Foreign Shareholders Getting in on U.S. Class Actions

Apparently, even the U.S. legal system is feeling the effects of increased globalization.

Recent research shows more and more non-U.S. investors are actively participating in U.S. securities class actions, and in some cases, serving as lead plaintiffs.

Participation by international institutional investors in securities class actions increased substantially over the last five years, according to data from RiskMetrics (formerly Institutional Shareholder Services’ Securities Class Action Services), which found more than 182 instances in which international institutional investors sought to serve as lead plaintiffs in U.S. securities class actions from 1996 through March of 2007.

Based on additional data gathered after the study was published in May of this year, Adam Savett, author of the report, says the number of lead plaintiff motions filed during that period was even higher than the 182 originally reported. The report also noted that, in every year since 2002, international institutional investors have filed lead plaintiff motions in more than 5 percent of all new federal securities class actions. Savett expects lead plaintiff motion filings for 2007 to be at least that high.

“I think the trend of active involvement [in U.S. class actions] by international investors will continue,” says Savett. “In this day and age, institutional investors don’t have a home country bias in their portfolios.”

Indeed, foreign investors figured prominently in recent U.S. securities class actions against companies that are headquartered overseas but trade on U.S. exchanges, such as Parmalat, Royal Dutch Shell, and Royal Ahold. Foreign shareholders even served as lead plaintiffs in class action litigation against Parmalat and Nortel Networks.

Observers say the huge jury verdicts in cases, along with the unique features of the U.S. legal system—such as the availability of opt-out class actions, contingency fees and discovery—are attracting foreign investors to U.S. courts.

Coffee

“While the possibility that a foreign class could get certified in the U.S. has long existed, it’s only in the last three to four years that we’ve seen billion dollar settlements involving foreign companies,” says John C. Coffee, a professor at Columbia Law School and director of its center on corporate governance.

Coffee calls it “the follow the leader phenomenon.” Huge settlements in recent U.S. securities class actions, such as those agreed to by Royal Ahold and Nortel Networks, have caught the eye of foreign investors, he says.

Observers note another major reason international investors are increasingly seeking to bring disputes in U.S. courts: Securities class actions aren’t available most other places.

Savett

“Most institutional investors lack an adequate remedy at home to get compensation for losses suffered as a result of fraud or misstatements,” says Savett. “The concepts of contingency fees and class actions don’t exist in other countries.”

Outside of the U.S., securities class actions are a rarity. The Netherlands has a device that Savett says has a “fairly similar end result, but a far different process,” where the parties involved negotiate before going to court, and a settlement, rather than a complaint, is filed. The United Kingdom allows certain types of class actions, but doesn’t currently allow securities class actions. While South Korea allows class actions, Savett says, so far, none have been filed.

Still, while they may never adopt U.S-style class-action litigation, observers say other countries may eventually provide similar or alternative remedies for investors. “As more wealth is developed in more far-flung places, we may see investors in other countries seek to participate in our system or try to get change in their home country,” says Savett.

Denmark will begin allowing securities class actions in 2008, and Savett says France, Italy, and Germany are thought to be most likely to be next to allow class-action lawsuits.

LaCroix

“It’s clear institutional investors outside the U.S. have awakened to the advantages they may have in pursuing U.S.-based class-action securities litigation,” says Kevin LaCroix, a director at OakBridge Insurance Services and the author of a blog on director and officer liability issues.

“It’s clear institutional investors outside the U.S. have awakened to the advantages they may have in pursuing U.S. based class action securities litigation.”

— Kevin LaCroix,

Director,

OakBridge Insurance Services

“Institutional investors outside the U.S. are increasingly becoming accustomed to the idea that they should be able to hold management accountable and get compensation for misconduct,” says LaCroix. “The best place to do that is in the U.S.”

Further fueling the trend may be the fact that U.S. securities plaintiffs’ law firms are spending more time courting international investors, Savett notes.

F-Cubed Plaintiffs

Meanwhile, a study by NERA Economic Consulting shows another trend.

Historically the percentage of class-action filings in federal courts against foreign companies listed on U.S. exchanges has been lower than the proportion of non-U.S. company listings, states the September 2007 report, Recent Trends in Shareholder Class Action Litigation. “However, in recent years this gap has been narrowing.”

Five years ago the rate of securities litigation against foreign companies was about 5 percent of securities class actions, according to the NERA study. Today, it’s 12 percent.

That’s a troubling trend to some observers, including Coffee, who says the trend of litigation being brought in U.S. courts by foreign plaintiffs who bought stock of a foreign company on a foreign exchange, so-called “f-cubed plaintiffs,” is driving foreign companies away from listing in the U.S.

The jurisdictional issues raised by those so-called “f-cubed plaintiffs” are still being addressed by U.S. courts.

This month, in a securities class-action lawsuit against U.K.-based GlaxoSmithKline, a U.S. court accepted Avon Pension Fund, a U.K. entity, as lead plaintiff. The pension fund, one of a number of foreign investors seeking lead plaintiff status, was chosen over a German institutional investor group that had the largest financial interest due to uncertainty as to whether a German court would uphold a U.S. judgment or settlement.

Tim House, a partner in the London office of Allen & Overy, says the reasoning of the judge in that case “perpetuates the myth” that an English court would recognize the binding effect of the U.S. class-action judgment or settlement on UK shareholders who didn’t opt out of the class.

House

“The further this untested point becomes accepted wisdom in the U.S. courts, the greater the risk that UK claimants will feel drawn to U.S. class actions, and the greater the exposure of UK companies to them,” says House.

The judge cited a March decision in which the same court, in certifying a class action in securities litigation against Vivendi, included investors from France, the U.K, and the Netherlands, but excluded investors from Germany and Austria, because those countries were unlikely to recognize a U.S. class-action judgment or settlement, possibly subjecting the defendants to duplicate litigation.

In another case in September, a New York district court dismissed a class action against Rhodia, a French chemicals company, brought by two foreign investment funds on behalf of foreign investors who purchased shares overseas, on the ground that it didn’t have subject matter jurisdiction over the dispute.

Flumenbaum

Martin Flumenbaum, a partner in the law firm Paul, Weiss, Rifkind, Wharton & Garrison, which represented Rhodia, says the court “was absolutely correct in rejecting an attempt to have federal jurisdiction in the U.S. in what’s essentially a foreign dispute involving foreign shareholders, who for the most part, purchased shares abroad in a foreign company.”

“The decision shows the courts won’t hesitate to dismiss those cases,” says Flumenbaum.

However, it’s a pending appeal that observers say may have the most sway over whether U.S. courts will accept securities class actions involving f-cubed plaintiffs going forward.

A pending decision in a case involving National Bank of Australia is expected to be “one of the more important modern appeal court decisions on whether f-cubed plaintiff cases can be heard,” says Coffee.

Last October, a New York district court dismissed a class-action compliant brought by Australian investors who purchased NAB shares on an Australian exchange, holding that the court lacked subject matter jurisdiction. An appeal of that decision is pending in the Second Circuit, the primary circuit for securities litigation.

“The second circuit may rewrite or clarify the rules on when foreign plaintiffs who brought securities abroad can sue in the U.S.,” says Coffee.