QUANTIFYING DAMAGES IN GROUP AND SHAREHOLDER ACTIONS FOR THE FINANCIAL SERVICES SECTOR

Transcription

1 QUANTIFYING DAMAGES IN GROUP AND SHAREHOLDER ACTIONS FOR THE FINANCIAL SERVICES SECTOR REPRINTED FROM: CORPORATE DISPUTES MAGAZINE OCT-DEC 2017 ISSUE corporate CDdisputes Visit the website to request a free copy of the full e-magazine Published by Financier Worldwide Ltd corporatedisputes@financierworldwide.com 2017 Financier Worldwide Ltd. All rights reserved.

2 ONE-ON-ONE INTERVIEW O N E- O N- O N E I N T E RV I E W QUANTIFYING DAMAGES IN GROUP AND SHAREHOLDER ACTIONS FOR THE FINANCIAL SERVICES SECTOR Dr James Dimech-DeBono Director CEG Europe T: +44 (0) E: jdebono@ceg-europe.com Dr James Dimech-DeBono is a director at CEG Europe and leads the firm s quantitative finance practice in Europe. He has over 26 years advisory experience and his clients include financial institutions and law firms. He has a strong academic background in quantitative finance and expertise in the areas of banking, investment management, complex valuation and risk. He has been appointed as a testifying expert on numerous occasions. 2 CORPORATE DISPUTES Oct-Dec 2017

3 CD: To what extent has litigation in the financial services sector increased in terms of both group and shareholder actions? Dimech-DeBono: A number of factors contributed to the growth that we have observed during the past years in financial services disputes of both group and shareholder action in Europe. The global financial crisis brought a particularly difficult landscape for such litigation, but also increased incentives to litigate due to uncertainty and distress leading financial institutions to behave abnormally. Shareholder activism across Europe was also a major force, as institutional investors started to challenge boardroom pay and funds to pursue claims for misleading financial statements in investee companies. The rise of shareholder associations helped to facilitate the aggregation of claimants and the sharing of dispute costs. Another factor has been changes to the legislative and regulatory frameworks that have facilitated such claims to be taken forward. The development of insurance products and funding in the litigation market has also contributed to the growth trend in such actions over recent years. It is also worth mentioning the 2010 decision by the US Supreme Court in Morrison v. National Australia Bank, which held that investors that acquired securities outside the US were not able to bring claims pursuant to US securities laws. CD: Could you outline the key challenges involved in defining, assessing and quantifying damages in these cases? Being able to determine the real damage value in an accurate manner is always a challenge. Dr James Dimech-DeBono, CEG Europe Dimech-DeBono: Being able to determine the real damage value in an accurate manner is always a challenge. Typically, damage estimation is a two-stage process. The first involves defining and determining the counterfactual scenario, or scenarios. This requires an assessment of what would have happened in a hypothetical context. The second involves moving from the factual, and counterfactual, to a final value. This stage involves converting the difference between the factual and CORPORATE DISPUTES Oct-Dec

4 counterfactual scenario into a final damages value. Economics and financial literature provide a toolkit of methods, models and techniques that can be used for the quantification aspect. A model is based on the data and assumptions used. Both need to be reasonable in order to draw a robust inference from the output. It is important to keep in mind that a model is a representation of the real world, which at times includes simplifying assumptions. Besides ensuring that the model is properly validated, the output must be tested for its reasonableness. Being overzealous in deriving some of the assumptions may result in overestimating damages, which would bring to light an issue of credibility. CD: What strategies and methodologies can be used to ensure that calculated damages are logical, justifiable and defendable? times its original worth over a short space of time, beating even the best indices multiple-fold. Another important aspect to consider is whether claimants have benefitted somehow from the conduct of the defendants. Indeed, balance sheets are made up of both liabilities and assets, and hedging is an inherent part of financial sector risk management techniques. It is therefore particularly important to assess whether the claimant may not have benefitted somehow. Robust data analysis remains key and this can be a real challenge as data cannot always be supplied in quantity or quality needed. CD: What legal and economic frameworks need to be considered when calculating damages for financial services disputes? What steps should be taken to identify the relevant facts and issues of the case? Dimech-DeBono: Logical, justifiable and defendable are the key words here. Any claim put forward needs to fulfil this very simple measure. I have alluded to this earlier but this is key in coming up with damages calculation and the definition of counterfactual scenarios. It is important that whatever methodology is used, the assumptions used are logical, justifiable and defendable. To most, this reflects common sense. However, I have seen cases where the assumptions would have resulted in the portfolio being worth four or five Dimech-DeBono: For financial services disputes, as with any disputes, the legal and economic frameworks to use will be very dependent on the claims made. In general, I would classify the economic frameworks for financial services under three headings: market-based, fundamental analysisbased and comparator-based. A market-based approach method would be a market event study, often used to analyse the effect of information on security prices. Using this framework allows for setting company-specific security price changes 4 CORPORATE DISPUTES Oct-Dec 2017

