Minister for Financial Services, Superannuation and Corporate Law
9 June 2009 - 14 September 2010
Address to Shareholder Class Action Conference
Quay Grand Suites, Sydney
4 May 2010
I'd like to thank Robert Ishak and William Roberts Lawyers for the invitation to address the 2010 Shareholder Class Action Conference.
With the implications of the Federal Court's October 2009 ruling in the Multiplex case a "hot topic" among the legal fraternity, this is an opportune time to bring the key players together to discuss these issues.
But first, I'd like to briefly outline my position on legislative reform as Minister responsible for corporate law.
I've taken the approach that a change to existing laws need to do one of two things. For people doing the right thing, we need to reduce the administrative burden and red-tape. For those doing the wrong thing, we need to send a strong message of deterrence and ensure we are dealing with a clear mischief.
Sons of Gwalia
That was the approach I took in my decision to reverse the effects of the High Court's 2007 decision in the case of Sons of Gwalia v Margaretic.
You may remember that, in that case, the High Court held that claims by shareholders against a company rank equally with those of unsecured creditors.
This decision overturned a longstanding and widespread view that all shareholder claims in a corporate wind-up ranked behind those of other, traditional, creditors. The decision also changed the well-accepted balance of risk between shareholders and unsecured creditors.
After carefully considering the issue, we came to the clear view that it is inappropriate for unsecured creditors to be ranked alongside investors as creditors, even where those investors were misled.
Investors make a conscious decision to invest money in a company in the hope of sharing in the company's profits. In doing so, they are entitled to expect proper disclosure from the company. But they must accept that they are taking a risk in making that investment.
In contrast, creditors are not hoping to increase their wealth by gambling on the future profitability of a company. They are often small businesses or trade creditors who are simply owed money for work they have already done, or for materials they have supplied.
So while investors who have been misled into making that investment should rightly be able to claim redress, they should not be able to do so to the detriment of creditors in terms of receiving distributions when a company is insolvent.
In deciding to reverse Sons of Gwalia, I am not suggesting that the legal basis of the High Court's decision was incorrect — only that it set a precedent that, from a policy standpoint, was inequitable.
We also saw evidence that the Sons of Gwalia decision had made creditors more wary of lending money. Cautious lenders tightened the terms on which they were willing to offer businesses credit, which, in turn, increased businesses' costs of borrowing.
This was bad news for shareholders, not just creditors – and it was bad news for shareholders of all companies, not just those who had invested in companies facing insolvency.
Another problem with the Sons of Gwalia decision — which relates to my earlier point about coming down hard on wrongdoers — was that it did not transfer losses arising from misconduct to those responsible for that misconduct. Or to put it another way, it did not create an incentive for those who had misled their shareholders to change their behaviour.
Instead, it burdened a company's creditors with the costs of misbehaviour by the company itself. This is a manifestly unfair redistribution of the costs of misbehaviour – from those in the company who did the misleading, to the company's creditors.
On the 23rd of April, I released for consultation an exposure draft of legislation to reverse Sons of Gwalia.
The closing date for submissions is the 18th of May. I welcome stakeholder comments on the final wording of the legislation, before it is introduced in the upcoming sittings of Parliament.
Turning now to class actions...
There is no doubt that class actions have become an important part of the Australian justice system.
Legislation was introduced to enable class actions to be brought before the Federal Court in 1992; and between 1992 and 2009, over 240 class actions had been brought before that court.
As at 4 November last year, at least 21 funded class actions were in train, involving about 35,000 class action members, and claims totalling an estimated $2.6 billion.
At that date, at least a further 16 funded class actions were proposed, with claims totalling an estimated $810 million.
The Australian Government sees class actions as an important way of enhancing the community's access to justice. Class actions allow numerous claims to be considered together — claims which, individually, may be too small to be worth pursuing.
I should add that, while class actions have become an important feature of our court system, the cost structure in Australia, which generally requires the loser to bear the legal costs of the winner, has prevented an explosion in the number of such actions. In this way, the Australian system has effectively prevented actions based on weak or doubtful claims to be brought forward.
This is in contrast with other jurisdictions, for example, the USA, which has a different system for dealing with legal costs.
The Government, and in particular my colleague the Attorney-General Robert McClelland, are committed to improving access to justice in Australia. An Access to Justice Taskforce in the Attorney-General's Department recently conducted a review which led to the Government's adoption of a Strategic Framework for Access to Justice.
The review recognised that a significant percentage of the general population is unlikely to take any action when faced with a legal issue. This could be due to factors such as a lack of knowledge, a lack of capacity, or feelings of disempowerment and exclusion.
