29 June 2020
The global health pandemic brought on by COVID-19 has devastated economies around the world. Directors and officers are in an incredibly challenging position right now. The current environment of lock-downs, travel bans and quarantines means that many companies are in financial difficulties or will run into financial difficulties very soon. Prime considerations are business contingency planning, supply chains, and relationships with shareholders, trade creditors and secured lenders.
Whilst COVID-19 related securities class actions have been announced in the USA, as we detail below, none have been announced in Australia. There may be rich material for plaintiff lawyers and litigation funding to mine. Between 1 December 2019 and 9 March 2020, 596 announcements referencing Coronavirus or COVID-19 were made by 326 ASX-listed entities (out of a total of 1,800).2 Recent statements from the Former Law Council president Stuart Clark suggested that COVID-19 class actions were “spreading like a virus in the US and they are now infecting Australia”. With limitations not presently being in issue, it is probably going to be a little time before we start seeing cases being filed. The risks of a shareholder class action arising from the current situation should be on the minds of directors and officers (and their insurers). However the degree to which we will see a huge surge of securities filings is still uncertain.
In this article, we consider the likely trends for securities class actions in the next 6 to 18 months as Australia emerges from its COVID-19 lockdown. We will consider the impact of the reforms to the continuous disclosure rules. We also look to whether the securities class actions already filed in the USA, as well the historical experience during the Global Financial Crisis (GFC), may provide some guidance in determining the current trends. Finally we will review some of the recent developments in class action procedure such as common fund orders and the fallout from the recent settlement of the Myer claim to see the effects these are likely to have on how securities claims are likely to be brought.
Reforms to Continuous Disclosure Rules
The government’s amendment, facilitated by the Corporations (Coronavirus Economic Response) Determination (No 2) 2020, provides for a temporary change to the current test for establishing a breach of the continuous disclosure provisions in s.674, s.675 and s.677 of the Corporations Act. The amendment alters the previous objective test, requiring proof of actual knowledge, recklessness or negligence by the company or its officers with respect to whether information would, if it were generally available, have a material effect on the price or value of the securities of the entity. The amendment will be in effect for a short period, from 26 May 2020 to 26 November 2020, absent any further extension.
The government announced that the purpose of the amendment is to protect companies and their officers from the threat of “opportunistic class actions” and to make it harder for such actions to be brought during the COVID-19 crisis. It remains to be seen whether the amendments will achieve these aims.
We are sceptical that the amendments will provide substantive relief to companies, their directors and officers and insurers from securities class actions. The amendments do not provide a complete moratorium. Whilst an additional level of defence may be deployed by an entity, there is likely little practical difference between the previous due diligence defence available to a director3 involved in a contravention and a claim in negligence. A director’s duty of care is likely to be informed by ASX Listing Rule 3.1 which requires the entity to disclose all information it is aware of, if a reasonable person would expect the information to have a material effect on the price or value of its securities. There may be a slight change as the standard of care shifts from what information a “reasonable person” would expect to be material, to a “reasonable director”, but practically the difference may be indistinguishable. Critically, the changes do not affect the Australian Consumer Law (ACL) and will still allow plaintiffs to bring class actions alleging misleading or deceptive conduct in respect to disclosures made to the market and as noted, there have already been a significant number of COVID-19 related disclosures. Such causes of action are frequently prosecuted in securities class actions.
The uncertainty around the appropriate legal test is unlikely to discourage plaintiff lawyers filing proceedings, just as it has not done previously. Uncertainty itself can be a significant driver for settlements given the significant quantum often involved in these types of claims. After all, around 120 securities class actions were commenced and finalised before the first judgment last year in the Myer shareholder class action.
In addition to the short-term reforms to continuous disclosure, the Federal Government recently announced a Parliamentary inquiry into litigation funding and the regulation of the class action market, with a report due by 7 December 2020. The inquiry will consider whether the present level of regulation applying to Australia’s growing class action industry is impacting fair and equitable outcomes for plaintiffs. Particular issues to be considered include:
-
What evidence is available regarding the quantum of fees, costs, and commissions earned by litigation funders, and the treatment of that income;
-
The impact of litigation funding on the damages and other compensation received by group members in class actions funded by litigation funders;
-
The potential impact of proposals to allow contingency fees, and whether this could lead to less financially-viable outcomes for plaintiffs;
-
The application of common fund orders and similar arrangements in class actions;
-
The consequences of allowing Australian lawyers to enter into contingency fee agreements, or a court to make a costs order based on the percentage of any judgment or settlement;
-
The Australian financial services regulatory regime and its application to litigation funding; and
-
The potential impact of Australia’s current class action industry on vulnerable Australian businesses already suffering the impacts of the COVID-19 pandemic.
