updated on 31 May 2022
QuestionWhat role have litigation lawyers played in recent headline-making market movements involving big tech in the US and could similar claims arise in the UK?
Elon Musk's recent buyout of Twitter and Netflix's giant drop in share price have both resulted in work for disputes lawyers acting on behalf of different groups of shareholders, all utilising their legal rights, in various and sometimes ingenious ways, to try and recover the losses they have allegedly suffered due to these events. While these sorts of claims have been common in the US for decades now, the changing legal landscape in the UK suggests that similar claims could also soon be seen in English courts.
Elon Musk, the world’s richest man, briefly rocked the world of high finance and big tech with news of his sudden and somewhat controversial decision to acquire social media giant Twitter. As is usually the case with such mega mergers, the financial media focused their attention on the transactional elements of the deal and in particular the financing arrangements behind the proposed takeover. However, the saga also highlights the important and varied roles that disputes lawyers often play in headline-making acquisitions of this kind, while also serving as a useful reminder of the outsized influence that litigation lawyers are likely to have on big tech dramas of the future.
Claims by shareholders following change in company's members/corporate structure
Following a high-value merger it is common for disputes to be brought by factions of shareholders who, in some way or another, feel aggrieved by the acquisition in question. For instance, Musk has been accused of securities fraud by a Twitter investor, who claims that the billionaire violated Securities and Exchange Commission (SEC) regulations by delaying disclosure of his stake in the social media company. This, the investor alleges, allowed Musk to purchase additional Twitter shares at a discount, as his eventual disclosure resulted in Twitter's share price markedly increasing. The investor also claimed that Musk's delayed disclosure caused loss to shareholders like him who had sold some of their shares in the company at the time Musk should have (according to the plaintiff investor at least) disclosed his shareholding (ie, when the price of the stock was still relatively low).
Most shareholder disputes that occur post-merger (in both the UK and the US) involve derivative actions (ie, proceedings filed by disgruntled shareholders on behalf of the company against the company's board of directors). Since the board of directors of a company oversee its day-to-day operations and can decide when and against whom the company can litigate, derivative actions allow minority shareholders to protect their interests, vis a vis the companies, even if the board and the majority of the other shareholders aren't necessarily on their side.
As regards the Twitter takeover, the Orlando Police Pension Fund brought a derivative action against Twitter's board contending that Musk was an "interested stockholder" at the time of the acquisition, because agreements that he had with Morgan Stanley, as well as with Twitter founder Jack Dorsey effectively made him the owner of more than 15% of the company’s shares.
According to the pension fund, this meant that Musk had to wait either three years to close the deal or win the support of investors who controlled at least 66% of Twitter's outstanding voting stock (ie, those individuals/entities not connected with him, such as the plaintiff pension fund itself).
Litigation between shareholders of a company and its board can also occur in instances that don’t involve a change in the company's members or corporate structure, for instance when the stock value of a company drops drastically. A recent and high-profile example of this involves streaming giant Netflix, whose stock in April of this year dropped by more than 35%, following which a class action lawsuit was launched by a group of Netflix shareholders under Section 10b and Rule 10b–5 promulgated thereunder of the Securities and Exchange Act 1934. These regulations make it unlawful for persons to make an untrue statement of a material fact or to omit to state a material fact in connection with the purchase or sale of any security.
In order to properly plead a violation of Section 10(b) and Rule 10b–5, a plaintiff must allege that the defendant (1) made misstatements or omissions of material fact, (2) with scienter (ie, with intent or knowledge) of wrongdoing, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff relied, and (5) that the plaintiff's reliance was the proximate cause of its injury.
In Netflix's case, the shareholders alleged that Netflix's board made materially false and misleading statements about the company's business, operations, and prospects, and more specifically its subscriber numbers, which induced the investors to purchase Netflix securities at artificially inflated prices. They contend that when the misrepresentations were ultimately revealed to the market, the price of the securities declined significantly causing large losses to the investors.
Rise in shareholder litigation in UK
These sorts of shareholder lawsuits have been a common source of liability for public companies in the US for decades. By contrast the UK only introduced its own legislative mechanisms for bringing claims against issuers of shares in 2000 via the passing of the Financial Services and Markets Act (FSMA), and in particular, Section 90 and Section 90A of the act in question.
Section 90 of FSMA provides that issuers of shares and their directors will be liable to pay compensation to shareholders who have purchased company shares and thereafter suffered loss as a result of any untrue, or misleading statements in the companies listing particulars or prospectus. Interestingly, there does not need to be any reliance by the claimants on the information contained in these documents.
Section 90A on the other hand creates liability for issuers of securities only, in circumstances where persons have suffered loss as a result of reliance on an untrue or misleading statement in, or omission from, certain publications made by the issuer (eg, annual reports or accounts), and a person discharging managerial responsibility within the company issuing the securities in question knew that the statement was untrue or misleading.
The only real case of note that involved Section 90/ Section 90a in the first decade after FSMA was introduced was a shareholder class action brought against The Royal Bank of Scotland (RBS) by investors who had bought shares in RBS’ rights issue in 2008 (known as the Rights Issue Litigation).
Since then however, and especially so in recent years, the number of shareholder actions brought in the UK under this legislation has increased drastically. Indeed, the origins of this trend can be traced back to the 2010 US Supreme Court decision in Morrison vs National Australia Bank. In this case, the Supreme Court held that Section 10b of the Securities and Exchange Act applied only to transactions in securities listed on US exchanges, and US transactions in other securities, thus severely limiting the ability of investors to pursue claims against issuers listed outside of the US. Investors had previously been able to bring claims in the US involving securities exchanged on foreign exchanges because US courts had, prior to this case, considered that the Securities and Exchange Act 1934 applied if the deception in dispute originated in the US.
In addition, the growth of the UK third-party litigation funding market (which according to law firm RPC doubled between 2018 and 2021) has led investors to work with funders to finance these high-value and lucrative claims, while a rise in Group Litigation Orders and specialist law firms with the expertise and willingness to pursue securities issuers has further contributed to the increased number of shareholder litigation proceedings issued in the UK in recent years. Furthermore, the fact that the first ever Section 90A case to reach trial in the UK (HP vs Autonomy Corporation), which was described by some as the "tech trial of the century”, was found in favour of the claimants in a judgment made in January this year, will no doubt provide additional encouragement to other investors contemplating or in the midst of pursuing similar claims.
A plethora of factors, including inflationary pressures stemming from the war in Ukraine, continued supply chain disruptions due to covid, the inherent volatility of certain industries such as tech, and the rise in activism by institutional investors on environmental, social and governance issues, all point to an increase in shareholder litigation in 2022 and beyond.
In addition, as shareholder litigation gathers momentum in the UK, and a body of case law emerges and matures around this area, be prepared for more big-ticket US-style shareholder disputes to take place in English courts going forward.
Ali Chowdhry is a second-seat trainee at RPC.