The Taskforce also recognised that cost can be a significant barrier to justice. Individual consumers or investors may be under some degree of financial hardship, and the cost of legal representation together with the possibility of adverse cost orders may well inhibit people from bringing worthwhile cases.
Implications of Federal Court decision in Multiplex case
In its ruling on the Multiplex case, the Full Court of the Federal Court concluded that the litigation funding arrangement comprised a managed investment scheme under the Corporations Act. This decision overturned a previous decision which found that class actions were not managed investment schemes.
This decision raises some interesting legal and practical considerations.
The Federal Court decision effectively means that funded class actions would be regulated under the Corporations Act provisions relating to managed investment schemes and financial products.
The regulatory regime for managed investment schemes imposes a wide range of obligations on these schemes and their operators. In the case of class actions, the main regulatory burden would fall on the person organising and leading the class action, who would be acting as the "responsible entity" of the scheme.
Each class action would need to be separately registered with ASIC, unless it satisfied the exemption requirements, for example, if it had less than 20 members.
"Responsible entities" of managed investment schemes would need to obtain an Australian Financial Services Licence from ASIC.
To satisfy the licensing requirements, the solicitor or litigation funder would need to demonstrate that they have the necessary expertise and resources to carry out their role to a high standard. They would also become subject to a wider range of conduct requirements and other additional obligations.
Effects of Federal Court decision
The Federal Court decision has effectively halted all existing class actions, as none currently comply with the managed investment scheme provisions.
While ASIC has provided temporary relief from the Federal Court decision on a case-by-case basis, ASIC has made it clear that this relief extends only to those class actions which were in train at the time of the decision.
In effect, no new class actions are going forward at this time, except those which are exempt from the managed investment scheme provisions, for example by being restricted to sophisticated investors only. I understand that there is some uncertainty about the impacts of the decision on other potential funded litigation.
ASIC's transitional relief will expire on 30 June 2010. Unless the Government intervenes with a regulatory solution, or ASIC extends its relief, even ongoing class actions will have to stop from that date until they comply with the managed investment scheme regime.
Of course, the decision by the Federal Court reflects their interpretation of the law as it stands. That is the appropriate role of the Court. The Federal Government, of course, has a different role. Our role is to assess the efficacy of laws as they are interpreted by the courts, and where necessary — after having weighed all the salient issues — change the law.
It is no disrespect to their Honours to say that the decision has had impacts which the Government has had to take into consideration as part of our deliberations.
In evaluating the merits of the Federal Court decision, the Government has made it a point to consult with a wide range of stakeholders. These include defendant and plaintiff lawyers, litigation funders, the Law Council, consumer representatives, regulators and leading academics in this field.
The decision raises several important policy issues.
A key point is that the regime for managed investment schemes was not developed with funded litigation in mind, and therefore in many respects, does not operate in a meaningful way when it is applied to class actions. Put simply, this was not the intention of the managed investment scheme regime.
This point was made clearly in the first instance judgement by the Federal Court. The ruling judge pointed out that it was not even clear which party was the "responsible entity" of any potential scheme, whether it was the litigation funder or the lawyer providing the legal services. Application of the rules created for managed investment scheme to class actions, would be akin to squeezing a square peg through a round hole.
The judge at first instance also made the point that few of the managed investment scheme obligations would protect class members, because many of them simply did not have a role in this context. Examples mentioned by the judge were:
- the minimum financial requirements imposed under the managed investment scheme regime;
- the obligation to provide a Product Disclosure Statement with the contents as specified in the Corporations Act; and
- the requirement for responsible entities to have compliance and risk management systems in place.
Also, imposing the regime would create significant additional costs and compliance burdens for litigation funders and class action lawyers.
Another point relates to consumer protection. While some stakeholders maintain that the Federal Court decision would provide class members with additional consumer protection, it is clear that they already enjoy a considerable amount of protection under existing conditions.
Existing consumer protection
For example, existing Commonwealth legislation covers the conduct of class actions.
The main financial risk for class action members is that they could be liable for the legal costs of the defendant if the action is unsuccessful and the litigation funder fails to perform its obligations to meet the costs of the defendant.
However, under the Federal Court of Australia Act, the members of the class other than the representative party cannot be made personally liable for the costs of the defendant.
The representative party, who is exposed to this potential liability, is legally represented and advised, and should therefore have been told how to take appropriate steps to guard against this liability.
The law also makes it clear that any settlement must obtain the approval of the Court, and must be fair, reasonable and adequate in the interests of all class members.
