ALRC examines class actions, third party funders
by Kate Tilley, Resolve Editor
No shareholder class actions in Australia have been prosecuted through to judgement, but the average settlement cost is $A50 million, compared to $C10 million in Canada.
Australian Law Reform Commission (ALRC) president Justice Sarah Derrington told the AILA Qld insurance law intensive the majority of funded class action proceedings filed in the Federal Court in the last five years were claims by shareholders (52.1%) or investors (23.9%).
The settlements meant there was no jurisprudence on how damages should be assessed. But the increase in actions was "not an avalanche". Of 99 cases currently "on foot", 54 were shareholder or investor actions. ALRC had been told three actions alone were sufficient to "exhaust the D&O pool".
ALRC is inquiring into litigation funding and class actions and must report to the Attorney-General by 21 December. A discussion paper was issued in May.
Justice Derrington said while shareholder and investor class actions were increasing, other class actions were decreasing; 100% of shareholder claims were funded and 65% of investor claims. Litigation funders only backed cases with "real prospects".
The inquiry was considering whether the class action regime was the most economically rational way to achieve good corporate governance outcomes, but would make no proposals for substantive law changes because that was beyond ALRC's terms of reference.
Australia's statutory position meant breaches of the continuous disclosure obligations not only attracted ASIC enforcement action but also permitted private causes of action. Before amendments in 2001, a claim for damages required proof of negligence, but there was no longer a requirement to prove intent or fault.
By comparison, in the UK, a private cause of action for breach of continuous disclosure required a claimant to establish that the conduct was reckless or dishonest. Rationale for the higher fault standard was that disclosure requirements were not aiming to sell securities. Negligence was deemed an appropriate fault standard. "If directors do their honest but incompetent best, the claim will fail," Justice Derrington said.
Canada had a statutory right of action for failure to make timely disclosures, including failure to make continuous disclosure of a "material change" in a responsible issuer's affairs, but a screening mechanism was added so leave of the court was required to launch an action.
In 2016, of 31 settlements of statutory secondary market cases, only eight were certified and granted leave. Cases required "a reasonable possibility of success" so the screening mechanism was "more than a speed bump".
Justice Derrington said Marsh statistics provided to ALRC showed from 2011 to 2018, the cost of D&O cover for ASX200 companies increased by 353%. From 2016 to 2018 the increase was 202%. Over the same periods, retention levels had increased 440% and 331%.
The cost of D&O securities class action claims to insurers now exceeded $1 billion (since 2011); four insurers had withdrawn from providing D&O cover to ASX-listed companies; and others were ratcheting back exposure. Marsh said, to break even, D&O premiums needed to triple immediately.
Justice Derrington said industry observations indicated a “chronic over-settling of shareholder class actions” caused by:
• formulaic pleading of allegations against corporate defendants
• relatively straightforward availability of coverage to such claims
• strict liability of continuous disclosure obligations
• corporate defendants weighing up the certainty of resolving against potential uninsured exposure from an adverse judgement
• further share price harm during n-going class actions
• Settlement negotiations being purely commercial, with no reference to the merits of the case.
Justice Derrington said there was emerging evidence of unintended consequences, including diminution of shareholder value and unavailability of D&O cover. "The consequences for boards may be unmanageable."
She asked whether Australia had a systemic problem, questioning:
• Have insurers simply chronically underpriced side C coverage?
• Should there be a thorough economic study into the effect of shareholder class actions (and the legal basis of those actions) on the insurance market?
• Are there longer-term impacts for the Australian corporate sector?
• Is it as simple as re-pricing coverage?
She said there were suggestions costs were being redistributed to insurers and customers and a "circularity problem" with settlement payments being transferred "from one pocket to another with half going to lawyers".
Shareholder who sold at inflated prices were winners, while settlement and defence costs were borne by shareholders at the time of the class action. Victims included those who sold when prices dropped. "Small shareholders who buy and hold are most affected by the circularity problem."
Submissions to ALRC suggested the class action system was designed to help smaller shareholders but instead they came off worse, but there was insufficient evidence to test that argument's validity.