The stunning collapse of Wirecard AG, a German payment processing company that lost 98 percent of its market value and filed for insolvency after admitting that €1.9 billion ($2.1 billion) on its books likely never existed, offers investors a reminder that accounting fraud can happen anywhere.
The Wirecard saga evokes epic frauds of the past, notably the turnof-the-century house of cards built by another financial middleman, U.S. energy trader Enron Corporation. There, too, an obscure startup rode a flashy sounding, opaque business model to blue-chip status. Fictitious accounts inflated sales and assets, driving stock prices ever upward. A “Big Four” accounting firm approved years of clean audits and itself became subject to civil and criminal liability. And when the scandal was revealed, the company’s disgraced CEO faced prison.
To be sure, Wirecard features its own plot twists. Faced with persistent reports of suspicious accounting at Wirecard, for example, Germany’s financial regulator, BaFin, chose to investigate short sellers who stood to benefit from the allegations instead of the company.
There is another major difference for investors harmed by apparent fraud, one familiar by now to readers of this publication. While Enron shareholders could sue under U.S. securities laws, investors in Wirecard stock—nearly all of which trades on European exchanges— must look to other jurisdictions for compensation. Here are some recent developments impacting investors’ ability to seek collective redress for securities fraud in non-U.S. jurisdictions.
Germany: Ruling in Consumer Case Finds Volkswagen Liable
In Germany, plaintiffs can file civil lawsuits under the Capital Market Investors’ Model Proceedings Act (KapMuG) to seek damages resulting from false, misleading, and/or omitted information in the capital markets. Under KapMuG, courts select a “model case” to establish culpability and damages for lawsuits with common legal and factual questions. All other cases are stayed until the model case is decided.
In the Wirecard matter mentioned above, in fact, the first lawsuit seeking model case status was filed by the TILP law firm on May 12 in the Regional Court of Munich. The TILP firm represents plaintiffs in other KapMuG model proceedings, most notably in a shareholder suit against Volkswagen AG damaged by stock drops stemming from U.S. regulators’ 2015 discovery that VW had cheated on emissions tests by installing “defeat devices” in 11 million diesel vehicles.
On May 25, VW investors registered for lawsuits associated with the KapMuG proceeding received a boost when a German court found the company liable in another bellwether case, this one a consumer lawsuit brought by a minivan owner. In that case, the Federal Court of Justice in Karlsruhe ruled that VW used “deliberately immoral” methods to rig the tests. The illegal devices alerted diesel engines when tested to produce results with drastically fewer toxic emissions than the vehicles produced on the road.
The federal court ordered VW to pay the plaintiff in the model case €28,000 for the minivan he bought in 2014, clearing the way for VW to compensate up to 60,000 vehicle owners who did not accept or join a settlement with the German consumer federation. That earlier suit, which settled for a total of €830 million, is expected to pay between €1,350 and €6,300 each to approximately 235,000 car owners.
Volkswagen said the federal court’s decision “provide[d] clarity” for most of the 60,000 cases still open in Germany. It planned to offer eligible car owners “adequate settlement proposals” in line with the model case ruling. The so-called Dieselgate scandal has already cost Volkswagen more than €30 billion in fines, legally mandated fixes, and settlements, most notably in the United States. Until now, however, the company has largely escaped paying large sums to consumers in Germany–though in May the company reached a deal with German prosecutors to pay €9 million to end legal proceedings against VW’s chief executive and board chair, who had faced on market manipulation charges. It also faces a class action brought by 91,000 VW owners in the United Kingdom.
Back in Germany, investors from around the world awaiting results of the KapMuG model proceeding should take heart from the Karlsruhe federal court’s decision to find wrongdoing and award damages.
European Parliament Poised to Approve EU-Wide Rules for Collective Redress
Although implementation is still up to two years off, the European Union is poised to approve rules for investors and other consumers to pursue collective actions after negotiators for the European Parliament and the European Commission reached a deal that includes a loser-pays provision.
The Representative Action Directive, announced June 22, affects consumers harmed by domestic and cross-border violations of data protection, financial services, travel and tourism, energy, telecommunications, environment and health, air and train passenger rights, and general consumer law. The draft Directive has been the subject of negotiations since it was announced as part of a “New Deal for Consumers” in April 2018 to strengthen consumer protection in the European Union.
According to a news release issued by the European Parliament, the draft Directive requires each EU country to offer consumers “at least one representative action procedure for injunction and redress” both domestically and on an “EU level.” Consumers launching a cross-border action must be represented by “qualified” non-profit consumer organizations or public entities. Member states that already have working collective redress procedures can follow their own laws for domestic matters if they are “consistent” with the objectives of the EU directive.
While the text of the measure has not been released, the news release made clear that European legislators wary of U.S.-style class actions included rules designed to protect businesses. It said the Parliament had introduced the loser-pays principle to “strike a balance between access to justice and protecting businesses from abusive lawsuits.” Another rule will give courts or administrative authorities the power to “dismiss manifestly unfounded cases at the earliest possible stage of the proceedings in accordance with national law.”
