After investors recently launched a securities class action lawsuit against Petrobras and certain of its directors and officers on behalf of those who purchased the company’s ADSs on U.S. exchanges, I speculated on whether or not investors who purchased their Petrobras shares in Brazil and are therefore precluded from participating in the U.S. lawsuit might try to file their own separate action in Brazil, subject to whatever procedural limitations might apply there.
This speculation in turn triggered an email exchange with Brazilian readers who alerted me about the press coverage in Brazil following the filing of the U.S. lawsuit. Among other things, the Braziian press coverage has raised the question whether the ADS investors have avenues to seek redress under U.S. law that are simply not available to those who purchased their Petrobras shares on the Brazilian exchange.
According to a December 14, 2014 post on the CLS Blue Sky blog (here), this discrepancy in the remedies available to investors for the same essential alleged wrongdoing and harm depending on where they bought their shares has arisen in Brazil before.
The blog post, by Érica Gorga, a Professor at Fundação Getulio Vargas São Paulo Law School and a research scholar at Yale Law School, takes a look at two prior situations in which Brazilian companies with securities listed on U.S. securities exchanges were sued in U.S. securities class action lawsuits, while Brazilian investors were left out with respect to their personal investment losses. (The blog post presents a summary of the author’s longer scholarly paper, which can be found here.)
According to Gorga’s analysis, not only did the U.S. investors in those two prior cases recover compensation for their losses while the Brazilian investors did not, but the company’s settlement payments to the U.S. investors left Brazilian investors even worse off in a sort of double-whammy Gorga calls a “double circularity.”
The two prior situations that the author examined involved Sadia S.A. and Aracruz Celulose S.A. Both of these companies and certain of their directors and officers were sued in securities class action lawsuits in the U.S. on behalf of investors who purchased the companies’ American Depositary Receipts on U.S. exchanges. The Sadia U.S. lawsuit, which is described here, settled for $27 million. The Aracruz U.S. lawsuit, which is described here, settled for $37 million.
Shareholders of these two companies who purchased their shares on Brazilian exchanges also tried to initiate litigation in Brazil, relying on the same alleged wrongdoing alleged in the U.S. lawsuits. However, the author notes, “because of the lack of private class actions” in Brazil, the Brazilian investors “had to rely on derivative suits, which provided only a small recovery to one of the companies, rather than to harmed investors.”
The author says that the Sadia and Aracruz cases “provide concrete examples of the financial value distribution that characterizes the current system of transnational securities litigation.” The current state of affairs where investors who purchase their shares on U.S. exchanges can attempt to seek redress of their investment losses for alleged financial misrepresentations while investors who purchased their shares elsewhere cannot underscores the “costs borne by foreign investors” when non-U.S. companies cross-list in the U.S. As she puts it, the non-U.S. investors “who usually don’t enjoy the same antifraud protections overseas – due to the lack of appropriate law or enforcement mechanisms – are compelled to accept wealth transfers to U.S. investors.” These phenomena, the author suggests, are “aggravated” by the U.S. Supreme Court’s decision in Morrison v. National Australia Bank,
In commenting on this “wealth transfer,” the author suggests that the investors who purchased their shares in cross-listed companies on non-U.S. exchanges are hit with a sort of double whammy. This phenomenon is due in part to the so-called “circularity problem” in securities litigation, which refers to the fact that innocent shareholders who did not participate in the securities fraud bear the cost of compensating investors who lost value.
When a cross-listed company is involved, there is an extra layer of costs imposed on foreign shareholders, beyond those associated with the circularity problem. In what the author calls a “double circularity” problem, the shareholders who purchased their shares of the company on a non-U.S. exchange “bear twice the costs of failures in a company’s corporate governance practices: first, when their shares lost value due to the wrongdoing per se; second, when they bear the costs of indemnification paid exclusively to U.S. security holders.”
While the author’s analysis of these issues is focused particularly on the two Brazilian examples, these “foreign-bearer” costs are “likely to be generalized to foreign investors in all jurisdictions.” And while some jurisdictions have developed forms of aggregate litigation to provide avenues for redress for harmed investors, “there remain serious doubts whether these actions will provide an effective institutional framework that fully supports collective litigation and financial recovery.”
The general direction of the author’s analysis would seem to be a prelude to a call for other jurisdictions to provide investors who purchase shares on the jurisdiction’s exchanges with remedies equivalent to those available in the U.S. Indeed, she does note that there has been speculation in the wake of Morrison that the restriction on the availability of remedies in U.S courts for non-U.S. investors might lead to the expansion of investor remedies elsewhere. However, she also notes there are a host of structural restrictions – the absence of contingency fees, the loser pays model — that cut against the adoption of these kinds of reforms in many jurisdictions. Indeed, she notes, if there were a jurisdiction where the need for development of new remedies would seem to be apparent, it would be Brazil in the wake of the Sadia and Aracruz cases — but nothing along those lines has developed there, at least so far.
