Securities class actions represent an increasingly important aspect of the capital markets industry. Their rise has sparked an increased demand for infrastructure and insight that is adequate to deal with them. As global jurisdictions look to catch up with the highly developed legal system of the U.S., class-actions regimes are beginning to take shape in jurisdictions such as the U.K., Saudi Arabia, and Hong Kong. This blog post will outline some of the current trends, implications, and anxieties around the recent rise of class actions in the securities industry.
What are class actions and why do they matter?
The class-actions mechanism was first introduced into U.S. securities law in 1938, allowing investors to pursue litigation as single class rather than pursue their own individual litigations. Class actions are generally thought to improve efficiency for claimants and bring down costs by avoiding unnecessary and repetitive litigation.
While securities class actions were initially restricted to accountancy restatements by public companies, they have in recent years dramatically increased in complexity and volume. This has presented investors, vendors, custodians, regulators, and legal firms with a host of challenges and opportunities.
Securities class actions are commonly characterized as cases related to mergers and acquisitions or core filings (those not related to M&A).
Starting with core filings
Core filings can be divided into one of two camps: accounting cases that relate to errors in financial statements or event-driven cases that arise from a variety of adverse events such as product failures, public relations crises, or data security breaches. The number of accounting cases has remained relatively stable since 2014 while event-driven cases have grown by around 13% per year since 2014, according to data from Cornerstone Research. This rise of event-driven litigation is likely to continue growing the core class-actions market by offering investors a greater variety of means to hold companies to account.
Turning to M&A-related filings
Global economic growth, improved cash flows, and the low cost of debt have all driven strong M&A growth in recent years, and M&A-related class-actions litigation has increased accordingly. M&A-related litigation has become a common feature of public mergers and tends to follow a predictable formula: Shareholders sue the target directors, claiming that they have been disadvantaged by the sale.
The routine nature of merger-objection litigation means that filing is relatively easy. While the dismissal rate is high for M&A claims, and many judges have expressed frustration at the way M&A litigation has become an easy-money business, merging firms are often keen to settle to avoid disrupting the merger process. Increasing M&A activity and the relative ease of M&A filing mean that M&A-related litigation is unlikely to fall back anytime soon.
Pushback against frivolous litigation
After years of growing popularity in class actions, various judges, lawmakers, and policy analysts in the U.S. have become concerned that the original spirit of the law is in danger of being forgotten. Measures that might stem the tide of class actions have been proposed, and courts have often sought to raise the barrier for potential claimants in recent years. The late U.S. Supreme Court Justice Antonin Scalia denounced class actions as “trial by formula.” Market participants can expect further attempts to slow the growth of class actions in the U.S.
Future of class actions globally
Despite the 2010 U.S. Supreme Court ruling in Morrison v. National Australia Bank, that in principle restricted the use of American courts for international parties involved in class-action disputes, core filings against non-U.S. issuers remain at 23% of total core filings. This suggests that the U.S. courts are not as exclusive as the ruling suggests. Additionally, the number of class-action cases occurring outside the U.S. continues to increase year on year, with Australia leading the way with 75 class actions between 2014 and 2018. Recent reforms at both the level of the European Union and the member-state level are preparing the way for a collective redress regime in Europe that seeks to reduce the disparity between individual member-state systems and to lower the barriers to entry.
Implications for vendors
The rise in the global securities class-actions market is presenting opportunities and turning up the heat for the relatively few processing vendors in the class-actions space. Many of these vendors are feeling the pressure to keep up with the development of the class-actions market and the increasing demand from buy-side firms. Vendors are typically comfortable covering the U.S. market but are often more limited in their global capabilities. Many buy-side firms look for partners that offer comprehensive global coverage and often will look favorably on vendors that have a history of providing specialist knowledge and insight on more niche corners of the market, such as antitrust.
The class-actions market has grown significantly in volume, geographic presence, and complexity over the last decade. This market development has presented both challenges and opportunities for market participants. Aite Group’s Institutional Securities & Investments team has recognized that while the securities class-actions market grows, knowledge and understanding of this area is limited. In January 2020, we published a comprehensive study of the securities class-actions market complete with market research on many of the processing vendors operating in the class-actions space.