Continuous disclosure requirements enshrined in the Corporations Act ensure that investors in ASX-listed companies are publicly notified as soon as a company becomes aware of any material changes to their earnings, revenues, or profitability. These regulations are some of the most comprehensive in the world, and have benefited Australian shareholders by helping reduce the information asymmetry of directors in public firms.
While public companies may not be keen to admit it, they too benefit from such regulations. This benefit comes from reductions in the required cost of capital, and the ease with which Australian firms can conduct IPOs and secondary offerings. Indeed, ASX-listed firms have raised far more than their US or UK counterparts for exactly this reason.
In the absence of such regulations, the incentives, and temptations, for directors become divorced from those of their shareholders. Take Gunns Ltd as an example – a shareholder class action in which I was the lead applicant. Director (and convicted insider trader) John Gay knew Gunns was in trouble in mid-2009.
Rather than inform shareholders, he chose to raise $128 million of new shares in September 2009 (at 90c), and sell 3.4 million shares for $3 million in December 2009. When the news was released to the market, the share price rapidly slid to around 50c, and would ultimately be worth $0 in 2012 when Gunns entered bankruptcy. The “loss” Mr Gay avoided of ~$1.2 million was punished by ASIC with a non-custodial disgorgement of $500,000 and a fine of $50,000. Sounds like quite a good deal to me. And therein lies the problem.
From my research, most shareholder class actions in Australia are settled by the firms themselves – effectively admitting the breach was real, and preferring not to risk a court order carrying a significantly higher cost.
A large proportion of firms facing shareholder class actions eventually goes bankrupt before the case is settled, effectively placing those shareholders harmed together with all other creditors – as was the case with Gunns Ltd. The handful of actions we see per year are not frivolous – they are egregious.
Do we need shareholder class actions?
Opponents of shareholder class actions cite the profits made by litigation funders as evidence that the system is inefficient and hinders business. This is clearly not the case, with a June 2020 AICD survey reporting only 2.85 per cent of respondents identified complying with continuous disclosure obligations as the biggest regulatory challenge posed by the COVID-19 crisis.
The question that needs to be asked is not who ultimately pays, nor how the spoils are divided between misled shareholders and litigation funders.
Rather, the question is how much worse our market would be in the absence of private enforcement actions. ASIC has been quick to hand out “please explain” aware letters, but very reluctant to follow up with any meaningful enforcement actions. If company directors know that private enforcement actions were not possible, what would stop them from committing even more egregious acts of deception on an unsuspecting shareholder base?
Further, my research of concluded shareholder class actions shows that firms increase their engagement of “big 4” accounting firms, increase their expenditure on audits, and reduce directors’ fees and bonuses. Sounds like a win for shareholders to me.
If the gripe of critics is the fees paid to litigation funders, the strange and archaic rules we have in Australia could be easily amended to allow contingency fees, reducing the role for funders and allowing lawyers to take on worthy cases. Adverse cost orders have already been shown to be effective in eliminating frivolous lawsuits, so such a change is likely only to increase the amount of the compensation “pie” available to damaged class members.
We are all painfully aware rules absent sanctions are ineffective.
Removing one of the few enforcement mechanisms for breaches of continuous disclosure would place a heavy burden on ASIC, one it may not currently be well resourced to bear. ASIC certainly doesn’t have a strong record of sanctioning publicly listed firms, hence the need for private enforcement (or the threat of it).
Such a move may result in markets which become less fair, and less efficient, exactly the opposite of what well-regulated markets should aim for.
Sean Foley, associate professor, Macquarie Business School