Even so, some commentators said they expected the new measure would lead to more mass actions in the European Union, while others noted that the U.K., Italy, and the Netherlands have already codified opt-out lawsuits for certain consumer claims.
Once approved by the full Parliament and Commission and published, the Representative Action Directive will give EU member nations 24 months to enact laws that comply with its provisions and another six months to apply them.
Australian Class Actions: In Flux and Under Attack
It has been a tumultuous seven months for class actions in Australia, where a flurry of court rulings, government regulations, and legislation have affected the way shareholder lawsuits and other representative proceedings are funded.
In the first news, the High Court of Australia in December appeared to strike an important blow against so-called “open” class actions, in which settlements cover all damaged parties, including those who hadn’t previously registered their legal claims with a law firm.
While class actions have a long tradition in Australia, they are typically limited to registered plaintiffs who agree to pay fees to litigation organizers in exchange for protection from loser-pays rules. Though plaintiffs may opt out of settlements, these “closed” class actions effectively act like opt-in cases, since damaged investors are only included in the class if they register.
Closed classes also have encouraged the predominance of third-party litigation funders, who compete to sign up large groups of investors at the outset of the case so that potential class damages will yield a large enough fee to make underwriting the litigation worthwhile—a process known as “book building.” Plaintiffs agree to pay funders a percentage of future recoveries while the funders pay the costs of litigation, including legal fees, on a no-win, no-fee basis. (Lawyers in Australia have historically been prohibited from charging contingency fees, though that has changed in one state, as explained below).
Since 2016, however, some Australian federal and state courts have begun using “common fund orders” (CFOs) to “open” class actions beyond plaintiffs who have already agreed to pay funders. CFOs require all group members—including those who haven’t signed a funding agreement— to pay a share of the fee. Without a common fund order, funders are incentivized to seek closed classes.
In separate decisions reached after common hearings in BMW Australia Ltd v. Brewster and Westpac Banking Corporation v. Lenthall, the High Court ruled December 4 that neither the Federal Court nor the New South Wales Supreme Court had the power to make common fund orders at the early stages of litigation.
From the early reaction to Brewster, you would have thought the High Court had sounded the death knell for CFOs and open group proceedings. But while Brewster required judges to find that each CFO is “appropriate or necessary to ensure that justice is done in the proceeding,” it focused on two cases where the CFO had been issued early in the case. And since Brewster, at least two Federal Court judges have confirmed their power to make CFOs during the settlement approval process. Still, without the ability to secure a CFO early in a case, many funders are likely to rely on building a book of registered plaintiffs with large damages to ensure that their potential upside makes it financially viable.
On the positive side for investors, lawmakers in Victoria, the second most populous state, passed a law June 18 that allows plaintiffs’ lawyers to apply for contingency fees if they provide “security” that they can cover defendants’ court costs in the event of an adverse ruling.
Prior to the change, law firms, as elsewhere in Australia, were limited to charging an “uplift fee” capped at a 25% premium over their hourly fees, though they could pledge to waive their fee if they didn’t win the case. As a practical matter, that meant law firms teamed with third-party litigation funders. Proponents of the law claimed that the previous arrangement resulted in plaintiffs paying up to half of smaller settlements in fees and costs, since both attorneys’ uplift fees and funders contingency fees were subtracted from the total. While there is no cap on the percentage fee, the law grants Victoria’s state courts wide discretion in approving costs in group proceedings that are “appropriate or necessary to ensure justice is done.” The new law took effect July 1.
Finally, the conservative federal government headed by Prime Minister Scott Morrison, citing what it says is a three-fold increase in class actions over the past decade, has taken aim against funders and the rules that govern the lawsuits themselves.
On June 22, the Morrison government announced regulations to require that litigation funders be licensed as financial service providers by the Australian Securities and Investments Commission, the country’s top financial regulatory agency. The regulations, set to take effect in August, will impose auditing and reporting requirements on funders and oblige them to maintain “adequate” financial resources. Funders were exempted from the licensing requirement in 2013. Treasurer Josh Frydenberg said the rules were necessary to control a 325% increase in Federal class actions since 2010.
Funders and lawyers initially split over the change. Omni Bridgeway (formerly IMF Bentham), the country’s largest litigation funder, supported the requirements and urged that they be extended to law firms that fund their own class actions. Plaintiffs’ lawyer Damian Scattini of the Quinn Emanuel law firm said they unnecessarily increased “governmental red tape.”
The Morrison government is also pursuing a wide-ranging parliamentary investigation of the class action industry, a move backed by business groups (at least one of them aided by the U.S. Chamber of Commerce). The inquiry by the Parliamentary Joint Committee on Corporations and Financial Service was first announced in March. In May, its purview was expanded to include “the potential impact of Australia’s current class action industry on vulnerable Australian business already suffering the impacts of the COVID-19 pandemic. Hearings were set for July, with a report due in December 2020.