The Government inquiry indicates some unpredictability in the class action market and may cause litigation funders to reconsider immediate filings while they wait to see how future government reforms will affect the viability of any future investment.
Will the USA cases provide guidance?
There are at least seven securities class actions filed in the US arising from COVID-19:
- Norwegian Cruise Lines. The action was filed on 12 March 2020 and the complaint alleges that the company, a NYSE listed cruise line, was making materially false and misleading statements in its February SEC filings as to the resilience of the company and its ability to manage the effects of COVID-19 on its business. The complaint alleges that the company failed to disclose it was using misleading sales tactics to entice customers to book cruises including making a false statement about the risk of COVID-19 on its cruise
- Inovio Pharmaceuticals. The Claim was filed on 12 March 2012. The complaint alleges that the CEO of the company made several false public claims regarding how quickly it was able to develop a COVID0-19 vaccine, with it announcing plans to start clinical trials by April 2020. Following an activist short seller releasing a report that the company was not working on a COVID-19 vaccine but rather had designed a vaccine precursor and would not be able to begin clinical trials by the date, the share price fell 71%
- Zoom Video Telecommunications. On 7 April 2020, a claim was filed against Zoom, which produces videoconferencing software which has become popular during the COVID-19 pandemic. The complaint alleges that recent alleged privacy and security concerns had revealed that the company had inadequate data privacy and security measures, including those arising from the nature of the encryption used and the use of customer data by third parties such as Facebook, despite previous representations by the company to the contrary
- iAnthus Capital Holdings. On 15 April 2020, a claim was filed against iAnthus Capital Holdings, a Canadian holding company with interests in different cannabis cultivators, processors and dispensaries. Its shares are listed on the Canadian Stock Exchange and are also traded in over-the- counter American Depositary Receipts (ADRs) in the US. The complaint alleges that iAnthus failed to make interest payments under a debenture agreement with a private equity company as market conditions caused by COVID-19 caused a fall in the value of its cannabis equity holdings
- Phoenix Tree Holdings. On 24 April 2020, a claim was filed against Phoenix Tree Holdings a Cayman Island holding company that leases and manages apartments in 13 Chinese cities, including Wuhan. Its shares are traded in the USA through ADRs on the NYSE. The complaint alleges that the company’s January 2020 IPO documents failed to disclose the effects that COVID-19 was already having on the Chinese property market, especially in the cities that Phoenix tree operates
- SCWorx Corp. On 29 April 2020, a claim was filed against SCWorx Corp, a healthcare information software services company. The complaint alleges that the company had represented that it had signed a contract to provide 2 million COVID-19 Rapid Testing Units. The complaint, based on allegations made by a short seller’s research report, alleges that this contract was overstated or entirely fabricated and likely to be materially misleading
- Sorrento Therapeutics. On 26 May 2020, a claim was filed against Sorrento Therapeutics over comments its CEO made to Fox News, to the effect that it had discovered an antibody that could cure COVID-19. Following this announcement activist short sellers published a research report questioning these claims and Sorrento’s shares dropped 43% It is difficult to draw solid conclusions from only seven cases; however, some interesting patterns are emerging.
Most of these cases are a direct result of comments made by the management of businesses directly affected by the COVID-19 pandemic including in the healthcare/ pharmaceuticals, tourism and property management industry sectors.
The Zoom case reveals the increasing importance of privacy- related breaches to event-driven class actions in the USA, a phenomenon that has not yet reached Australia, but may become an increasing feature given Australia’s recent strengthening of its personal data and privacy laws and the increased confidence of the regulator.
The iAnthus case, which concerns alleged misrepresentations around the failure to meet debt obligations may be repeated as the disruption and volatility of the financial markets continues.
