A touch of class

Securities fraud is the act of using misleading information to artificially bolster a US company’s share price. Typical frauds involve lying about the true state of the finances, such as hiding losses, or pulling in expected revenue to help make current annual figures look better. The most famous securities fraud is that of Enron.

Redress for investors is normally taken through legal action on a class action basis. A curious quirk of these class actions is that most cases settle before they reach trial.

Class action specialists Risk Metrics calculate that since 1996 only 19 class actions have actually reached trial. It estimates too, that a third of cases are denied permission to proceed by US courts, while two-thirds settle in favour of the investors. This might sound promising, but some actions can take up to seven years before a pay-out is made.

European investor involvement in US class actions is growing. The National Association of Pension Funds estimated $18.3bn (£9.3bn) was paid out in securities fraud class actions by US companies in 2006, but if UK and European investors had been more active that figure could have grown by $2.4bn (£1.2bn).

The number of class actions put through the US courts in 1996 was 147. This number rose to 485 in 2001, and in 2006, it was 214. The numbers fluctuate from year to year but the general trend has been upward since 1996

Are class actions designed solely to win money or to influence corporate culture of US companies?
UK pension funds often say that supporting class actions encourages better corporate governance across all US companies. However, not all see such a happy ending in sight.

Former securities litigator and Risk Metrics’ current head of securities class action Adam Savett says: “I do not see it like that, but I wish that it were so. If you go back to the Michael Douglas movie Wall Street all those years ago, with its saying “greed is good”; that mentality still exists on a large level, through many different personalities and entities.

“You will always find people being creative and pushing the boundaries. In a perfect world there is a deterrent effect and the federal securities laws will deter a small percentage of people that contemplate fraud, but for those that truly wish to perpetrate fraud, the securities laws are not going to stop them.”

However, institutional investors believe bigger returns can be made from reform rather than legal action. The Universities Superannuation Scheme feels this would happen if US directors were forced to have a similar level of accountability to shareholders, as that in the UK.

USS co-head of responsible investment Daniel Summerfield says: “Shareholder litigation is unfortunately sometimes the only way you can get a board’s attention in the US.

“There is often such an insignificant proportion of losses recovered in an average law suit, that in the long-term, one also needs to consider corporate reforms as part of any settlement. When we look to file a law suit we ask ourselves: ‘Could the litigation process bring about changes which would result in a company being better run?’.”

Summerfield adds that the USS will not enter class actions where a pay-out will only limit the ability of that company to make bigger returns next year.

West Midlands Pension Fund’s chief investment officer Judy Saunders expresses a similar sentiment.

She says: “We see class actions as a way to encourage responsible corporate behaviour and if we manage to recoup some funds then that is a bonus as the two elements are not mutually exclusive.”

Is taking part in class actions a fiduciary responsibility for UK pension funds?
It could be speculated a trustee of a pension fund deep in deficit might be found lacking in their fiduciary responsibility, if they had not claimed on class actions for which they might have gained considerable returns. Such a claim though is only likely to arise as part of a wider list of wrong-doing aimed at trustees.

Many state there is no case law at present and trustees should have little to worry about, but the thoughts of experts in this area suggest trustees who have not looked into this should consider it now.

Railpen Investments’ head of corporate governance Frank Curtis says: “A settled class action is like collecting something that is owed to you like a dividend. It is just good housekeeping.

Similarly, NAPF’s head of corporate governance David Paterson added last year: “At a time when pension 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.”

While monitoring and class action costs are so small, says the West Midland Pensions Authority, schemes cannot ignore their responsibilities in this area.

The only clear get-out for trustees is where the effort and expense in claiming outweighs the potential gains.
If you believe that what happens in the US tends to follow in the UK a few years later then a fiduciary responsibility to claim would appear to be on the cards.

Risk Metrics’ Savett explains: “In the US it is fairly universally believed that institutional investors have an affirmative legal duty to file a claim in a securities class action settlement. Various laws state in essence that the claim is an asset that belongs to the institutional investor or the fund and they cannot simply abandon that without reason, unless the cost of filing is more than the money they can get back.”

Well run pension funds have come to see this as normal practice.

Another reason it might be a fiduciary responsibility, is where a fund’s proportion of US equities has grown. The Universities Superannuation Scheme currently holds 13pc of assets in US equities.

Summerfield says: “By virtue of the fact you are operating in these markets means you have to utilise different engagement tools. It might be culturally unappetising for UK pension funds to do something they would not consider for the UK market, but there is a general understanding that there is money sitting there with our name on it and if we do not file then other members of the class will.

“There is a growing awareness there is money waiting on the table for us to collect.”

Why are some UK funds acting as lead plaintiffs?
While it could be argued there is a fiduciary responsibility to claim in settled class actions, there is a much weaker argument that UK pension funds have a duty to file lead plaintiff cases. These often arise when US lawyers urge investors to opt out of class actions on the logic they can present a better case with a chance of earning more money.

