Listed Securities: ACS Ownership Rights
Local Government Pension Schemes (‟LGPS”) funds, together with public pension funds around the world, increasingly have been leading securities fraud lawsuits in a variety of jurisdictions as representative plaintiffs and claimants.
The cases involved generate billions of dollars in recoveries for investors every year and, where possible, governance reforms designed to reduce recidivism. But, by pooling their ownership of listed securities via an authorized contractual scheme (“ACS”) without retaining the right to seek legal redress when they have been defrauded, LGPS funds could lose their ability to participate actively in future cases. That may be of less concern if the ACS operator is owned by the participant funds and all of the various ACS constituents are in and remain in sufficient agreement. Indeed, in those agreeable circumstances, the leverage in litigation of participating LGPS funds will increase dramatically. However, where the operator is rented or where the various parties fail to agree or fall out, powerful rights could be lost to the funds and left unexercised.
Over the last two decades, pension fund investors in publicly traded securities, including LGPS funds, have answered the clarion call to be responsible owners of otherwise “ownerless” public companies in various ways, including:
- Signing up to and following the prescriptions of stewardship codes and responsible investing initiatives;
- Exercising their voting rights;
- Engaging directly or via their chosen managers with the companies in which they invest; and
- Exercising their litigation rights, including seeking monetary redress and governance reforms via legal action when defrauded or otherwise harmed by redressable financial misconduct.
Even if some of the perceived benefits of the drive to responsible ownership can be debated, what cannot be is the fact that close to $100 billion has been recovered for defrauded securities investors over the last 20 years. Governance reforms are also being insisted upon with increasing frequency, all largely as a result of pension funds exercising their legal rights in various jurisdictions in which they entrust their money.
Pension funds have been readily able to lead class action efforts to secure such compensation – and governance reforms along the way – because significant amounts of their securities portfolios are segregated rather than pooled and because many fund members and officers are convinced that the responsible exercise of ownership rights is the right thing to do. The funds have been able to pursue such cases at no out-of-pocket cost to themselves because the proceedings are usually prosecuted and funded on a contingent “no win, no fee” basis. They have won governance reforms such as shareholder-nominated directors, auditor rotation, limitations on options grants, separation of the CEO and chairman positions, ethics monitoring, whistleblower hotlines and other bespoke governance enhancements as a result of the leverage that can be brought to bear when concluding meritorious cases.
The problem facing more proactive owners with the collective pooling of ownership is with the nature of an ACS itself:
- Typically only a complete owner of a security, and not a fractional owner, will have legal standing to assert any related claim; and
- ACS rules provide that only the ACS operator can exert day-to-day control over property in the ACS.
This in part explains why pooled funds are rarely at the vanguard of securities litigation recovery efforts. Their participants are often uncoordinated or are prevented from becoming involved, and most managers and operators have yet to pick up the mantle.
Only if the fractionalized ownership obstacle is overcome and funds are also assured that they are acting within their authority will there remain a path by which LGPS funds who choose the ACS route may still actively participate in anti-fraud cases for themselves and for other similarly damaged investors.
Who Owns What Matters
Unsurprisingly, it has been the real owners of publicly traded companies who, when defrauded by those companies, have led the charge for financial redress in courts across the world, and particularly in the United States. It stands to reason that the owner who suffers a loss owing to the purchase of securities at fraudulently inflated prices is more likely to assert a claim than a manager whose function is to select the securities for the owner and who may be, or feel, conflicted in myriad ways. And, in any event, it may be that the jurisdiction in which the claim is asserted requires that the claim be brought by the asset owner and not by the manager, unless the claim is sufficiently assigned.
Who, then, is the “owner” of listed securities purchased by an ACS? While the regulations say that the constituent LGPS funds will be the owners as “tenants in common” of the assets held by the ACS and the funds own units in the ACS, legal title to the underlying securities is held by or to the order of the depositary.
This confusion allows for the distinct possibility that LGPS funds, which in the past would have had no problem asserting their claims in court as segregated owners of securities with sufficient legal standing, may find themselves disabled from taking action. Courts may decline to recognize claims asserted by just one fund or a subset of constituent funds that all collectively own a security in an ACS, leaving it either to the non-owner operator to convince the courts of its standing (should it be motivated to do so) or perhaps to the manager of some sub-fund in which the loss manifested itself.
To date, depositaries have not displayed any appetite for asserting such claims, notwithstanding their possession of legal title or their status as trustees. The reality is that the more distance (and more fees) between beneficial asset ownership and asset management, the less aggressive the assertion of ownership rights is likely to be.
Even if the fractionalized ownership obstacle associated with ACS arrangements is overcome, LGPS participants still will be faced with the fact that they cannot exercise day-to-day control over the acquisition, holding, management or disposal of property in the ACS – only the operator can. The operator, however, is called upon by the rules to instruct the depositary as to how rights attaching to the ownership of property are to be exercised. How then can LGPS participants ensure that any erstwhile ownership rights over any listed securities are being exercised appropriately?
Directions and Board Oversight
ACS participants can issue directions to the operator so long as they do not amount to the exertion of non-FCA approved day-to-day control. Directions can be envisaged that mandate fraud monitoring, require the appropriate consideration by the operator or depositary of the exercise of litigation rights, and enable oversight and recommendations concerning litigation decisions by establishing an oversight board comprised of the participant funds. To ensure a court recognizes the legal standing of the non-owner operator, in circumstances where it will, but the depositary declines, to act, such directions could also anticipate the assignment of any right to sue in chosen situations. Assignments of litigation rights are recognized in most jurisdictions and can provide sufficient authority and legal standing for the assignee to pursue the claims as if the assignee were the legal or beneficial owner.
Reserving the Right to Sue
The “property” over which the ACS operator has day-to-day control and with respect to which the depositary notionally is directed by the operator concerning the exercise of “ownership” rights arguably includes the “chose in action,” which is the right to sue. The “right” is itself an asset. Accordingly, if that right enters the ACS then it may be that only the operator or depositary can exercise it, albeit with a level of oversight by participant funds. Measures that LGPS funds may wish to consider taking in order to retain control over rights attaching to “legacy” securities they already own, but are transferring to the pool, include explicitly reserving such rights so that they do not enter the pool in the first place (even if any proceeds derived from their exercise are to be transferred to the pool).
As for the exercise of rights attaching to non-legacy securities purchased in the ACS, unless agreements that pass FCA muster can be crafted prior to their purchase that ensure such rights are to be held outside the ACS by the participants or their nominee, LGPS funds may find themselves disabled from exercising any of the ownership rights that attach to them.
The ACS was not designed to promote active and responsible ownership. Nor was it designed with LGPS pools in mind. It was designed as a tax-transparent collectivized investment vehicle to attract multiple cross-border investors to the United Kingdom from Europe and around the world.
LGPS funds seeking whatever they perceive to be the benefits of collectivized investing in an ACS, while also preserving the accountability of the companies in which they invest, must carefully consider with their advisors how they can best fashion their ACS arrangements and still meet FCA approval. At stake is ensuring that at least one of the ACS entities – a participant fund, the operator, or even the depositary – continues the exercise and vindication of important, hard-won shareholder rights when the participant LGPS funds are victimized by securities fraud.
The above article was written by Robbins Geller partner Mark Solomon and featured in the UK's Pensions and Lifetime Savings Association’s Viewpoint supplement, “Local Authority Pooling Focus.” For a copy of the supplement, please visit: http://www.plsa.co.uk/PressCentre/news/0796-Viewpoint-feature-on-Local-Authority-pooling. aspx.