Foreign companies are increasingly finding themselves the victims of costly US securities class actions. Adam Kemal-Brooke explains what this could mean in terms of potential liabilities
Foreign shareholders are becoming more of a permanent fixture in US securities class actions and, while not a new development, foreign-based companies are increasingly seen as a major target for the US plaintiff's bar.
Given the jurisdictional laws of the US and the steady increase in value of the average class action settlement, this issue remains a major concern for European companies, their directors and officers, and insurers. Along with extradition, this particular type of class action represents one of the greatest risks of loss to European companies from the long-arm of the US court system.
Many European corporations have found themselves embroiled in US securities class-action lawsuits. To name a few: Royal Ahold, Daimler-Chrysler, Vivendi, Astrazeneca and Glaxosmithkline have all been subject to one or more actions in recent times.
Dutch company Royal Ahold settled the securities lawsuits against it for $1.1bn (£561m) in cash. The action filed in New York against Italian company Parmalat could top this, as the underlying fraud in that case is reported to be as much as 10 times the $1.2bn financial restatement that triggered the Royal Ahold case.
Subject matter jurisdiction
Many of the companies that find themselves named in securities class actions are listed on the US exchanges. These companies willingly subject themselves to the prevailing US law for any losses stemming from those listings. While it is easy to understand how US courts can assert jurisdiction over disputes in relation to US-listed American Depository Receipts and those involving US nationals, it is less clear how they can adjudicate on matters involving securities traded on foreign exchanges.
However, the US courts have repeatedly affirmed that they can also assert jurisdiction with respect to foreign purchasers of the ADRs and foreign purchasers of non-US traded securities.
The US courts do not require a company to be listed on a US exchange, or even to have a major business presence in the US, to find jurisdiction over the company and a dispute. To establish whether jurisdiction exists - called subject-matter jurisdiction - the courts have developed two tests: the conduct test and the effects test.
In applying the tests, the court considers whether the conduct upon which the claim is based was committed in the US and, if so, was more than 'merely preparatory'. In the effects test, the conduct is committed outside of the US, but the court considers whether the effect of such conduct had a significant effect on the US market. In this way it was possible for US courts to assert jurisdiction and enable shareholders in the Vivendi and Royal Ahold cases to sue in the US, based on losses stemming from securities purchased on non-US exchanges, in a non-US company, by non-US residents.
If the court finds jurisdiction based on one of these tests, the defendants have only one other chance to defeat the class-action lawsuit before trial and that is at the class certification stage. US securities laws provide a number of specific requirements, both implicit and explicit, that the plaintiffs must satisfy in order for the court to certify a class. One such requirement is the 'superiority' of a class action. That is, the class action is superior to other available methods for the fair and efficient adjudication of the controversy.
There are a few common arguments raised in objection to class certification when a class consists of foreign shareholders. One is based on the way in which a class member is notified and given an opportunity to opt-out. Another is the potential lack of claim preclusion or Res Judicata. Both of these issues not only affect any determination of class certification, but they also affect the ability of the parties to settle on a global basis.
When a US class is certified, a notification procedure takes place. The idea is that the plaintiffs are required to notify as many of the potential class members as reasonably possible. The notification essentially puts the potential member on notice that they are a purported member of the class and offers them an opportunity to opt-out. If a potential member of a class opts-out then they are not included in the class and are not entitled to a share of any judgment or settlement in the class's favour. The individuals (or, more commonly, institutional investors) who opt-out are then free to pursue their own claim against the defendant.
Once the court is happy that adequate notification has taken place, it certifies the class, and binds all members of the class, absent the opt-outs. This means that all those who failed to opt-out, or who were just unaware of the action, will be bound by any judgment or settlement entered into by the class representative. The logistical problems of attempting notification to purported members of a class who may reside in several non-US jurisdictions are obvious.
For this reason, defendants generally argue that US notification requirements cannot be satisfied in many foreign jurisdictions, therefore rendering a class action inappropriate. Most jurisdictions in Europe would also be likely to consider any judgment based on such a process as unconstitutional.
Serious problem area
When the inherent difficulties with the notification procedure are combined with the absence of treaties between foreign jurisdictions and the US to enforce the judgments of its courts, it is unlikely that either a court judgment or a settlement agreement, which binds non-participants or non-signatories, would be enforceable in a European court. The principle of Res Judicata is fundamental in common law jurisprudence.
If a final judgment will not be binding against class members in a securities suit, and this will leave the defendant exposed to a second action for the same wrong, how can it be a superior method of adjudication? This very question is awaiting an answer in the Vivendi case and will also be raised during the course of the Parmalat securities litigation. These decisions could finally decide the issue of whether foreign investors can be included in a certified class action lawsuit, thus resolving 20 years of divided authority.
Settlement suffers from a similar problem. Most plaintiffs' lawyers and some defence ones advocate that it is probably a good idea that defendants in any securities suit, which consists of foreign shareholders, should settle on a global basis for peace of mind. However, it is unlikely that a European court would uphold any such settlement as a bar to a future claim. Effectively, any settlement would only be binding on US courts, precluding re-litigation in the US but leaving foreign shareholders free to file suit in their home jurisdiction and, therefore, getting two bites at the cherry. Therefore, any settlement of a US claim by a foreign-based company may well not bind the foreign members of the class.
Some class actions consist of 95% foreign-based securities and only 5% US-based ADRs. Considering this, it is clear that if a company settles for an amount that takes into consideration 100% of the claims by investors while 95% can still sue, that settlement might not look like such good value.
Settling the bill
Consider Royal Ahold, a $1.1bn settlement for all class members, the vast majority of which were foreign-based nationals who invested on a foreign exchange. The settlement figure for a class action in the absence of foreign investors would have been substantially reduced, perhaps by as much as $1bn.
Likewise, the $165m share of that settlement, which represented the amount of fees claimed by the plaintiff law firm, would also have been significantly reduced. But the fact remains that it is unlikely a settlement on a global basis is enforceable in most European jurisdictions.
So, what do companies get for their money? They are definitely buying claim preclusion and issue preclusion in the US - neither ADR nor foreign shareholders could sue again in the US courts for the same alleged wrongs. They are also probably buying the same for US nationals who purchased shares on a foreign exchange.
However, unless the foreign purchaser was named as lead plaintiff or similar and had actively ceded to the jurisdiction of the US courts, it is unlikely that they bought a complete bar to foreign purchasers suing in their home country. Even if such an investor had ceded in this way, it is unclear if this would be enough to preclude them from suing in their home jurisdiction. This would depend on the particular laws of the jurisdiction.
The only way that complete peace of mind could be bought is an impractical - if not impossible - one. It would consist of each and every foreign shareholder agreeing to be bound to a settlement and/or signing a release, which conforms to his particular home jurisdiction's law. Ultimately, the decision to settle has to be based on a consideration of the risk of foreign shareholders suing again, weighed up against the benefit of concluding the US litigation.
- Adam Kemal-Brooke is the special counsel US attorney for Fishburns Solicitors.
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