Growing Class-Action Trend Can Hurt Shareholders (The Australian Financial Review)
Jones Day partners Mark Crean and Michael Lishman explain how the rise of irresponsible shareholder class actions in Australia is unfairly lining the pockets of a few at the expense of the overall equity market’s health.
At the moment there is debate in Australia about the increase in shareholder class actions. The debate about these actions and directors’ duties and shareholder rights generally is of little interest to the public when cast in complex terms focusing on issues which the average Australian sees as only relevant to the top end of town. It is time to recast the debate in terms that are relevant to people.
A significant part of Australia’s $2.7 trillion of superannuation is invested in listed Australian companies. Every Australian worker and retiree has a personal interest in how our listed companies perform. Even small differences in returns can make a big difference to the sort of retirement people have. For example, if someone has $100,000 in super and they get 8 percent per annum with a 15-percent tax rate, the nominal value of that money in 30 years is about $760,000. If they get 7 percent the nominal value is $590,000. Small differences in returns in superannuation matter.
Shareholder class actions based on an alleged breach of the ASX disclosure rules cannot be justified by reference to improving the performance of companies and the returns to shareholders or indeed of improving disclosure. These actions simply line the pockets of some shareholders, the litigation funder, and law firm.
Australia’s disclosure rules for listed companies are unique. They require (with some exceptions) the "immediate" disclosure of information that affects a company’s share price. The problem in practice is that life is not that simple. Business is complicated, and the impact of facts is often only fully understood with the benefit of hindsight. Companies sometimes get this wrong, release information late, and then the share price drops.
Litigation funders and plaintiff law firms bring action on behalf of people who bought shares in the period between when the company should have announced and when it did announce. They are suing the company for alleged loss on the assumption that had the announcement been made before the plaintiffs bought shares, they could have bought at a lower price or might not have bought at all. The losses are claimed from the company and directors, which both in turn may claim against insurance.
Australia has become a very attractive market for litigation funders because of the ease of making such claims. Even in the litigious US, such actions are not as easily made. This year Australia had 20 such class actions.
These actions don’t get to trial. The insurers and the company usually payout.
Such actions are a bad thing for many reasons.
First, they add to the disincentives to people being directors and distract directors from growing the company. Because of superannuation, all Australians have an interest in the very best people serving as directors on listed company boards and in those boards spending their time working on making better products, growing sales, expanding into new markets, and efficiently deploying the company’s capital.
Second, if the purpose of these class actions is to compensate some shareholders, they are inefficient. Too much of the compensation goes to litigation funders and their lawyers and not the shareholders who suffered the loss.
Third, the cost of remedying the alleged wrong is borne by the company, in effect by the other shareholders. Money paid out by the company lowers the value of the company and therefore all shares. Money paid out by the insurers is recovered by increased premiums. Again the cost is borne by shareholders. Why should one group of shareholders compensate another group when the value of all shares has gone down and shareholders have done nothing wrong?
Directors tell us that directors and officers insurance premiums are going up. In a recent case, the insurer successfully argued that each class member had a separate claim, meaning the $2 million deductible or "excess" payable by the company before the insurer had to pay, was in fact more than $200 million (being $2 million multiplied by more than 100 “claims”), rendering the policy worthless. These actions are a material financial risk to listed companies. Something must be done.
So what should be done?
Ideally such class actions should be legislated away. However, there will be extreme examples of breaches of continuous disclosure which litigation funders and law firms will point to as justifying such actions being available. So a complete legislative ban on such actions probably won’t get political support.
A number of solutions have been canvassed recently, including modifying the disclosure regime or requiring more proof of causation. Another solution which we suggest might be politically achievable is to legislate that a breach of continuous disclosure laws does not give rise to any shareholder right to claim, but to give the Australian Securities and Investments Commission (ASIC) the ability to seek not only penalties but also the sole ability to seek compensation for affected shareholders. ASIC can already bring civil and in some cases criminal proceedings against a company and directors for breach of disclosure rules. In extreme cases, ASIC could be given the role of seeking compensation on behalf of affected shareholders. This would reduce the amount of such actions and eliminate the returns to litigation funders.
Mark Crean and Michael Lishman are partners at the global law firm Jones Day, based in Sydney and Melbourne respectively. The views and opinions set forth herein are the personal views or opinions of the authors; they do not necessarily reflect the views or opinions of the law firm with which they are associated.