these are public purposes: litigating torts is a branch of law enforcement.”
Morfee argues that efficient law enforcement in the business environment demands civil litigation of torts as well as action by regulators. “Arguably, the growth of intrusive regulation seen over the last 30 years has been the mirror image of the decreasing accessibility of redress through the civil courts. Class actions are a way of increasing that accessibility, and so, perverse though it may seem, of benefit to business generally.”
While the UK legal system currently only supports collective actions (see Pensions Week March 30, 2009 for more information), Lord Justice Jackson is currently undertaking a root and branch review of the cost of English and Welsh civil litigation; cost-shifting, where the losing party pays for court costs; and contingency fee arrangements. Any changes implemented as a result of his review could see the door open to class actions in the UK.
For the time being however, these class actions are only available in the US and a handful of other countries, including the Netherlands. One of the most prolific is that of Royal Dutch Shell, which was found to have misrepresentations concerning its ‘proved’ oil and gas reserves between 1999 and early 2004 – leading to all oil companies using a much more stringent method of proving how much they have stockpiled. Morfee continues: “The prospect of prospectus litigation must help keep capital-raising clean. Oil tankers are now being built with double hulls to protect the environment – this must have something to do with oil spill litigations.”
But it’s in the US that the corporate governance angle of class actions has really taken off. Beata Farber, partner at US firm Bernstein Litowitz Berger & Grossmann, says lead plaintiffs often negotiate an extensive corporate governance reform plan in addition to the monetary settlement.
“While systemic corporate governance changes through engagement and regulation are undoubtedly necessary, in some cases litigation is the most effective and often the fastest tool to achieve the desired results for a particular company,” she continues. “Importantly, corporate governance changes achieved through litigation are very targeted and enforceable by court order for several years after the settlement.”
Changing attitudes
Historically, pension funds and other institutional investors in the UK have regarded class actions as ambulance chasing: litigation was a dirty word. However, the credit crunch has caused a number of funds to reassess their views. “Often these folk have little or no experience of litigation, and no understanding of its social purpose, says Morfee.”
Indeed, much stems from the misunderstanding of the Private Securities Litigation Reform Act of 1995, which heightened the pleading standards for securities cases to ensure that only meritorious cases survive the motions to dismiss. It also introduced a preference for the institutional investors to lead these litigations to ensure that litigation is client and not lawyer driven.
But for those trustees who remain cautious about the potential costs involved in litigation, Morfee has this advice: “Class actions should be done on the basis that it is a sensible investment. Trustees should know in advance what their investment is likely to be, and what their expected return.” He adds that while the UK collective actions are not free to enter, as the US class action models are, if managed properly, the returns can be substantial. “Returns on gross capital outlay of over 500% should be regarded as normal,” he concludes.
Cases where corporate governance improved through class actions
All the cases referenced below were brought by one or several large US and European pension schemes.
WorldCom securities litigation:
In addition to $6.2bn (£3.8bn) recovery, the court rulings in this litigation established high due diligence standards in connection with public offerings of securities. Numerous investment banks changed their internal due diligence policies as a result. The WorldCom decisions and settlement have also had a profound impact on corporate boardrooms and auditors profession.
Cendant Corporation securities litigation:
In addition to $3.2bn recovery, lead plaintiffs developed corporate governance plan that at the time incorpora-ted the most significant changes ever agreed to by a public company, including the complete restructuring
of Cendant’s board to ensure it would be effectively independent.
Columbia/HCA derivative litigation:
After six years of demanding litigation, some of the most comprehensive corporate governance reforms in history were achieved. Under the sweeping governance plan, the HCA board of directors were made substantially independent, and given increased power and responsibility to oversee fair and accurate financial reporting. The trial court praised the settlement as conferring “an exceptional benefit upon the company and the shareholders by way of the corporate governance plan”.
Nortel securities litigation:
The board agreed to broaden disclosure regarding how executive compensation was determined and to include ‘clawbacks’ should fraud occur, in addition to a $1.3bn recovery for investors.
UnitedHealth derivative litigation:
This litigation revamped the company’s executive compensation system, which cost the company billions of dollars. As a result of litigation, the company agreed to adopt far-reaching corporate governance reforms to curb executive compensation abuses, including a shareholder-nominated director, and the separation of chief executive and chairman functions.
Source: B. Farber, BLBG
