The EU’S Struggles with Collective Action for Securities Fraud

Abstract

Notwithstanding the apparent exit of the United Kingdom, the European Union (“EU”) has grown in membership and power since its modest beginnings after World War II, now rivaling the U.S. in economic strength. With the goal of promoting the security and prosperity of all the citizens of the countries that belong to it, the EU is pressing ahead to adopt laws that will promote their political and financial integration. Along those lines, it has also recently acknowledged a deficiency in the legal systems of its member states when it comes to allowing collective actions for victims of various types of economic harm. To address that, the EU is now developing guidelines for such procedures that can redress those injuries. In the area of securities fraud, establishing such measures has taken on more importance after both a spate of financial frauds by European companies and a significant decision from the United States Supreme Court, Morrison v. National Australia Bank. That ruling cut back on the jurisdiction of American courts to adjudicate these claims against foreign defendants—even when a significant amount of the wrongdoing has occurred in the U.S. This EU initiative to develop a collective jurisprudence to redress securities fraud also supports another goal that would foster European economic well-being. It would promote a shift in the financing of businesses there from debt to equity. That would particularly help small- and medium-size firms by giving confidence to investors in those enterprises that if they were cheated they would have an effective means to remedy that wrong. As it is now, such stock frauds can typically involve a large number of investors, many of whom have relatively small holdings. Individual actions in those situations are not only too expensive to maintain but are often inadequate to compensate all their victims and deter future misconduct. The availability of effective collective remedies would help Europeans overcome their reluctance to make equity investments and therefore provide more flexible capital structures to businesses. The European Commission10 (“Commission”) is therefore trying to fashion legal tools to address that problem. This involves enhancement of the EU’s mechanisms for stockholder litigation—what one commentator defines as “an umbrella term for various forms of suit and a range of claims brought by shareholders against the company in which they hold shares or against its directors and officers.” The EU’s proposals in that regard seek to encourage what it calls “collective actions,”—its analog to U.S. class actions—where many stockholders with small claims can join together and adjudicate them in one suit. Without such a corrective mechanism, the costs of litigation would be too great for those individuals, and they would not be able to counter the substantial resources that the defendants typically have. The EU’s proposals, however, lack features that have made American class actions so effective. The Commission is reluctant to embrace that model because of what it calls our “abusive practices.” Chief among them are contingent fees that compensate lawyers who represent shareholders harmed by these frauds. In addition, the Europeans appear determined to hold on to several rules that discourage lawyers from taking these cases. One is “loser pay,” which makes those who are unsuccessful in litigation liable for the legal fees of their counterparties who prevail. The potential of that heavy extra charge is a disincentive for lawyers who would take these cases. Another is that only plaintiffs who directly consent to be parties can be part of these actions (opt-in), as opposed to the more generous opt-out practice which includes all victims of the common fraud as plaintiffs unless they specifically choose not to participate. This Article will therefore offer comment on those deficiencies in the developing European model and encourage our friends across the Atlantic to take a more realistic approach to their reforms. The American experience with securities class actions certainly has its detractors and may have had some failings which have now been corrected. All and all, however, the U.S. approach has served our economy well by protecting investors, checking corporate wrongdoing, and affording compensation to defrauded investors. First, this Article will give a brief overview of the historic problems that European companies have had with an over-reliance on debt financing. It will then discuss how reforms like better redress for fraud can change that by giving equity investors a stronger belief that they will get a fair shake. The EU’s proposals are a step in the right direction to address that concern, and the Article will go on to describe the current state of their development. After that, it will use an American perspective to point out their shortcomings with the goal of highlighting the benefits of the U.S. model to European policymakers.