Over the past decade, the governing boards of public pension funds and other institutional investors have acted swiftly to implement policies and procedures for monitoring U.S. securities class-action litigation.
Such efforts not only ensure that boards are fulfilling their fiduciary duties to protect and recover valuable plan assets lost to securities fraud and other corporate misconduct, but also have resulted in the recovery of an extraordinary amount of money that would have otherwise been left unclaimed. Indeed, an analysis by the Los Angeles County Employees' Retirement Association determined that it had recovered $40 million through shareholder litigation within just a few years of formalizing its securities monitoring procedures.
The U.S. Supreme Court, however, recently curtailed investors' ability to recover damages under the general anti-fraud provisions of the federal securities laws on international equities and other securities purchased outside the United States. As a result, foreign securities litigation is on the rise and institutional investors increasingly are receiving notices and solicitations concerning foreign securities actions in which they potentially have a financial interest. Because unique attributes of foreign legal systems can implicate logistic and strategic concerns, the decision on whether to participate in foreign shareholder litigation should involve careful analysis and consideration by in-house or external legal counsel who can timely identify foreign actions of interest, appropriately weigh the potential benefits and risks, and coordinate participation in actions determined to be in the fund's best interest.
Specifically, in its 2010 Morrison vs. National Australia Bank decision, the Supreme Court held that claims under Section 10(b) of the 1934 Securities and Exchange Act — the anti-fraud catchall provision — are limited to “securities purchased on domestic exchanges” and “domestic transactions in other securities.” With limited exceptions, lower courts have interpreted Morrison as precluding federal securities claims generally for damages incurred on foreign securities transactions. Investments in American depository receipts traded on U.S. exchanges, however, remain protected.
Since Morrison, investors increasingly are pursuing legal claims for recovery of securities fraud damages outside the United States. For example, securities class-action lawsuit filings in Canada and Australia have recently hit record levels. According to recent reports, in 2011, the total value of all outstanding shareholder litigation in Canada exceeded US$24 billion, and the total value of all shareholder settlements in Australia exceeded US$500 million. Moreover, in Europe, a Dutch court recently issued a groundbreaking decision in the Converium/SCOR litigation that resulted in a $58 million pan-European settlement. That decision established that there is a legally binding mechanism available in Europe to resolve collective securities claims against non-U.S. companies.
While the vast majority of shareholder actions continue to be resolved in the U.S. — 2011 filings totaled approximately $230 billion in value and 2011 settlements exceeded $2.6 billion — it is likely foreign shareholder litigation will continue to trend upward.
The decision to participate in foreign securities actions requires the careful attention of legal counsel — both for the unique attributes of foreign legal systems and the lack of transparency in many of the solicitations and notices provided to U.S. investors. Most importantly, investors cannot passively rely on their custodial banks to file claim forms in the event of a settlement, but must undertake an early analysis of the merits of participating in the foreign action and decide whether to join the litigation in order to share in any recovery. This might take a variety of forms, such as registering for a class action, e.g., in certain British commonwealth countries, joining a representative body, e.g., in the Netherlands, or initiating an individual suit that is then bundled with those of other investors, e.g., in Japan.
Moreover, there are many downside risks in foreign collective litigation that are not present in the U.S. class-action system. For example, many foreign jurisdictions apply “loser pays” provisions that might require investors to pay some of their adversary's litigation costs in unsuccessful suits. Institutions should consider purchasing third-party insurance to mitigate loser-pay risk prior to committing to participation in such actions. Likewise, many foreign jurisdictions do not permit attorney contingency fees, requiring investors to fund the litigation upfront or allocate a substantial portion of any recovery to an outside litigation funder. Logistical obstacles might also accompany certain foreign suits, including discovery obligations, required court attendance and other aspects of case prosecution — not to mention communication with counsel who might not speak fluent English.
Not surprisingly, investors in foreign shareholder actions are often unable to effectively supervise case strategy, management and settlement, and might lack a direct attorney-client relationship with the plaintiffs' counsel, who could be retained by an aggregator or other representative entity.
Further, it is critical to consider the experience and retention terms of legal counsel and any litigation aggregator. For example, does the agreement clearly articulate that the funder or investor is responsible for paying all court-ordered litigation costs in the event the suit fails? Does it contain adequate confidentiality and attorney-client privilege protections concerning investors' participation in the suit? Finally, does the retention agreement inappropriately claim fees from recoveries where no work was done — such as recoveries obtained via government actions? Because of these and other concerns, contracts governing participation in foreign securities actions should be carefully analyzed and negotiated as the potential risks of participating in a foreign securities action might outweigh any potential recovery.
In short, while foreign securities actions may represent one of the only viable options for institutional investors to recover securities fraud damages on foreign exchanges, institutions should be diligent about monitoring these actions, but selective in joining them.
Blair A. Nicholas is a partner and Dave Kaplan is a senior associate at Bernstein Litowitz Berger & Grossmann LLP in San Diego.