When Tesco PLC announced on September 22, 2014 that its previously forecast first-half profit had been overstated by £250 ($408.8 million), the news of the accounting irregularities was “serious,” as Tesco plc’s CEO of less than a month’s standing at the time put it. The company also announced that the overstatement, first flagged when an informed employee alerted the general counsel about the booking of income and the booking of costs, was under investigation by the Freshfields law firm and by the Deloitte accounting firm. The company also suspended four senior executives. A September 23, 2014 Wall Street Journal article about the company’s disclosures can be found here.
As bad as the initial announcement was, the news soon grew worse. On October 1, 2014, the company announced that the U.K.’s financial watchdog, the Financial Conduct Authority (FCA), has “commenced a full investigation” of the accounting irregularities at the company. An October 1, 2014 Reuters article about the FCA investigation can be found here.
The situation grew bleaker still on October 23, 2014, when the company announced that the amount of the overstatement was actually £263 million pounds ($422 million), rather than the previously announced £250, and that the company’s Board Chair, Richard Broadbent, would be stepping down. An October 23, 2014 Bloomberg article describing the company’s interim results and the Chair’s resignation can be found here.
The accounting woes follow a period of tumultuous change in the company’s executive offices. The new CEO, Dave Lewis, just assumed the CEO role on September 1, a month earlier than expected, after the former CEO, Phillip Clarke, was dismissed in July. For several months, the company had no CFO after the former CFO, Laurie McIlwee, stepped down in April. The new CFO designate, Alan Stewart, had not been scheduled to take up the role until December; however, on September 23, 2014, immediately after the initial disclosure of the overstatement, the company announced that Stewart’s starting date had been moved up and that he would take up the CFO role that same day.
These kinds of events involving a U.S. company would almost automatically attract a securities class action lawsuit. However, Tesco is a UK-based company. Its shares trade primarily on the London Stock Exchange. Under the U.S. Supreme Court’s July 2010 decision in Morrison v. National Australia Bank, the U.S. securities laws would not apply to the claims of any investors who had purchased company’s shares on the LSE. Just the same, the company has attracted a securities class action lawsuit filed in a U.S. court because, in addition to the shares trading on the LSE, the company also has American Depositary Receipts that trade over the counter in the U.S.
On October 23, 2014, plaintiffs’ lawyers initiated a lawsuit in the Southern District of New York on behalf of investors who purchased Tesco ADRs in the U.S. between February 2, 2014 and September 22, 2014. The complaint (which can be found here) was filed on by the Irving Fireman’s Relief and Retirement Fund, a pension fund for the Irving, Texas firefighters. The complaint names the company, McIlwee, and Clarke as defendants. The complaint alleges that through a variety of misrepresentations during the class period, the defendants violated the U.S. securities laws. The complaint asserts that the company’s share price dropped 12% following the disclosure of the accounting irregularities on September 22, and fell a total of 43% from its high during the class period. The plaintiffs’ lawyers’ October 23, 2014 press release can be found here.
At one level it is hardly surprising that developments of this kind have attracted a securities class action lawsuit. There are, however, a number of interesting things about the lawsuit that was filed. The first has to do with the plaintiff class. I suspect that the vast majority of the company’s shares trade on the London Stock Exchange. I can’t tell what percentage of the companies securities trade over the counter as ADRs in the U.S., but I am guessing it is a small percentage compared to the percentage of shares that trade on the LSE (I recognize that there is probably a very easy way to determine this from publicly available information, but the research staff resources are pretty thin here. I welcome input from any reader that can shed any light on this topic.) The U.S. plaintiffs’ lawyers could not under Morrison file claims on behalf of the LSE purchasers, but that still begs the question of how big the class of U.S. ADR purchasers might be. I could be wrong of course, but it wouldn’t surprise me to find out that the class of ADR purchasers is relatively small.
UPDATE: A reader notes as follows: ”Based on average trading volume, trading in London far exceeds trading in the US OTC market. Yahoo finance, for instance, shows average daily trading volume in London over the past 3 months of ~37,000,000 compared to just 900,000 ADRs in the OTC market (each ADR is convertible into 4 ordinary shares).”
The other interesting thing to me about the new securities suit against Tesco is that it represents yet another securities class action lawsuit filed in U.S. court against a non-U.S. domiciled company. After the U.S. Supreme Court’s decision in Morrison, it might have been expected that securities suits involving non-U.S. companies would be rare. As it has turned out, securities litigation involving non-U.S. companies has continued to be filed at a relatively brisk clip. The new lawsuit against Tesco represents, by my count, the nineteenth lawsuit filed so far during 2014 involving a non-U.S. company, out of an informal overall tally of 136 filings so far this year, or just about 14% of all securities suit filings.
While the rate of filings against non-U.S. companies so far this year is down slightly from last year (when 16.9% of all securities suit filings involved non-U.S. companies), even the lower rate so far this year is elevated compared to historical levels; during the period 1997 to 2009, the annual average percentage was around nine percent. So contrary to what you might have expected after the Supreme Court’s Morrison ruling, the filings against non-U.S. companies have consistently been up since the decision.
