Should investors participate in class actions?

AJ Financial PlanninginvestingShould investors participate in class actions?

A flurry of class actions over the past few years raises the question: is this area of law becoming the new feeding ground for ambulance-chasing lawyers?

The marketing and PR is slick: ‘If we don’t win your case, you don’t have to pay a cent’; ‘Just register for the class action and you might receive some money; if it fails, you don’t have to pay anything’.

With any great concept the question must be asked: does it make sense for an existing shareholder of a company to participate in a class action against that company? You hear the words ‘money’ and ‘free’ – is this too good to be true?

Let’s look at an example back in 2012, when National Australia Bank (NAB) settled a class action, paying out around $115 million in a settlement to its shareholders.

However, bearing in mind about 40% of this capital – according to the Australian Financial Review (AFR) newspaper – would have paid off the litigation funding partner, and about 10% would have gone to the lawyer representing the case. So, to keep the maths simple, about 50% of the ‘winnings’ went out the door, and shareholders got to keep the other 50%. Isn’t this just free money?

In another case involving NAB (the consumer bank fee settlement), again the AFR reported the sums paid to the litigation funding partner and the solicitor were even higher – about 70% – so each case can vary, but it’s still free money, right?

Now, let’s work out if this makes sense. To keep it simple, let’s assume you owned 100% of a large bank like NAB as a single shareholder. Congratulations, you are now $82 billion richer. One day, a smart lawyer with a glittering smile approaches you and begins a discussion.

…. ‘You have been a victim of misconduct by the NAB board and management. Here’s an idea: let’s sue the company you own and get you some money – because what they did was wrong!’

‘Wow, that sounds like a great idea! Let me get this straight; I can sue the company I own, and you will get me some money… so how much do I get if I win?’

‘Well,’ replies the clever lawyer, ‘you will get to keep between 30 to 50 per cent of the settlement money, but the best part is it won’t cost you a cent to go through the process and if you don’t win, you still won’t pay anything at all.’

‘Okay, great… let me just clarify to make sure I have the concept: I can engage you to sue the company that I own. If I win – let’s say settlement is worth $6.6 million – the company pays this amount to you, of which you keep $4.62 million and hand me $1.98 million.

‘Plus, the company I own will likely have spent at least $600,000 to $1 million defending the matter in the courts, and hands this over to the lawyers it has had to engage…’

‘Yes, isn’t it great?’ says the intelligent lawyer.

‘So, in total the company has spent $7.2 million in settlements and legals and I will receive $1.98 million. Aren’t I down $5.22 million overall on my investment as the company I own is an asset?

‘I’m a bit confused; wouldn’t it be simpler to simply raise this at the annual general meeting and vote against the board of directors and save all these costs?’

You can see how the absurdity of this argument only really becomes apparent when you imagine yourself as a 100% shareholder in the company. Why would anybody agree to such a ludicrous process?

In most cases, an investor gets to have their say each year at the annual general meeting. Every shareholder gets a vote on how the company is run and yes, you are only a very small piece of the pie and with a very small point of influence. But so too is an individual in a class action. So, isn’t it time we started to use our votes, linking ‘the crowd’ with smart tech to save all the legal costs?

Keep in mind the situation can change, for example, you may not be a shareholder as in the case of the NAB bank fee settlement case, or if the company is no longer trading and is possibly placed into administration this changes things too; every person’s situation is different.

The reality is, however, that when I log onto a law firm’s website to see the final outcome from a class action, I am warmly greeted with a form that asks me to agree ‘not to disclose the loss assessment formula or its contents to any other person’.

Could it be that what this line really means is ‘Psst, we don’t want anybody to know what is really going on’?