Listed Securities Claims Averted as Passive Investors are Struck Out

In October 2024, in an English High Court judgment that will be welcomed by financial lines insurers, it was held that for investors’ listed securities claims to succeed, the claimants had to prove that they actively relied on misleading statements.

Following this judgment, if a dishonestly misleading statement is made in a regulatory publication (i.e. financial reports and Regulatory News Services / RNS market releases of listed securities issuers), only those investors who had actively read and relied on the misleading information can claim under section 90A of the Financial Services and Markets Act 2000 (FSMA).

Any investor who purchased a listed security at a market price that was artificially inflated under the influence of a misleading publication, but without actively relying on it, will therefore be left without any remedy.

The ever-growing number of ‘passive investors’, for example those investing in index-linked funds, will lose out to their more active peers who can prove that they carried out research before making their investment decisions.

Subject to the possibility of an appeal, the outcome for this litigation is that the majority of claims, with a value exceeding £330 million, have been struck out. There are significant ramifications for the overall framework of UK securities claims, as for all issuers of listed shares and bonds, their directors and insurers.

 

Background

In November 2020, several hundred investors (the Claimants), who had held shares in Barclays Bank (the Bank), issued a claim (the Shareholder Claim) for over £500 million. The Bank denies liability.

The Shareholder Claim was brought in the wake of a securities fraud lawsuit that was filed in June 2014 against the Bank by the New York Attorney-General, settled in January 2016, and caused the Bank’s share price to drop.

The complaints related to a ‘dark pool’ share trading system that the Bank had operated. Such a system is designed to allow securities sales to be negotiated and agreed, without the price becoming known to the market until after the sale has completed. It was alleged that the Bank had made misleading statements about the privacy of the system’s trading environment, for example, the possibility of information leaking out that would favour high-frequency traders.

The Claimants alleged that the Bank had been legally required to publish the true facts about its dark pool trading system to the market, but that it had dishonestly failed to do so. The Claimants also alleged that the Bank had instead issued regulatory publications to the market, in which untrue and misleading statements concerning the risks arising from its trading system were included.

Some Claimants allege that they read and relied on the Bank’s regulatory publications directly; others allege that they relied on the published information indirectly, e.g. via press or financial brokers’ reports.

However the majority of Claimants alleged that they had relied on the regulatory information even more indirectly, only by dealing in the Bank’s shares at a certain market price. Given that the Bank’s shares were listed on the London Stock Exchange, which was argued to be “an efficient market in which the price of [the Bank’s] shares was determined and/or influenced” by the regulatory publications that were available to the market at any particular time, this category of Claimants argued that, by relying on the market price at that point in time, they had thereby “relied indirectly” on the Bank’s published regulatory information, including any untrue or misleading statements that it contained.

The judgment in this case holds that such “indirect reliance” on regulatory publications is not sufficient.

The UK Investor Protection Framework

Where securities are listed in the UK on the basis of a prospectus (or listing particulars), if that document contains any untrue or misleading statements, investors may bring prospectus liability claims under s.90 of FSMA.

While s.90 claimants are not required to prove that they actually relied on the terms of the prospectus, it is a defence for the issuer to have carried out reasonable due diligence. In other words, liability is based on the negligence standard. Investors therefore enjoy quite a high degree of protection in relation to any misleading statements that are made in prospectuses.

Investors in UK-listed securities also enjoy - under s.90A of FSMA - more limited protections in respect of losses arising from any untrue or misleading statements that are made in an issuer’s regulatory publications more broadly (i.e. its financial reports and RNS market releases).

However, under s.90A, liability is not based on the negligence standard, but instead, dishonesty / deceit. In order for claimants to succeed, they are required to prove that they relied on dishonestly misleading statements when making investment decisions.

The Requirement for Reliance

The judge held the Claimants had to prove that:

“they read or heard the representation, that they understood it in the sense which they allege was false and that it caused them to act in a way which caused them loss […]

This is because the test is one of causation and a statement can only cause an individual to act or operate on their decision-making process if they hear or read the statement […]"

Dishonest Omissions

Listed securities investors also benefit from protection under s.90A of FSMA in respect of the dishonest omission of any information that is required to be included in an issuer’s regulatory publications.

While it is conceptually more difficult to see how an investor can be said to rely on information that is not actually included in any particular publication, the judge solved this conundrum by holding that the Claimants were only required to prove that (1) their investment decision-maker actually reviewed the regulatory publication in question, and (2) the decision-maker would have acted differently if the dishonestly omitted information had been included in the publication as it ought to have been.

Comment

The Court has robustly upheld the requirement for claimants under s.90A to prove reliance and causation.

Active investor decision-makers should heed this judgment by keeping written records of any regulatory publications that they rely on when making decisions. This case highlights that such reliance has to be individually proven at trial.

In reaching his decision, the judge rejected the Claimants’ argument based on the “efficient capital markets hypothesis”: that because an efficient securities market is taken to reflect in the price all of the information that is publicly known, an investor purchasing securities at any given market price is thereby impliedly relying on all of the information that is available to the market at that time.

This outcome contrasts with the class certification decision in the related US securities class action, in which it was found that the presumption of reliance (based on the fraud-on-the-market theory that is followed in the US) applied, because the market for the Bank’s US-listed securities was held to be efficient. The US action settled in 2019 for USD 27 million.

In this judgment, the Court declined to follow the US fraud-on-the-market theory. The judge referred to academic commentary (by Professor Eilis Ferran of Cambridge University) that “developments in financial economics […] have undermined the once seemingly unassailable position of the efficient capital markets hypothesis as an accurate explanation of how capital markets actually work.”

The judge left open the possibility that claimants could establish reliance on the basis that they had used artificial intelligence to assess an issuer’s regulatory publications. This may encourage institutional investors to employ AI technology accordingly, and we predict that this factor is likely be explored in future claims. The very significant question also remains open for now, whether reliance on regulatory publications only indirectly via media or broker reports can be sufficient to establish the reliance requirement.

The judge referred to evidence that, by the end of 2020, passive investments, e.g. in tracker funds, had come to represent more than one third - or around £3 trillion - of the total UK investment market, and still remained a growing trend. Substantially limiting the potential number of s.90A securities claimants by excluding passive investors means that the economics of pursuing group litigation will be less attractive for claimants.

D&O and POSI (Public offering of securities insurance) insurers, in particular, should welcome this decision, as subject to any appeal or other developments in future caselaw, countless potential claims by passive investors in UK-listed securities will be averted.

Read other items in Professions and Financial Lines Brief - December 2024