Railpen’s Curtis says: “An attorney will say: ‘We can do better because the lead attorney in the class action has sold out for too little and we have a better case.’ Sometimes they are right, sometimes they are wrong. An opt-out claim will go faster, it will not go through the glacial process of a claims administrator. You are just dealing with the other side and they pay up. But there is a bigger risk. If the class action wins later on, you can lose out if your case loses.

“Plus if it is your own legal action you can expect a lot more intrusive disclosure requirements from the defendants lawyers in terms of information and this takes time.”

Another reason for becoming a lead plaintiff is when UK funds find it easier to seek redress against UK companies in the US rather than in Europe. On this basis the London Pensions Fund Authority has filed a law suit against BP in the US and the Avon Pension fund have brought one against GlaxoSmithKline.

What involvement have UK pension funds had in US class actions so far?
The West Midlands Pensions Fund has been involved in this area for three years and in that time has won $220,000 (£112,000) in settlements. However it is waiting to hear from more than 20 outstanding cases where a settlement has yet to be agreed by the US courts.

Not everything has gone the fund’s way however. Last year, the fund applied to the US Federal court as a co-lead plaintiff against US computer giant Dell. It accused Dell of false and misleading statements which inflated the share price during 2003 to 2005, followed by a sharp decline in market value as the company’s financial position became clear. The fund calculated losses of $1.8m (£914,000), but the court rejected its application.

The Universities Superannuation Scheme was more successful in an action it brought with 11 other institutional investors against News Corporation in 2005. The complaint argued that News Corp, in shifting its operations to the USA and modifying its legal entity, was seeking to diminish current shareholder rights.

The action was successful and the verdict given by the Delaware Court of Chancery read: “When shareholders exercise their right to vote to assert control of the business and the affairs of the corporation the board must give way. This is because the board’s power, which is that of an agent’s with regards to its principal, derives from the shareholders – who are the ultimate holders of power under Delaware law.”

Summerfield says: “In the US this was quite a powerful signal that we as shareholders are the ultimate holders of power under Delaware law.”

Interestingly, this case was not about winning financial compensation, more about asserting shareholder rights. The USS has been involved in two other cases against Shell, which settled out of court, and against Time Warner.

Railpen has also won a class settlement against the advisers to failed US business WorldCom. Railpen’s Curtis says the settlement was “significant” and the first payment was made in December 2006.

Will there ever be class actions brought in Europe/UK?
Class actions do not tend to take off in Europe because here litigants will face legal costs if they fail, whereas in the US that is not the case. However, as European funds become accustomed to class actions the incidence is rising.

The most high-profile European class action was against Shell, after it overstated the amount of oil reserves it was holding. The European action started after the Pennsylvania State Teachers Fund filed a claim against Shell in the New Jersey courts. The sentiment among European investors was that they would not gain favourable terms in a US court and as European investors hold some 80pc of the value of Shell, they should seek a European remedy.

Helped by a change in Dutch law, a class action claim was filed in the Dutch courts and a settlement reached with Shell for a $400m (£203m) payout, plus costs.

Curtis says: “The settlement is consensual and reasonable. It does not involve the company being tied up in litigation for years and years. The management can get on with running the company. It is a European solution to a European issue.”

One understanding of the settlement is that if the US class action settles for more, then the Dutch mass settlement will make up the difference. According to the specialist pensions law firm Sacker & Partners, European investors might bring class actions against EU member states that have contravened EU law on tax.

What new services are there to help UK pension funds?
Firstly, there are the specialist class action firms that will monitor class actions in the US and inform UK investors if they should take part. Most of these are based in the US, but some are now setting up offices in London.

Once these specialists have the data of a scheme’s investments the hard work is over and pension funds can sit back and wait for their US equities to be tallied with any current class settlements.

These services are especially useful for pension funds that have switched their investment managers or custodians frequently, as they specialise in forensic accounting which can recreate past positions. These firms will combine a range of accounting, investment and legal expertise.

One of the leading firms in this area, Risk Metrics, offers a loss calculator service that will calculate how much one of their clients has lost as a result of securities fraud in a particular class action.

The class actions specialists have stepped into a space that many custodians operate in and custodians are being forced to respond. As such Northern Trust is to offer a daily reporting system that alerts its clients on the full range of live class actions.

Northern Trust’s product manager Paul Cocklin says: “Our new reporting will be particularly useful for clients that have changed their asset servicing provider or investment managers since the class action was originally lodged and who are, therefore, no longer supported by their previous service providers.

“Our process ensures claims are filed in the event the client or their investment manager is not actively tracking and making decisions about class actions.

“Furthermore, Northern Trust will credit the client’s account when the payment is received, with the added benefit that we make the proceeds immediately available for the client to invest.”

Other services on offer to UK pension funds are US law firms that seek no-win, no-fee agreements to take part in class actions.