Responsible shareholders using litigation against poor governance

If shares lose value due to negligent or illegal behaviour investors are entitled to seek redress


John Naughton, COO, Institutional Protection

The maxim “let the buyer beware” is the idea that a purchasing party alone is responsible for checking the quality and suitability of goods or services before a purchase is made. But when you buy something that doesn’t work or develops a fault, it’s rare to shrug your shoulders, put it away and forget about it.

Most people would return a faulty item. They’d ask for a replacement or refund. After all, they would have been given an expectation it worked as described. Indeed, they may have researched the item before purchase. They might have received advice and feedback. They certainly would have considered if the item was worth buying for the price paid.

The same principles should apply when purchasing financial instruments, whether it be equities or debt on the stock exchange, or FX transactions on the currency markets.

Most share purchasers undertake pre-purchase research into prospective investments. They often buy based on information published by that company on its performance to date, and its current and future activities.

Justifiable restitution

As an investor, you probably see this one all the time: “Please note the value of investments can go down as well as up so you may get back less than you invested.”

Shares of course go up as well as down in value – and poor management and bad decision making do not constitute a reason for making a claim against a company.

However, if a company neglects to publish information or illegally withholds it from the market, and if the subsequent uncovering and publishing of this information has a detrimental effect on the price of that company’s shares, causing the value of a purchaser’s investment falls as a result, then the purchaser should be entitled to recoup their investment losses.

In short, if someone buys shares in a company – and then sees those shares lose value due to negligent or illegal behaviour by that company – they are entitled to seek redress. The unreasonable or illegal withholding of information, especially at the time shares were purchased, most certainly constitutes a valid reason.

There have been numerous examples of such activity recently, where the nature of the information being withheld from the market may relate to illegal accounting practices (Wirecard), allegations of bribery and corruption (Rolls Royce & Glencore) or the withholding of material information to investors (Volkswagen) resulting in groups of like-minded institutions seeking restitution through the courts.

Inaction is not an option

So should shareholders do nothing when malpractice is discovered, causing significant investor loss? Should the perpetrators of shareholder value destruction (typically the senior management) be permitted to continue to proceed without sanction?

In some cases, regulators step in to halt or prosecute wrongdoing. But if they do not, there needs to be a legitimate restitution process available to investors without which the principle of shareholder ownership in the long term could be undermined. Some may even be discouraged from investing in shares in the first place.

Here enter the nay-sayers.

An oft-quoted counter to the thought of recovering financial loss is that that such a move only serves to further the impact on those very same investors, since any recovery from the company would ultimately diminish the value of their investment, a zero-sum game if you will.

However, this crude and simplistic line overlooks the fact that company value is made up of multiple inputs. These include but are not limited to future earnings forecasts, market sentiment, and future regulatory changes.

There is also a governance argument here. If company management teams understand that regulators and shareholders alike will hold them to account, in multiple ways, they will be less likely to transgress in the first place. Thanks to recent swings in sentiment, driven by myriad concerns (sometimes but not always accurately branded under the ESG umbrella), company owners are more readily being reminded that they have some responsibility for the actions of the company.

Shareholder litigation is another string to that bow.

An increasing number of responsible institutional shareholders are now reviewing their internal policies regarding litigation and are joining shareholder actions both to recoup investors losses incurred through no fault of their own, together with ensuring that good corporate governance is on the same agenda as delivering sustainable shareholder returns. This can improve management and leadership practices and prevent the recurrence of similar events.

Ultimately, it shouldn’t be left to regulators alone. They exist to monitor and promote fair and efficient market functioning. The fines they levy are an appropriate and oft-used sanction, but they are not typically distributed to the affected shareholders.

Shareholder actions allow investors to not only recover such losses but offer the chance to effect governance change to improve investments for the long term.

These are benefits to the broader society, benefits to the companies and their employees, and of course benefits to the end-beneficiaries. It can therefore be a vital tool and one certainly worth exploring.


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