By Associate Professor Michael Legg, UNSW Law, John Emmerig, Partner and head of Jones Day's class action practice for Australia, and Mark Fisher, Associate with Jones Day.

SYDNEY: 7 August 2014 - The last nine months has seen a major increase in shareholder class actions.  Thirteen class actions have been threatened or filed against eleven ASX listed corporations including Treasury Wine Estates Limited, Leighton Holdings Limited, WorleyParsons Limited and Newcrest Mining Limited.   Consequently there have been eleven ASX listed corporations, the majority of which form part of the ASX 100, subject to allegations that they contravened their continuous disclosure obligations and engaged in misleading or deceptive conduct.  What is driving this sudden increase in shareholder class action activity?    

A part of the explanation is the increase in new law firm and funder entrants to the market (ie the market for funded class action litigation).  The traditional plaintiff law firms of Maurice Blackburn and Slater & Gordon are involved in some of the thirteen actions.  As is Australia’s largest litigation funder, Bentham IMF Limited.  But there are also some new names. Melbourne solicitor Mark Elliott, and his investment company Melbourne City Investments Pty Ltd (MCI), are behind four class actions.  Although the Supreme Court of Victoria in proceedings against Treasury Wine and Leightons has ordered that Mr Elliott be restrained from acting for MCI whilst it is the lead plaintiff and that the proceedings not be permitted to continue as a class action whilst MCI and Mr Elliott act in tandem as plaintiff and solicitor due to concerns about conflicts of interest.  Another new entrant, ACA Lawyers in Sydney is also responsible for five class actions.  Three of which are backed by the UK-based litigation funder Harbour Litigation and a fourth is funded by Litigation Lending Services Limited.

Outside of shareholder class actions new entrants are also behind a number of other class actions.  Shine Lawyers is investigating a financial advice class action involving the Commonwealth Bank.  Piper Alderman has entered the class actions market with a number of class actions against financial advisors, investment banks and rating agencies on behalf of local councils in relation to financial products.  Macpherson + Kelley have pursued class action in relation to the collapse of the Timbercorp and Great Southern managed investment schemes.

The new entrants will not come as a surprise to those with a passing knowledge of economics and the significant returns that securities class actions have delivered to funders and lawyers.  By way of example, Bentham IMF Limited has generated revenue of $1.2 billion of which $429 million went to IMF in the period from listing until 30 June 2013.  IMF has a gross return on investment (ROI) of 290%.  Class action lawyers have done well too.  The Centro shareholder class actions saw the plaintiffs lawyers be paid $30 million. The Multiplex and NAB shareholder class actions saw the plaintiffs’ lawyers receive around $10 million in each case.

Profitable markets that yield high returns will attract new firms, particularly where barriers to entry are low.  But what will the impact be? 

On one view, the new entrants should cause the size of commissions charged by funders (typically, 25 to 45%) to fall as a wider pool of funders start competing against each other for the available class actions. To a degree this is happening as shown by multiple class actions against some corporations.  However, an alternative outcome is that the size of the class action market may expand with an increase in the volume of claims, at least for a further period of time, before there is any drop off in funder commissions until the number of new funders and level of available litigation funding starts to saturate the plaintiff market.  The Productivity Commission’s recommendation for lawyers to be able to charge contingency fees would, if implemented by government, provide a significant source of new funding over and above the increase in litigation funders.  In this environment, significant pressure will be present for the volume of shareholder class actions to continue to increase as funders and lawyers search for signs of a potential contravention.  With increased volume comes reason for concern that the quality or merits of the new claims that are pursued will start to fall. 

Shareholder class actions are not like tangible commodities where the product quality is more readily and immediately observable.  With shareholder class actions the unmeritorious action may get filed because it attracts shareholders who have seen the share price drop but are unable to effectively evaluate the strength (read: quality) of the claim.  A manifestation of this problem in the US, that has caused no end of difficulty to address, is the ‘strike suit’ — ie a class action filed based on a share price dip and in the hope that it attracts a settlement payout by the target defendant company because this is assessed as preferable to the cost and delay associated with defending the case.  Litigation funders don’t make profits unless they fund litigation against someone.   

The previous federal government lowered barriers to entry by exempting litigation funding from a range of regulatory requirements that the courts had found applicable.  Government also chose not to impose any licensing or capital adequacy requirement.  Instead, litigation funders were only required to manage conflicts of interest.

The legislature could put downward pressure on the expansion of shareholder class actions by regulating the market for class actions or adding barriers to entry.  This could include stricter regulation of litigation funding in terms of the requirements to be permitted to operate as a funder in Australia.  It could also include putting caps on the fees that funders may charge – a step that has been frequently taken in relation to contingency fees in overseas jurisdictions.  The surge in shareholder class actions could also be addressed by imposing stricter procedural requirements for the commencement of class actions, such as revisiting what amounts to a ‘substantial common issue of law or fact’.  Equally, Parliament could revisit the substantive law to require some degree of fault or negligence for breach of the continuous disclosure requirements to be actionable.  Government has many levers at its disposal but regulating funding would be a positive start.