Money for nothing?

The last 12 months have seen UK schemes becoming increasingly involved with class action law suits in the US.

Class action – or group litigation as it is known in the UK – can be a potent weapon in the trustees’ arsenal if one of their bigger investments is suspected of inflating its figures or issuing misleading data on which the scheme can show it based its investment decision.

Estimates for 2006 show pension funds missed out on around $2.4bn (£1.4bn) in compensation due to a reluctance to engage with lawsuits across the Atlantic. But as trustees have become increasingly aware of the benefits of monitoring and recovering assets from US securities class actions, a growing number are reaping the rewards.

In the early part of 2007, the National Association of Pension Funds brought the issue of US class actions to the attention of all trustees with the publication of a paper detailing the key questions they should be asking on the subject.

At the launch of Securities Litigation – Questions for trustees at the NAPF Investment Conference in March, head of corporate governance David Paterson said: “This paper sets out in practical terms the measures trustees should take to ensure they are not missing out.

“At a time when pensions scheme deficits are a matter of ongoing concern, scheme members could be forgiven for asking why trustees are not taking every available opportunity to recoup funds to which they are rightfully entitled.”

Since then the profile of US class action cases has been raised further with the growing involvement of large public sector schemes, the most recent of these being the announcement in September that the Avon Pension Fund had been appointed lead plaintiff in a class action lawsuit against US pharmaceutical giant GlaxoSmithKline.

Avon, together with the North Yorkshire Pension Fund, was among several schemes that suffered losses when the GSK share price fell amid controversy over its diabetes drug Avandia.

The drug has been associated with increased heart attack risks and around £3.5bn was wiped off the firm’s share price value in a matter of days when the allegations about the risks of taking Avandia appeared.

The claimants allege that GSK issued misleading statements over the controversy, which contributed to significant losses by UK pension schemes. Avon lost around £1.3m and became the first UK scheme to be appointed lead plaintiff.

So why are UK schemes only now becoming actively involved in chasing the billions owed to them in settlements? And what should trustees be doing to ensure they are not left behind?

Adam Savett of RiskMetrics believes the increase is a sign that litigation is on the wane.

Savett adds: “This is likely a result of increased education with respect to what these cases mean and the value that they bring to the securities markets.

“It is also a function of increased exposure to the processes and concepts involved.”

Scott Reynolds, dispute resolution partner in the New York office of Lovells, puts at least some of this exposure down to savvy lawyers.

He says: “The growing number of UK institutions taking a leading role in securities class actions can be attributed at least in part to the US plaintiffs’ bar targeting such institutions as clients.

“The plaintiffs’ firm that recruits an institutional investor with significant losses, and which is willing to serve as lead plaintiff in the class action, has a good chance to be appointed lead counsel in the action and to collect the lion’s share of court-awarded attorneys’ fees.”

So now trustees are aware of the class actions, just how should they go about reclaiming what is owed to them?
According to Lovells counsel Penny Pilzer, the answer is surprisingly simple.

Pilzer says: “Trustees should be aware that they do not need to take any steps to join a class action in the United States. They will be entitled to a recovery, and bound by any adverse decision, in a US class action so long as they are within the class identified by the named plaintiffs, and they have not opted out of the suit.”

But while schemes are automatically included in relevant class actions, they must monitor the case closely if they are to reap the rewards.

Eversheds pensions solicitor Jason Shaw explains: “Unlike US investors, foreign investors are not automatically notified of any settlement reached in a class action.

“The trustees of the scheme will normally become aware of the existence of a class action through their investment manager or, more likely, the custodian. If the trustees are unsure whether their custodian is monitoring their investments and the existence of a class action in relation to those invests, then they should request the custodian to do so. As well as the custodian, there are specialised firms who can notify trustees of class actions and monitor them for the trustees.”

The Universities Superannuation Scheme has so far been actively involved in three cases in the US, the largest against Rupert Murdoch’s News Corporation.

USS co-head of responsible investment Daniel Summerfield says schemes should view shareholder litigation as a powerful tool with uses beyond winning compensation.

“If you look at the corporate governance system in the US it is sub-optimal in terms of the ability of shareholders to hold directors to account,” says Summerfield.

“In most cases, it is very difficult to put forward shareholder nominated directors or even vote directors off the company board. We also have not got the right to requisition extraordinary general meetings and shareholder resolutions are non-binding in nature. With all that in mind we have to look at the tools and techniques used in different markets to exert our influence, when necessary, and exercise our rights and responsibilities.

