What do funds have to lose?
The number of securities class action suits in American courts has been growing consistently, a fact that those foreign companies listed on US exchanges are well aware of. According to the Stanford University Securities Class Action Clearinghouse, there were 327 securities class action lawsuits filed in 2001, an increase of 60% over the previous year.
(The involvement of foreign companies is also growing – 22 were named in securities class actions in 2002, up from 15 the previous year.)
This exponential growth is in part caused by the fallout from the passage of the Private Securities Litigation Reform Act (PSLRA), passed by a Republican-dominated Congress in 1995, over President Clinton’s veto.
This established that the lead plaintiff in a securities class action suit has to be the individual or, more likely, the institution that has incurred the largest loss. The ongoing globalisation of investment means that the lead plaintiff in a securities class action increasingly may be European or other international investors.
The dollar amount of settlements has been growing dramatically, along with the number of cases. Before the adoption of the PSLRA in 1995, the average settlement was less than $7m – by 2003, it had risen to a startling $25m and has continued to grow since then. From 2003 to 2004 the average settlement size increased by another 25%, according to Washington DC-based Cornerstone Research.
Cornerstone found that in cases where the lead plaintiff was an institutional investor, the settlements were much higher – a median settlement value of $10.1m against $4.9m without an institution at the lead. In the latest case involving a non-US listed company to reach a conclusion, Dutch retailer Ahold settled in a Maryland court for $1.1bn at the end of November, and that was negotiated down significantly from what the plaintiffs were originally seeking.
With the PSLRA, Congress had hoped to control the number of cases– and also to rein in law firms, on the assumption that large institutional investors would cap their legal fees.
Legal fees are now negotiated – but the number of cases has grown, settlements have increased, and American law firms involved in securities class actions are extending their reach overseas.
European institutional investors confront sound business reasons for getting involved in US-based securities class actions, according to Deborah Sturman of Milberg Weiss Bershad & Shulman, one of the earliest firms to turn its attention to European institutional investors. “If you are an investor in US securities, you are involved in class actions, whether you know it or not,” she explains. “There is a strong argument that you have a fiduciary duty to at least file claims.” In short, if there is a chance to recoup losses, it
would be irresponsible not to.”
Sturman pointed out that substantial amounts remain unclaimed and the pool of money is divided equally only among those investors who submit claims. “It is important to know that your interests are represented,” she maintains. One way of doing so is by establishing a relationship with a law firm. American investors, with long experience, have automated systems that keep them aware of the potential for signing on to securities class actions. Milberg Weiss, like other law firms, offers a securities monitoring service to their clients.
There are several points during the process when legal representation is key. For example, non-US investors are not automatically included in the class for securities suits, explains Milberg Weiss partner Michael Spencer.
“When the amended complaint is filed after the lead plaintiff is chosen, the decision is made whether to include foreign investors or not.” If the lead plaintiff is a foreign investor, however, the class will inevitably include foreign investors.
If the class is defined to exclude foreign investors, there is potential recourse. The Daimler Chrysler US suit and settlement did not include foreign investors, but Milberg Weiss brought a follow-on suit to include them.
It is also possible to opt out of the class and to pursue an individual action. This route may be taken if an institutional investor has losses so substantial that they prefer to go it alone; public funds are less likely to get involved in this route than are other kinds of institutional investors. While class actions are tried in federal court, individual actions can be tried either in federal or state courts, and state laws may offer the potential for recovery that would not be available federally.
While the settlement may be higher, the process is more time-consuming and there is a longer wait for settlement, especially if a class action is being heard at the same time.
Most cases - “99%” in the words of one lawyer - settle out of court. Yet it is not a quick process by any means.
Only 48%of class actions reached a settlement within five years of first filing, according to a study by NERA Economic Consulting. However, it is the law firm that finds itself out of pocket, not the plaintiff.
All securities class action suits in the US are conducted on a contingency basis. This means that the law firm covers the costs of bringing the case and only recoups its expenses – and charges its fee – if the case is won.
“It is a very expensive and challenging process,” says Tony Gelderman, partner in Bernstein Litowitz Berger & Grossmann (BLBG), the firm feted for its $6.2bn victory in the WorldCom case. “We can spend millions just organising and reviewing the documents.”
In addition, plaintiffs’ lawyers face up against the deep resources of the banks and large corporations.