After reviewing a number of academic reform proposals, the author comes out in favor of a “system of adjudication of transnational securities litigation providing equal treatment for securities holders subject to the same wrongdoing regardless of the national of the purchasers or the location of the purchase/sale,” which could be achieved “through issuer or investor choice of applicable legal regime.”
Before the U.S. Supreme Court’s Morrison decision, it was a frequent topic of discussion whether so called f-cubed lawsuits – involving claims by foreign investors who bought their shares in foreign companies on foreign exchanges – were appropriately being heard in the U.S. However, when the U.S. Supreme Court made it clear in the Morrison case that the U.S securities laws do not apply to f-cubed cases, the practical impact arguably may have been – at least from the perspective of this academic’s article – to substitute one problem for another.
The author’s paper describes what she calls the transnational securities litigation problem, in which different investors have different remedies (or some investors have no remedies) for similar wrongdoing based solely on where the investors bought their shares. Her paper emphasizes not just that the different investors have different remedies, but that the availability of remedies to one group of investors arguably comes at the expense of the other investors. This is an interesting and valuable insight.
While I appreciate the value of the authors’ observations, I nonetheless believe certain additional considerations need to be taken in to account
First, the presence of D&O insurance may ameliorate the concern the author describes. As the author acknowledges in her longer academic paper, most of the cost of one the U.S. securities suit against the two Brazilian companies (Aracruz) was paid for by the company’s D&O Insurers, and thus was not borne by non-U.S. investors. (The author notes that the costs of the D&O insurance was borne by all investors, but inured to the benefit only of the investors who purchased shares on U.S. exchanges)
Because in many cases U.S. class action securities litigation settlements are funded in whole or in part by D&O insurance, the magnitude of the adverse financial impact on non-U.S. investors from the settlement of U.S. securities litigation often arguably will be significantly less than the author suggests. The frequent role of D&O insurance in these kinds of settlements is a factor that adds a layer of complexity to the analysis of these issues and arguably reduces the magnitude of the “double circularity” issue the author describes.
Second, the “transnational securities litigation problem” the author describes arguably is at least in part a side-effect of advantages that the U.S. securities markets have in the global financial marketplace. To be sure, the availability of securities litigation remedies to investors who purchase securities on the U.S. exchanges means that companies with securities listed on the U.S. exchanges face a heightened risk of litigation. This litigation risk is well known and often decried, both within and outside the U.S. Yet despite these well- recognized litigation risks, non-U.S. companies continue to list their shares on U.S. exchanges. Indeed, as I noted in a recent post on 2014 IPOs, 23% of all IPOs on U.S. exchanges during 2014 involved non-U.S. companies, and these non-U.S. company IPOs represented 52% of all cross-border IPO deals globally during the year.
There are of course a host of reasons why non-U.S. companies seek to list their shares on U.S. exchanges. I would argue that among other reasons companies seek U.S listings is that because of the requirements for transparency and accountability, a U.S. listing communicates a willingness to be subject to a certain level of scrutiny. One of the elements of the increased scrutiny prevailing in U.S. securities markets is the ability of investors who purchase their shares to collectively seek damages for financial misrepresentations. The increased level of accountability supports transparency, which in turn supports overall market confidence.
The absence of remedies to investors who purchase shares elsewhere is of course a detriment to those investors, but the availability of remedies is a clear advantage to investors who purchase shares on the U.S. exchanges. The availability of these remedies in turn helps support the U.S. markets’ reputation for transparency that makes the U.S. exchanges an attractive place for companies to list their shares. From that perspective, then, the circumstances of which the author complains are part of the features that make the U.S. exchanges attractive to issuers and to investors.
Third, I have long thought that the absence of equivalent investor remedies in other countries sooner or later would motivate investors to agitate for reform in their home countries. Change has been slow in coming. But despite the lack of progress to date on these issues, the prospect for the development of mechanisms for redress within individual countries seems likelier to occur than the development of complex mechanisms of the kind the author supports that would require cross-border collaboration of securities regulators.
Finally, there is the possibility that certain existing mechanisms could also provide investors with avenues for redress. It is beyond the scope of this blog post, but there have been developments in the Netherlands that suggest means by which global investors could seek to recover investment losses. In addition, there have been class action developments in other countries (including in particular Canada and Australia) that could also allow for global class actions where jurisdictional requirements in those countries are otherwise met. In other words, there may be other forces at work that could help ameliorate the transnational securities litigation problem that the author describes.
A final note. It may be that the two prior cases to which the author refers may not have been sufficient to provoke a chance in the remedies available to Brazilian investors. I wonder whether the scope and scale of the new Petrobras scandal might be enough to bring about change. Brazil only recently adopted strong antibribery laws yet authorities have moved quickly to move against corruption. Could the same kind of thing develop with respect to allegations of securities fraud?