Another interesting thing about this lawsuit is the specific individuals that are named as defendants. Though the two individual defendants, Clarke and McIlwee, served as CEO and CFO respectively during the class period, McIlwee was long gone from the company and Clarke had already been terminated by August 29, 2014, which was the date of the guidance that the company later had to revise on September 22, 2014. The problem for the plaintiffs is that, at least as far as I can tell, on August 29, the company had no CFO and a CEO who had already been terminated and who was stepping down in favor of Dave Lewis, owing to the tumult in the company’s executive offices. To be sure, the company did state in its October 23 earnings release that the irregularities started prior to this year, and the plaintiffs do allege that there were other misrepresentations during the class period. But the heart of this lawsuit is the alleged overstatement of projected profits in the company’s August 29 guidance. The individuals the plaintiff named as defendant arguably are not the most logical defendants for a case that really has to be built around the company’s August 29 profit forecast. .
The final interesting thing to me about this case is that the accounting issues first came to light as a result of a whistleblower’s report. The public information about the whistleblower report is fairly scant, but it appears that someone with knowledge approached the company’s general counsel with information about the accelerated recognition of income and the delayed accounting of costs. An interesting question is why the whistleblower chose to report internally rather than reporting the improprieties to the SEC, and thereby trying to qualify for a whistleblower bounty award. Whether a report to the SEC about Tesco, a U.K. based company whose shares only trade OTC in the U.S., would have garnered a whistleblower bounty is an interesting question, but it is worth noting that the recent record $30 million whistleblower bounty award was made to a foreign domiciled individual.
In any event, the lawsuit filed against Tesco represents the latest example of a something that I think we will be seeing a lot more of — that is, a securities class action being filed after a whistleblower’s revelation of accounting or other improprieties. As I noted in an earlier post (here), particularly in light of the incentives that the Dodd-Frank whistleblower bounty provides, we will likely see many more securities suits following after whistleblower reports.
Eleventh Circuit Vacates Dismissal of Integrity Bank Lawsuit, Remands Case to District Court: In a July 2014 opinion, the Georgia Supreme Court answered certified questions in The Buckhead Community Bank case having to do with the availability of the business judgment rule under Georgia law and whether bank directors and officers could be liable under the state’s law for claims of ordinary negligence. The Buckhead Community Bank case had been submitted to Georgia’s highest court on certified questions by Northern District of Georgia Judge Thomas W. Thrash, Jr. Similar questions were also certified to the Georgia Supreme Court in the Integrity Bank case by the Eleventh Circuit. The question certified was in both cases nearly identical – that is, the courts sought to determine whether or not under Georgia law a bank director could be held liable for claims of negligence or whether liability for those claims would be precluded by the business judgment rule.
As discussed here, in its July 2014 opinion in the The Buckhead Community Bank case, the Georgia Supreme Court ruled that that the common law of Georgia recognizes the business judgment rule — but while the rule insulates directors and officers from claims of negligence concerning the wisdom of their judgment, it does not foreclose negligence claims against them alleging that their decision making was made without deliberation or the requisite diligence, or in bad faith.
On October 24, 2014, the Eleventh Circuit issued a per curiam opinion in the Integrity Bank case, based on the Georgia Supreme Court’s response to the federal appellate court’s certified questions. The Eleventh Circuit recited that in light of its opinion in The Buckhead Community Bank case, the Supreme Court of Georgia “now advises us that a bank director may violate the standard of care” under applicable Georgia statutes “even where he acts in good faith, where, with respect to process by which he makes decisions, he fails to exercise the diligence, care and skill of ordinarily prudent med action under similar circumstances in like positions.” (Citations omitted).
The per curiam opinion vacates the order of dismissal the district court had entered in the case and remands the case back to the district court for further proceedings in light of the Georgia Supreme Court’s opinion.
It’s All Part of My Rock and Roll Fantasy: Prior to this past weekend, about the only thing I knew about the Grog Shop, a music club in the Coventry neighborhood in Cleveland Heights, is that when they still lived at home my kids used to go there for concerts. However, this past Saturday night, my wife and I were part of the crowd at the Grog Shop bar, there for some live music. We had come to hear the local rock and roll bank Faith & Whiskey (“If you don’t have one, you’d better have the other”) play a righteous round of classic rock music. Among the band members was our good friend Jerry Kysela, of AON Cleveland, on rhythm guitar. (That’s Jerry on near side in the pictures above and below) It was also a costume event for Halloween, so the crowd was in high spirits. In all honesty, the D&O Diary doesn’t rock out that much any more, but I can still enjoy a good rock and roll band. I have to say that watching the (mostly middle-age) guys rocking out on the stage, it looked like they were having a heck of a lot of fun.
We took a few pictures and I asked Jerry if it was OK if I wrote about his band on my blog, and he said “You can do whatever you want.” So along with the pictures of the event, I will invoke the lyrics of the Bad Company song “Rock and Roll Fantasy,” which go like this: “Here come the jesters, one, two, three./It’s all part of my fantasy/I love the music and I love to see the crowd/Dancing in the aisles and singing out loud.” It’s all part of my rock and roll fantasy.
My son says “Now that you and Mom have been to the Grog Shop, anything might happen.” Seriously.
In addition to some great rock and roll, there were some great costumes.
These pictures don’t have anything to do with Rock and Roll or the Grog Shop, but it wass such a beautiful weekend here it seems like a shame not to drop them in here as well. Taken on Sunday at Lower Shaker Lake, Shaker Heights, Ohio.