“Shareholder litigation is one such tool we will consider on a case-by-case basis, once we have explored all other avenues, if it means the company is going to be potentially better governed as a result.”

One of the most attractive aspects of class action in the US is that it is practically risk-free. There will of course be some costs involved but unless a scheme is an active party to the proceedings and not just seeking a part of the settlement sum as one would expect, the financial risks are minimal.

Because the US does not have a “loser pays” fee-shifting procedure, and because plaintiffs’ class action lawyers work pursuant to a contingency fee arrangement, unless the suit is deemed entirely frivolous there is very little risk should the claim fail.

Savett says: “Most of these cases are brought on a contingent basis, so the scheme would not have to pay their own attorneys for the work that was performed.

“The US litigation system is different from the UK system, in that except in rare circumstances, the losing party does not have to pay the legal fees of the winning party. That is an exceptionally rare result and normally would occur only where the claims were entirely frivolous and losing party did not have a good faith basis for bringing the claim.”

As a general rule of thumb, things become more serious the more involved a scheme becomes in the case. As lead plaintiff you may have the ability to guide the suit but that demands a lot more effort.

Summerfield adds: “Becoming lead plaintiff could be much more resource and time-intensive and I think the risks are perhaps slightly higher.

But if you are a member of a class suit along with other institutions, the risks are minimised because you are working with other investors and hopefully working with a good law firm who will advise you.

“There are risks but they are reputational risks at the end of the day. But they can be managed if you use this tool sparingly and in the right way.”

So what happens next? Very few of these cases ever go to trial, so settling is often the most favourable outcome for schemes.

Once this happens the court has to approve the settlement and once that occurs, notification is sent to the class members or more often their broker, bank or other nominee.

Investors then have to fill out a proof of claim form, attach supporting documentation and return it to a third party that will assess and validate the claims. This is generally carried out on a pro-rata basis, but it is somewhat dependent on how the settlement is structured.

Savett says: “The calculations can be quite complex and depend on the number of claimants, how many shares were purchased or sold and when and for what price, among other factors.

“After all the claims are processed, the settlement fund is disbursed to the claimants.”

So it seems class actions are a valuable and low-risk tool that can be used by trustees to reap financial benefits and a louder voice as an engaged shareholder.

Will we see more schemes join the party in 2008? It’s impossible to say for sure, but the rewards are there for those prepared to chase them.

As Shaw puts it: “If the trustees win they can be in for a windfall, depending on the size of their holding and the settlement sum. All in all, it is not quite money for nothing, but it is not far off.”


CASE STUDY
The Universities Superannuation Scheme is the UK’s second largest scheme and has been involved in three class actions on a proactive basis, successfully taking on oil giant Royal Dutch Shell, entertainment firm Viacom and Rupert Murdoch’s News Corporation.

Co-head of responsible investment Daniel Summerfield explains how the scheme reviews class action lawsuits.

“We look at each case on its individual merits to assess whether we should get involved or not, but to date we have only been involved in three cases on a proactive basis. We would apply for any settlement that has been made in our name, and that is done for us automatically by a third party service provider. The more proactive side is something we consider on a case-by-case basis because it’s more complex.

“The most noteworthy case we have been involved in was against News Corporation, and this was a direct action specifically on a governance issue.

“When the company reincorporated itself from Australia to Delaware it made a number of assurances to shareholders. One such assurance was that it would not put in place a poison pill when it moved over to Delaware without putting it to a shareholder vote.

“As shareholders were not given the opportunity to approve the poison pill, 12 global investors subsequently decided to file a lawsuit. We were not questioning the merits or otherwise of a poison pill arrangement, we wanted the company to adhere to an agreement it made with shareholders. We wanted to send a strong message to News Corporation and other companies that investors expect agreements between companies and shareholders to be honoured.”

“Our negotiations with the company broke down at an early stage and we felt the only way we could actually get the company to listen to us was through this direct action.

“Another criterion we look at when assessing a case is what kind of message can we send to the market as a whole.
“No money was paid out to shareholders as a result of the News Corporation case but it sent a very strong message which was reiterated in a statement by the Delaware Court.

“Funds need to do their due diligence and be careful about the cases they get involved in and assess the potential ramifications.”

“I would strongly recommend that any pension fund considering participation in a lawsuit should look at the track record of the law firm involved.

“We would also want to ensure that there is at least one US participant because we do not want it to be perceived as a case which is only relevant to non-US investors.”