Securities litigation – the third limb
The Financial Conduct Authority and the Financial Reporting Council (FRC) have recently consulted on updates to the UK’s corporate governance and stewardship codes: the FRC published an updated UK Corporate Governance Code in July 2018; and an updated UK Stewardship Code is due to be published this summer.
The two are welcome developments, in line with the FRC’s stated mission to promote transparency and integrity in business.
However, there is a third limb to this framework which is playing a vital role – securities litigation under sections 90 and 90A of the Financial Services and Markets Act 2000. Securities litigation was practically non-existent in the UK less than 10 years ago, even while common in jurisdictions like Australia, Canada and the US.
However it now plays an important role in driving better corporate governance and behaviour. This is to the benefit of all, as so many more of us find ourselves invested in a plc, either directly or indirectly (for example through workplace pensions).
Disclosure and transparency are at the heart of securities litigation, as they are for corporate governance and investor stewardship. The provisions of sections 90 and 90A seek to enshrine good corporate behaviour, to encourage efficient and transparent operation of the stock market, and thereby to let the market (and not the issuer) set the proper price for a plc’s shares.
The legislation seeks to achieve this by making a plc liable to pay compensation to investors in the following circumstances:
1. If a plc issues prospectuses or listing particulars which a) include misleading or untrue information, or b) do not include information required to be included, and the investor acquires the securities in question and suffers loss (s90); or
2. If a plc publishes information to the market which a) includes misleading or untrue information, when a person discharging managerial responsibilities (PDMR) knows the information is untrue or misleading or is reckless as to that fact, or b) does not include information required to be included, when a PDMR knows the omission to be a dishonest concealment of a material fact; and the investor relies on that information and buys, holds or sells shares in the plc in question and suffers loss (section 90A of schedule 10A, paragraph 3); or
3. If a plc delays publishing information to the market, when a PDMR acts dishonestly in doing so and the investor buys, holds or sells shares in the plc in question and suffers loss as a result of the delay (section 90A of schedule 10A, paragraph 5).
The first major example of securities litigation under section 90A are the two cases currently being jointly case-managed in the Financial List arising from the financial reporting scandal which erupted at Tesco plc in September and October 2014 – Omers Administration Corporation & Ors v Tesco plc and Manning & Napier Fund, Inc & Anor v Tesco plc. Investigations of further potential cases which have been announced include those against Patisserie Valerie, Glencore and Metro Bank (all relate to admitted past incidences of financial misreporting as revealed by the companies). There will be others.
The new UK Corporate Governance Code applies to accounting periods beginning on or after 1 January 2019. The new code places greater emphasis on relationships between companies, shareholders and stakeholders. All companies with a premium listing of equity shares in the UK are required to report in their annual report and accounts on how they have applied the code.
One of the code’s principles which will often be pertinent in securities litigation is: ‘O: The board should establish procedures to manage risk, oversee the internal control framework, and determine the nature and extent of the principal risks the company is willing to take in order to achieve its long-term strategic objectives.’
In the provisions which accompany the principles, this is expanded: ‘28. The board should carry out a robust assessment of the company’s emerging and principal risks. The board should confirm in the annual report that it has completed this assessment, including a description of its principal risks, what procedures are in place to identify emerging risks, and an explanation of how these are being managed or mitigated.’
The revised UK Corporate Governance Code deliberately pushes the onus of holding a plc to account on to the shareholders.
To support the Corporate Governance Code, investors are ‘encouraged’ to commit to the principles of the UK Stewardship Code, which sets standards for investors for monitoring and engaging with the companies they own. Of the seven principles of the code (last updated in 2012), two are most pertinent for securities litigation, requiring institutional investors to:
4. establish clear guidelines on when and how they will escalate their stewardship activities; and
5. be willing to act collectively with other investors where appropriate.
The published guidance for principles 4 and 5 explains that instances where investors may want to intervene include ‘when they have concerns about the company’s strategy, performance, governance, remuneration or approach to risks, including those that may arise from social and environmental matters’. The guidance sets out examples of the form which such intervention may take, from holding meetings with management to discuss concerns through to (but limited to) requisitioning a general meeting. It goes further to say that collective engagement may be most appropriate at times of significant corporate or wider economic stress, or when the risks posed threaten to destroy significant value.
Again, the UK Stewardship Code is to be applauded. But both the corporate governance and stewardship codes depend on a fundamental requirement for transparenc y and disclosure by UK plcs. Where those requirements are not met, and there is a negative impact on share price, in a ‘carrot and stick’ approach to corporate governance, it is the ‘stick’ of securities litigation which can both offer investors redress and push a plc to improve.
Gavin Foggo and Andrew Hill are partners at Fox Williams and members of the London Solicitors Litigation Association