A number of these cases have been triggered following activist short-seller attacks. Before COVID-19, short-seller- linked class actions were becoming more frequent in Australia, for example, the Quintus and Blue Sky Alternative Investments class actions, and are may to become an increasing feature of class actions brought as a result of COVID-19.
Finally, the fact that two of the class actions have been filed concerning foreign companies through their American Depository Receipts/Shares provides as a timely reminder of the risks that Australian companies with ADRs potentially face, as detailed in Clyde & Co’s previous article.
Will Any Securities Class Action Patterns Repeat From the GFC?
Even though it is always tempting to seek to draw comparisons between historic events, differences between the cause of the COVID-19 crisis and the GFC make it more difficult to draw comparisons when it comes to predicting the likely direction of securities class actions. The 2008 GFC was precipitated by a banking crisis and too much bad debt, whereas the COVID-19 crisis has been caused by severe worldwide lockdowns that have hampered almost all aspects of the supply-side economy. In contrast to the GFC, the current economic crisis has not been triggered by the mis-selling of complex financial products, and as such we are unlikely to see similar securities class actions like Pathways Investments Pty Ltd v National Australia Bank Limited, which revealed the failure of NAB to properly disclose the extent of its exposure to collateral debt obligations and failed to make adequate provision to cover expected losses.
Whereas financial institutions and their directors were seen as fair game following the GFC, it remains to be seen whether shareholders have the same appetite for class actions in the context of an unprecedented worldwide health pandemic.
The one potential similarity between the two crises is the risk associated with the failure of companies to disclose debt exposures. Securities class actions during the GFC were primarily a consequence of the global credit crunch. Corporations affected generally included highly geared companies and companies with a business model dependent on short term liquidity.
A number of class actions after the GFC were based upon disclosures around the refinancing of debt obligations or loans became problematic for some companies when the squeeze of credit markets made refinancing impossible. Examples included the Centro Properties class action which involved Centro failing to disclose the full extent of their maturing debt obligations, valued in the billions of dollars and the risk that they may not be able to refinance their maturing debts at forecasted costs or at all. The matter settled in 2012 for AUD 200 million. Other examples include the OZ Minerals class actions where the allegations of breach of continuous disclosure were the failures to disclose refinancing of loans and the true debt position of the company. The two matters settled for AUD 56.9 million and AUD 32.5 million respectively.
One procedural matter to note from the GFC class actions is the amount of time that it took between one year (for Centro, filed in 2008) and five years, (for Allco, filed in 2014) for securities class actions to be filed. Further, it took up to
4 years for these actions to be successfully settled. A similar pattern is likely to be repeated and a long tail of securities class actions should be expected by insurers.
Recent legal decisions that may affect future trends
A number of recent court decisions are also likely to factor in to future trends, specifically the recent Myer judgement and the ongoing issues common fund orders may have an effect on securities class actions.
The Myer Decision
As we have previously detailed the Myer decision was the first judgment issued in a securities class action in Australia. The judgment did not totally resolve the claim, as although his Honour Justice Beach found that Myer had failed to disclose to the market that it would not reach its forecast, the Applicant and Group Members had not been able to establish any loss, because there was already healthy scepticism in the market that Myer would not meet its forecast and this had been factored into the market price of its securities. Despite that, his Honour provided the applicants with a second opportunity to prove that they had suffered a financial loss, although the matter settled in early May 2020 with an agreement that the case be dismissed with both parties to pay their own costs, in part due to the difficulty in establishing a financial loss.
The decision provides a mixed benefit for future securities actions. On the one hand, the finding that market based causation is available to plaintiffs as a matter of law, is favourable to applicants as it potentially makes it easier for future securities class actions to establish causation depending on the facts of any particular case. However the decision also emphasises the difficulty an Applicant and group members may encounter in establishing loss. While Justice Beach accepted an inflation-based measurement as a means of establishing a loss, he determined that the Applicant and group members had not established that the shares were inflated and that the Company’s contraventions had not caused any loss to shareholders. The decision emphasise the importance of expert evidence on the appropriate loss methodology in any particular case.
Considered in the light of the current financial market conditions, and healthy scepticism arising from the Myer decision, this will likely give pause to applicants rushing to file securities claims as it is not necessarily the case that an updated disclosure and an accompanied price decline is all that is required to establish a successful claim. Litigation funders are likely to require substantial due diligence on the issue of loss at an early stage before committing their funds. As a result we predict that if there is an explosion in securities claims arising from COVID-19 disclosures, it will take some time for such claims to materialise.