“They have the best legal representation,” says BLBG partner Douglas McKeige, “so you have to bring the best against them.”
The fees and expenses, which are deducted from the settlement, are substantial. In 2003, class action lawyers won some $3bn on behalf of their clients but also took a total cut from that of some $800m. As a percentage of settlement, fees and expenses ranged from 23.5% for BLBG to 30% for Milberg Weiss, and up to 40% for other leading firms, according to research by Securities Class Action Services and Verteris.
Another factor limiting the risk for clients is the fact that there is no ‘loser pays’ rule in the US. “If you lose, under normal circumstances at worst there may be some nominal costs, which the law firm will pay, and even then the foreign investor has demonstrated a constructive willingness to be active against fraud,” points out Milberg Weiss’s Spencer.
The law firms do more than just make the financial investment upfront. They also bear the burden of the workload, according to Hubertus Becker, legal counsel for Activest, a German fund manager that has served as plaintiff in several US class action suits. “It is not expensive – the law firm handles all the costs, so we do not pay any money.”
Nor is it time-consuming: Becker estimates that he only puts in around one hour a week in looking after the fund’s role in the US courts.
“If we were to do it on our own, I do not think it would be so easy. There is a lot of paperwork,” all handled in New York by its law firm.
“There really is no catch” for non-US institutional investors who chose to be plaintiffs in US securities class action suits, says Darren Check, partner and director of institutional relations for Schiffrin & Barroway, based near Philadelphia. “Sometimes we have to convince them of that. The big fear is that the American lawyers are coming over trying to make money off of them.”
The firm “almost fell into” working with European investors “by accident”, says Check. Around two and half years ago, the firm was contacted by a Swiss bank regarding a case against a US company. “This was our wake-up call,” he explains. Since then the firm has taken what it terms “an educational approach” to growing its international client base, running seminars, speaking at conferences and meeting with potential clients. Initial efforts focused on Scandinavia, Germany, Austria, the UK and Italy, and the firm has more recently ventured into France, Belgium and the Netherlands.
BLBG, noted for its long-term relationship with many US public pension funds, is taking a similarly gentle approach to the European market.
“We do not want to go and challenge the culture necessarily. We just want to make sure that European investors know that our services are available here,” Gelderman explains. In the US, BLBG is known for its good relations with many of the large public funds.
There is more than just money involved in securities class actions.
Such suits often have a corporate goverance angle. So in addition to financial recompense, investors can gain a PR advantage, particularly in their home country, by taking part in US securities class actions. Milberg Weiss’s Sturman mentions one client of the firm’s, an Austrian bank, involved in the Parmalat case, which has been receiving positive coverage in its domestic press for its willingness to step forward.
“The pension fund community is realising that it has a shared responsibility to regulate the marketplace,” says Gelderman. “Serious frauds demand restitution.”
The fear of lawsuits is one deterrent against corporate fraud. In addition to that, “there is an option in settlements to effect corporate governance reforms,” Gelderman explains. With the advent of public pension funds as lead plaintiffs, they have tried to change corporate culture, asking for settlements that have included corporate governance reforms, he says.
These changes have included amending the election structure for board members to eliminate staggered boards; insisting on effective independent audit committees; and prohibiting the resetting of stock option prices without shareholder approval.
Opinion is pretty evenly split among investors, according to Check of Schiffrin & Barroway. “Some want corporate governance reforms; some just want their money back,” he notes, pointing out that “there are only certain cases in which you can get corporate reforms. A lot of cases are just about getting your losses back”.
Even as US law firms are actively prospecting for business from overseas clients, they are also seeing legal changes abroad to open courts to similar class actions suits.
In Germany, class action suits are now possible, although the system is geared more towards retail investors – Deutche Telekom is the first big case to hit the courts, and there are others in the pipeline. And in January, Canadian law is also changing to come more into line with the American system.
Hubertus Becker of Activest has a positive impression of the American system of securities class actions.
“Sometimes it is not easy to understand, but we are getting more used to it. I think it’s a really good system.”
These changes are also smoothing conditions for the American law firms, suggests Check of Schiffrin and Barroway.
The firm has strategic partnerships in Europe that help build its client base and has found growing interest from potential partners.
“With the laws changing, they not only are able to provide additional services to their clients, but they are also able to learn about the process,” he says.