5 apart, to identify whether company-specific information can explain them. It is particularly useful in cases where damages calculations require the building of a counterfactual, and therefore show that the losses suffered were caused by, for example, the alleged misconduct. The fundamental analysis-based approach would look into developing bottom-up models to reflect the financial performance of the asset or institution. Finally, comparator-based or benchmarks are often used in the calculation of damages. These benchmarks need to have similar characteristics take the example of portfolio characteristics to the one which would have otherwise prevailed. An expert typically uses a series of tools in order to ensure that the estimates are reasonable. CD: What are some of the difficulties surrounding counterfactual scenarios in the financial sector, particularly for group actions? Dimech-DeBono: The financial sector is highly complex and many factors contribute to this complexity. Often with unique characteristics, this makes them particularly arduous to use for comparison purposes. Products themselves can be complex in nature, and illiquid. In such cases, getting hold of good data for analysis purposes can be quite difficult. Troubled markets usually lend themselves to abnormal conditions and, as such, this is reflected in securities prices. The recent global financial crisis is a good example where prices became stagnant or heavily discounted due to lack of trading. This obviously led to difficulties in estimating counterfactual scenarios, as this cannot be described as a normal situation, and therefore many arguments can be overturned on the basis of the uncertainty surrounding the sector during that time. In the case of group actions, there exists an added complexity as the different parties to the action may have considered different counterfactuals, which means that getting consensus can often be challenging. CD: How important is it for parties to engage an expert to evaluate the case and assess the range of issues associated with quantifying damages? Dimech-DeBono: Engaging an expert is particularly important when assessing whether the claim is worth taking forward. Litigation is expensive, and the return of such claims needs to be economically viable. An expert in the financial sector, who has worked on similar cases before, will be able to use experience to approach issues which may arise in building both the theoretical and analytical framework needed for the quantification of damages. When disputes arise involving economic damages, the valuation of a financial institution, or even financial losses, the quantum expertise is often CORPORATE DISPUTES Oct-Dec

6 the most important part of showing liability. Along with a strong legal team, employing an expert who has financial services industry expertise, as well as sufficient knowledge about valuation techniques and damage calculation, is second to none to the success of a case. This is particularly true as many cases will involve the building of counterfactuals and but for models requiring the specialist knowledge, and data analysis skills experts can offer. Further to compiling the analysis, the expert will further be able to put together arguments from complex analysis into arguments easy to put forward to a court, in the form of a report and, if subsequently required, an expert testimony. Without an expert at hand, these analyses may never be performed, or not be put forward in an appropriate manner. CD: Going forward, are any recent developments likely to affect claims filed against banks, financial institutions, investment managers, insurers, financial advisers, insurance brokers, and so on? Will it also affect the potential damages involved? Dimech-DeBono: I have already highlighted the major changes that I believe will have an impact on the financial institutions described. While the drivers of shareholder class action have been historically related to the business climate, bad news or industry-wide scandals, the rise in shareholder activism, especially in private companies, is changing the whole landscape. The amendments to the Financial Services and Market Act, that allows for misleading published financial statements claims to be brought forward, will certainly increase the ability of investors to put forward such claims. The ability of funders to step in and fund the legal costs in bringing a claim forward for a share of any damages has also been a very important development. Cases such as RBS, Lloyds, Visa and Mastercard will certainly have an impact, providing clarity and direction going forward. The RBS case has attracted attention as it brought more than 27,000 shareholders to claim that they were misled by RBS with respect to its health prior to a rights issue in The case has now been settled to the favour of the claimants. This case is a good example of shareholder activism and available funding, as without such funding, this claim would not have been taken forward. CD: How do you expect group and shareholder actions to unfold over the coming months and beyond? Is the process of quantifying damages in these cases likely to become even more complex? Dimech-DeBono: The outcome of the RBS and Tesco cases are very likely to have an impact on other future cases in terms of the likelihood of shareholders considering taking such actions, as 6 CORPORATE DISPUTES Oct-Dec 2017

7 well as funders of litigation becoming interested in the damages potentially awarded. Multiple barriers have been taken down in the past five years, adding to the rise in shareholder activism, the acceptance of collective redress in Europe following the 2013 recommendation by the European Commission, and we will likely see a constant flow in such actions brought forward, particularly in the financial services sector. Companies with dual listings may have to face shareholder action in multiple jurisdictions and this adds more complexity. Quantifying damages can become more complex, however getting the right experts on board remains key in quantifying damages. One aspect not necessarily touched upon relates to data availability and quality. Data availability is key in any case and data capture has certainly improved. This, combined with the use of the right and sophisticated techniques, would make the quantification of damages easier. CD CORPORATE DISPUTES Oct-Dec