Court rules at both Commonwealth, and State and Territory levels, also act to protect the interests of consumers. For example, the risk of disreputable operators, especially those located overseas, not performing their financial obligations is generally addressed through the requirement for the funder to provide security. This could take the form of a bank guarantee, either based on a court order or the terms and conditions of the funding agreement.
And finally, the relations between lawyers and their clients are already extensively regulated through several avenues.
For example, there is little or no risk that class action proceeds will not be paid to members, as regulations relating to legal practice require that such funds are paid to a solicitor who has a statutory obligation to pay the monies into a regulated and audited trust account. In turn, the trust account is also protected by a statutory compensation scheme.
These arrangements provide a wide range of consumer protection measures — measures that are specifically tailored to the consumers of legal services.
ASIC has considered what risks class members may be exposed to. However, the current regulatory system and other consumer protection arrangements applying to class actions contain safeguards against most of these risks — with one possible exception, which I will return to shortly.
On balance, I think it's safe to say that any additional consumer protection provided by regulating class actions as managed investment schemes or as financial products would be very limited. And in any case, it would be unlikely to be proportionate to the costs imposed.
Importantly, I should also add that there is little evidence of any consumer suffering losses, or encountering other problems, in the conduct of class actions. This has especially been the view of consumer groups in this field.
For example, during the recent consultation process it became clear that there is no record of consumers complaining in significant numbers about class actions and the way they are conducted in Australia.
It is clear that any Government intervention would need to be proportionate to the problem. Otherwise, we would risk placing an excessive burden on the industry, and potentially impose barriers to entry; all to the detriment of Australian consumers.
Government action on class action issue
For many consumers, class actions provide an important way of accessing the Australian courts and justice system. They provide access at little or no cost for those consumers with claims that are too small to justify legal action on their own.
The Government is determined to ensure that Australians do not lose this important avenue for obtaining access to the courts.
But imposing the managed investment regulatory regime on class actions would have the unintended consequence of restricting consumer access to funded class action arrangements — either due to the increased costs, or because of the withdrawal of litigation funders and class action lawyers from the market due to the increased compliance burden.
For these reasons, the Government has decided that regulations should be made carving out class actions and proof of debt arrangements from the definition of a managed investment scheme in the Corporations Act.
I have directed Treasury to ensure that the regulations can be made before the transitional relief provided by ASIC expires on 30 June.
Treasury will continue to work with relevant stakeholders and groups to ensure an efficient and effective carve-out.
The regulations will also clarify that funders of class actions and class action lawyers are not subject to all the licensing, conduct and disclosure requirements applying to financial services in the Corporations Act.
This measure ensures that the onerous compliance requirements based on the general definition of a financial product in the law do not apply to class action funders. Without this provision, it is possible, for example, that funded class actions could be captured through the definition of a derivative as a financial product, creating uncertainty for participants in this field.
Again, I do not consider that the current arrangements expose consumers to such high levels of risk to justify imposing licensing and other onerous requirements on class action funders. The regulations will therefore provide a range of exemptions that will ensure that this does not happen; and will provide certainty for litigation funders, consumers and law firms.
As I mentioned earlier, there is one area of consumer protection that may need enhancement. The Government wants to ensure that potential conflicts of interest arising, for example, when funders of class actions or class action lawyers are assessing awards or settlements are properly addressed.
For this reason, while the Government will not be imposing the heavy regulatory burden of managed investment schemes, we are considering regulation to manage potential conflicts of interest through guidance issued by ASIC.
This will be to ensure that the interests of class action members are held as paramount. There may be some situations in which conflicts of interest may arise, such as where the class action lawyer and the class action funder are assessing proposed awards or settlements; or before proceedings are issued. In such instances, it is important to ensure that appropriate arrangements are in place to protect consumers and ensure that their interests are paramount.
While it will be up to each class action funder or class action lawyer to determine their own conflict management arrangements, these arrangements could include procedures to refer any disputes about accepting a settlement to a panel of independent experts for ultimate resolution. In conjunction with the regulations I earlier announced, ASIC may be called upon to prepare and release guidance to explaining the types of arrangements that considered adequate for the management of conflicts in class actions.
ASIC would need to complete a number of formal steps — including issuing a consultation paper — before this guidance could be released. In developing the relevant guidance, ASIC would consider its approach against the other regulatory controls over class actions, particularly with Court Rules.
The reforms I have outlined this afternoon are being introduced after consulting widely with stakeholders, and carefully weighing up the implications for all parties.
As always, the principles which guide our decisions are making it easier for people to do the right thing, while deterring wrongdoers — ultimately enhancing the efficient functioning and integrity of Australia's markets; for the benefits of all Australians.
Thank you for the opportunity to speak with you this afternoon; and I wish you a fruitful and informative conference.