In the UK and Europe, a US-style litigation culture has largely remained the preserve of daytime television adverts urging personal-injury victims to sue over accidents that might or might not have happened. After all, where there is blame, there is a claim. And now, even institutional investors are proving that they too can reach for a phone and dial 1–800–LITIGATION.
Last year, for example, the UK Local Authority Pension Fund Forum asked George Bompas QC for his opinion on the legality of accounts prepared under IFRS. He concluded that it was “questionable whether statutory accounts prepared in accordance with international accounting standards…. will always give a true and fair view.” On the back of that, institutional investors in the UK have demanded that the International Accounting Standards Board reintroduces an explicit reference to prudence into its conceptual framework.
And last month, the RBS Shareholder Action Group issued proceedings at the High Court in London against former bank chiefs Fred Goodwin, Tom McKillop, Johnny Cameron, and Guy Whittaker, as well as the bank itself. The action group comprises retail investors, former RBS staff, and over 100 institutional investors who lost money on a 2008 rights issue. The claimants allege they were conned into buying the shares; RBS has said it will vigorously defend the claims.
What makes the RBS case unusual is the mere that fact it has happened. “People might wonder why there are few, if any, class actions in the UK – apart from the recent action launched against RBS,” notes proxy voting adviser Sarah Wilson, CEO and founder of Manifest, a UK-based proxy adviser.
As Wilson points out, European shareholders have far-reaching powers and can use these to remove directors, appoint auditors and block rights issues. These rights are legally binding on companies.
“Stateside we see that ownership rights are prescribed by the SEC and so it is not a matter of law if a director is removed at an AGM. In other words, a vote against a resolution in an AGM is not backed by legal redress and so most votes are precatory or ‘pleading’. The US also has cumulative voting, so if there is just one vote is cast in favour of a resolution, it is carried. Overall, shareholder rights are much less secure in the US, so shareholders have tended to turn to the courts for redress.”
Stuart Grant, the co-founder and managing director of US class action law firm Grant & Eisenhofer, adds that litigation is about finding an edge. “In the US we’ve chosen a litigation-oriented model. I would not be surprised to see more and more litigation coming out of both the UK and Europe. There are some advantages to this model but there is a high cost. Culturally, the litigation model fits the US environment better than it does a more homogeneous model such as the UK.”
Grant adds: “Sometimes litigating a specific case is easier than the one-size-fits-all approach that you have with regulation. Regulation is done on a high-level, big-picture basis, whereas litigation is a rifle shot.”
One curiosity of the rush to litigation is the way it has outpaced the public debate, leaving two questions largely unexplored: who are the litigants, and why are they going to court?
“In the debate about Bompas, one point that has been overlooked is why shareholders got together and sought that opinion,” says Wilson. “Over the years, we have seen a dramatic shift in the purpose and focus of audit in that it has been dramatically misunderstood. What we have seen with financial reporting in recent years is a shift toward providing information that will facilitate trading rather than stewardship.
“The conflict is really this: Wall Street wants quarterly figures and a rock-solid audit once a year that address the issue of going concern. And this is really where we have seen the conflict play out in the UK. People talk about an Anglo-Saxon corporate governance model, but I view this as a misnomer. There is a fundamental difference between the two markets: just because the US and the UK speak English does not make them the same.
“If you look back to the Cadbury Report in 1992, it examined how audit failed to highlight risks and the inappropriate behaviour of management. This matters because there is a societal risk if companies run amok. Audit is an important, arguably the first, line of defence for shareholders, because the latter looks to auditors look to auditors to confirm that investment won’t backfire because of an unseen risk.”
There is, says Grant, a conflict between the pension fund, on the one hand, and the short-term investor – perhaps an activist investor – who, rather than owning a stock in the traditional sense, effectively rents it.
“Then there is the distinction between the beneficial owners and the money managers, the latter looking, for example, at quarterly earnings with little interest in the long term. This investor might not care about company results but what they’re getting in fees. In other words, they are not really wedded to the ownership of any company,” he adds.
Clearly, a litigation culture will have its downside, one aspect of which could be less reliance on regulation, says Grant: “Maybe the disadvantage is that litigation takes place after the fact. Regulation is supposed to be prophylactic. So, from a shareholder perspective, regulation is a better approach in some ways.”
On the other hand, he adds, litigation holds specific people or entitles to account when things go wrong, whereas regulation tries to deal with broader issues. So whereas regulation, is about a smaller burden spread among a large group of people, he explains, litigation is a heavier burden landing on a smaller group of people. “In a way, litigation is a form of regulation, albeit not by government but by saying that the consequences of going down a path are so great that entities will try to avoid it.”
But does it work? On balance, Grant suggests that it does. “If you look at the example of product liability, I think you can see that products are much safer now because of it. Similarly, the accounting firms have been hit in the US and Arthur Anderson went under as a result of litigation.
“The audit profession has finally woken up and started to jettison their high-risk clients and take their audit work more seriously. It was only when there was an economic penalty for screwing up audits that they realised it wasn’t worth it. So, yes, you do see a change in behaviour, because boards are getting more serious about what they do.”