Class actions have become a billion-dollar business. It’s not surprising because the amounts paid are often enormous. Those who do not participate potentially miss out if the action is successful and when any damages paid are divided. Money is not the only reason to participate in a class action. ESG factors play an increasingly important role to institutional investors.
05 Feb 2018
A class action is a joint legal proceeding of disadvantaged shareholders against a stock listed company. The aim is to ensure compensation is paid to investors for unknown but relevant business actions and operations that unduly affected investors decisions on whether or not to invest. The most famous recent example is the class action against Volkswagen. After it became clear they cheated with software, Volkswagen's share price dropped considerably. In the meantime, Volkswagen has reserved billions of dollars to be able to pay claims. Participating in a class action can therefore be very lucrative.
ESG factors are playing an increasingly important role
ESG factors are getting more important in class actions, especially for European institutional investors. Encouraged by the ultimate beneficial owners, they are not only barking, but also biting more often . They are making concerted efforts to live up to their socially responsible investment policy so actions speak louder than words. Goldman Sachs, for example, initially reacted with some amusement to a claim from pension provider APG after offering unclear investment products, until it turned out APG was actually prepared to start proceedings. The settlement that followed was favourable for the 'ultimate beneficial owners', namely the participants and pension beneficiaries of ABP.
A second important ESG reason is poor governance at a company. In plain language: fraud and accounting scandals which often result in an investor losing a lot of money. A class action is then not only a means of obtaining monetary compensation for mismanagement, but also an important instrument in showing a company the benefits of good governance and social responsibility, with the aim of preventing future reoccurrences.
Starting a class action from ESG considerations is by no means a foregone conclusion . In France, for example, the French State refused to take part in a class action against Renault primarily because they were a major shareholder and had prior knowledge of the issues relating to diesel emissions ‘cheating’. In this instance a class action could have been politically harmful.
Class actions are also a fiduciary obligation
Participating in a class action touches on the fiduciary obligation of institutional investors to watch over their clients' collective assets as a good steward. Those shareholders that choose not to participate in an initial class action cannot bring a further action post judgement. A court decision is binding on all shareholders on the register of the relevant fund during the period to which the class action relates.
Pension funds and insurers must therefore explain why they would choose not to participate in a class action and having no prior knowledge of the class action is not a reasonable excuse. There are a multitude of organisations that specialise purely in managing class actions. An individual’s own expertise is useful but certainly not a prerequisite to participation.
Are class actions always started for 'idealistic' considerations? It is very unlikely as in this day and age the 'search for yield' also plays an important role. This applies not only to 'ordinary' investors but also to wealthy oil states, especially now that their revenues from oil extraction are declining and are finite. And as an institutional investor, you do not want to be accused afterwards of having let your money 'lie'. For that reason, American pension funds and state institutions in particular are very active in class actions.
Class action - a guaranteed lottery?
Should an investor then take part in a class action as standard practice, to protect his investment? That is dependent on where the class action takes place as the rules for participation differ everywhere in the world. Not participating due to a Calimero-complex is in any case, not a reason because as an investor you benefit from the joint nature of the proceedings. There is strength in numbers. Should the class action succeed, the group pay a certain percentage of the compensation to the party who has conducted the proceedings on their behalf. Moreover, the “no win, no fee” principle applies to participation which is an important factor because class action proceedings are not inexpensive. The costs can amount to tens of millions, which in itself is a good reason to join together. The majority of class actions end in substantial settlements and therefore participating in a class action is akin to a guaranteed lottery.
View examples of Class Actions in relation to ESG factors.
This KAS Insights article has been written based on a Round Table session about ESG/class actions that was presented by Jeannet Bijker (KAS BANK) and Guus Warringa (Grant & Eisenhofer).