Class Action Funding
The Australian class action market was shaken up in December 2019 when the High Court handed down its decision in BMW Australia Ltd v Brewster; Westpac Banking Corporation v Lenthall [2019] HCA 45 (BMW Australia) in respect of common fund orders. Prior to this decision, the practice of litigation funders was to approach the courts for an order at inception of a class action, which order would provide for a common fund to be implemented upon settlement or judgment and in terms of which the funder would receive a set percentage or commission from the settlement or judgment amount, whether or not all group members had entered into a funding agreement with the funder. Once the funder’s commission was paid from the settlement, the remaining proceeds would be spread between the group members – the result being that in effect all group members contributed to the funder’s commission, whether or not they had agreed to so do. The judgment in BMW Australia held that the Federal Court and the New South Wales Supreme Court do not in fact have the power to make such orders at an early stage of the proceeding.
Although this was a significant judgment in that it disrupted a common practice, the disruption is likely minimal. An early common fund order was never a guarantee as it was always subject to review or amendment by the Court as part of its deliberations for settlement approval. Further, as securities class actions are commonly backed by large institutional investors, such as superannuation funds or pension trusts, the need for early common fund orders is generally less than in other areas such as consumer class actions, where the need for funders to “book build” has been significantly hampered by the BMW Australia decision.
In addition, funding equalisation orders are still available. This is an order made at settlement or judgment in terms of which only the group members who entered into a funding agreement are liable for the funder’s commission. However, the Court makes an additional order that those who did not enter into the funding agreement are required to contribute to those who did. Therefore, the funder will still receive its agreed commission from the settlement or judgment proceeds first. Without a funding equalisation order, the group members who entered into a funding agreement would receive a lower share of the remaining proceeds than those who did not, as the latter would not be responsible for the funder’s commission. A funding equalisation order compels those group members to contribute a portion of their share pro rata to the group members liable for the funder’s commission, such that effectively all group members bear the funder’s commission equally.
Another event causing upheaval in the funding market is the introduction of contingency fees in Victoria. Under the reforms plaintiff lawyers will be allowed to apply for an order to the Supreme Court to allow them to claim percentage of the damages in class actions, including securities class actions. The rise of contingency fees are likely to cause a rise in competition between plaintiff firms and traditional litigation funders.
Conclusion
The full extent of the securities action risk is likely to emerge slowly after the lockdown in Australia is finished, and business starts to work through the issues of re-opening. Further, investigations by liquidators and regulators into allegations of misconduct are likely to take time. Whilst they can be brought concurrently, securities class actions are usually secondary to insolvency proceedings or prosecutions that usually follow corporate collapses linked to economic downturns, as investors will await the outcome before trying to recoup their losses.
The slow speed of filings is likely to be exacerbated by the outcome of the newly-announced government inquiry and Court intervention in the interim, as litigation funders may be reluctant to commit to funds while it is uncertain whether they may be able to obtain some form of assurance of a rate of return and the Courts have already expressed a willingness to interfere in commission rates. The recent changes announced in relation to funders being subject to some regulation (for example, from 22 August 2020 funders will by requiring them to hold an Australian Financial Services Licence)4 is not likely to have any chilling effect on the bringing of claims.
Despite the government’s short-term reforms to continuous disclosure laws, the risk of securities class actions still remain. The categories of representations to the market which are likely to come under scrutiny (in the context of later corrective announcements/share price falls) include:
-
Announcements which downplayed the anticipated impact of COVID-19 on the business;
-
False assurances about business contingency plans being in place and adequate to meet challenges;
-
Statements that business model/ supply chains were resilient and would not be interrupted; and
-
Disclosures about their ability to meet large debt obligations.
For further information, please contact:
Christopher Smith, Partner, Clyde & Co
christopher.smith@clydeco.com
1 The authors would like to thank Olivia Kiss (Associate) and Himisha Hewage (Law Graduate) for their assistance in preparing this update.
2. Morningstar Data Analysis (data retrieved 9 March 2020).
3 See ss674(2A) and (2B) of the Corporations Act.
