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The Times: Don’t sue fellow shareholders

May 19, 2007
Graham Searjeant, Personal Investor

Whenever companies fail to stand up to an abuse, they give a green light for more and bigger malpractice. That is true of bribery and corruption, of cutting corners on safety or quality, of settling frivolous product liability claims and now of uninsurable class actions from shareholders.

A month ago Royal Dutch Shell agreed a $450 million (£230 million) settlement with lawyers “representing” mainly European investors who claim to have been misled when they bought Royal Dutch shares. The board, you may recall, had overstated its proven commercial oil and gas reserves in the years up to 2004, relative to the formula laid down by the US Securities and Exchange Commission. Heads rolled.

In addition, Shell agreed to pay about $45 million, a 10 per cent commission, to Grant & Eisenhofer, the Delaware law firm that ran the case. Lawyers love pay days like that. They will try still harder in future.

The company had already made life hard for itself by settling a related American case for as smaller amount. How big will the next lawsuit be? Actually, we know already.

This week Tyco, the US conglomerate, agreed to pay $3 billion, more than 5 per cent of its market value. This vast sum settled a class action on behalf of investors who bought Tyco shares between the end of 1999 and the middle of 2002.

Buying any shares in 2000 or 2001 was likely to land you with big losses. The argument was that Tyco’s board, then led by Dennis Kozlowski, made things worse by overstating earnings, as Bernard Ebbers did at WorldCom. Mr Kozlowski followed recently in the footsteps of Mr Ebbers to start a 25-year jail sentence, one of the top US scapegoats for the stock market crash.

Mr Kozlowski and his cronies are long gone, leaving others to clear up the mess. They settled because they want to hive off two divisions and do not want corporate action frozen by the lawsuit. The losers are all the other shareholders in Tyco: those who held the shares before 2000 and those who bought after the fall, which cut its market value by three quarters.

They gained nothing and are in no way to blame for the losses incurred by a particular group of investors. If longer-term shareholders had known what was going on, they would have sold and saved themselves from loss. The only people who did benefit from false accounting, apart from the Kozlowski set, were those who sold to the complaining buyers at the offending time.

If the board is acting in the interest of all present shareholders, as it must, it should, on their behalf, sue those selling shareholders to recompense the mistaken buyers. Yet it seems doubtful that any court would let such an action succeed. The fortunate sellers were merely fortunate, just as those who kept their shares were unfortunate.

If investors are to sue companies, as if they were contract customers, they stop acting as owners who are entitled to vote and elect the board. Any shareholder who does not employ a lawyer is liable to become a second-class investor. Likewise, if some investors are suing, everyone should join them so they that they become complainers rather than the people who pay compensation.

On that principle, the main Dutch pension funds, Morley investment Management and AXA, joined in the lawsuit against Shell. It was harder for private investors. More than a year ago, when the Shell case started, it was argued here that big company boards should resist begger-my-neighbour lawsuits that pitch shareholders against each other to earn money for lawyers.

Apart from pitching hedge and pension funds against small investors, it undermines the legitimacy of companies trying to maximise shareholder value. If investors can sue each other, they forfeit any greater right of control than the other “stakeholders” we heard so much of ten years ago. If corporations are to forestall this, they must treat all their owners equally. If one group wins damages, the corporation should pay out to all. It may defy business sense, but at least it is their own money.

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