The Centro settlement is not significant because of the law that it creates.  Indeed, settlements may be seen as missed opportunities for the development of the law.  However, the Centro case provides another stepping stone in the development of shareholder class actions in Australia.  As a result it is the latest learning on where shareholder class actions are headed, following on from earlier cases such as Telstra, Aristocrat, AWB and Multiplex.

Although many of the details of the settlement are currently unknown as there has not been the required settlement hearing before the Federal Court of Australia, and indeed many of those settlement details will be protected by orders for confidentiality so that they may never be known by the public, there are a number of issues that still deserve comment.

$200 million settlement but what were the losses

Much has been made of the size of the settlement, being $200 million.  This is indeed the largest shareholder class action settlement in Australian history.  However, focussing on the absolute amount of the settlement misses a more important question.  What proportion of shareholders actual losses are being compensated?  This requires a comparison between the settlement with the quantum of the claim.  This comparison is made difficult because the law is unsettled as to how both causation and quantification of loss are to be determined in shareholder class actions.  Nonetheless the efficacy of shareholder class actions in achieving compensation means the comparison is essential.

The Age on 25 August 2008 ran a headline "Centro in court over $1 billion class action". Similarly, the Australian Financial Review on 28 May 2008 reported that the claims against Centro "could now stretch to more than $1 billion".  The $1 billion figure was repeated in other newspapers such as the Sydney Morning Herald and The Australian towards the end of 2008.  The basis of the calculation of the $1 billion claim amount is unclear, but appears to derive from the fact that Centro's shares were trading at close to $10 prior to the start of the group period for the class action and then plummeted to less than 10 cents.  If the $1 billion estimate, or more, is correct, then the shareholders have taken a substantial haircut.  This then raises serious questions about whether the class action is effective in compensating shareholders.  Of course, it may be argued that without the class action, no shareholders would sue and recovery would be zero.  However, the evaluation of class actions can do better than simply requiring shareholders to be grateful for whatever they can get.

Lawyers' and Funders' Fees - Transaction Costs

The other drain on funds for compensation is the amount of transaction costs that are associated with the class action due to the need to pay the costs of the class action lawyers and to pay a percentage of the recovery to the litigation funders.  The amount of legal fees and the percentage paid to the litigation funder reduce the amount going to the people who actually suffered the loss.  This issue is not novel and questions have been raised about whether the percentage charged by the funder reflects the risks of the case or, because the funding market appears not to be competitive, it results in super profits that are far greater than the risk undertaken.  No answer has been forthcoming other than there must be a return on the funder's investment or they will do something else - mining perhaps.

The Centro case also raises a further issue in relation to costs.  The Centro proceedings actually involved three class actions – two  brought by Maurice Blackburn and IMF and another brought by Slater & Gordon and Comprehensive Legal Funding.  This is discussed further in relation to the efficient conduct of class actions, but an important question for the judge who will be asked to approve the settlement is whether the amounts claimed by the lawyers and the funders should take account of the fact that there may have been duplication in effort.  Did the proceedings need two sets of lawyers for the shareholders?  Further, while, the Federal Court approves the legal fees charged it has not reviewed the percentage claimed by the funder.  Should the Federal Court be required to approve the funder's percentage?

Who will pay? Targets for the Future

The Centro proceedings have highlighted the ability to expand the potential "deep pockets" that can be brought into a class action through Centro cross claiming against its auditors PricewaterhouseCoopers which in turn cross claimed against the individual directors.  As a result shareholder class actions may become more complex as they are no longer shareholders represented by a lead applicant against the company and instead include a number of potential respondents. 

This in turn raises questions for directors and advisors as to whether their potential liability becomes greater because they may find themselves brought into class action proceedings.  This necessarily raises questions about the insurance held by directors and advisers and whether it is adequate.  The Aristocrat class action settlement of $144.5 million in 2008 involved insurers picking up about $100 million of that liability and started some soul searching in the insurance industry as to how Directors & Officers liability policies should be structured.  It will be interesting to observe whether Centro has a similar impact in relation to professional indemnity insurance with PwC rumoured to be picking up one-third of the payment. 

Who is being compensated? Institutional Investors or Mums and Dads

Both are part of the Centro class actions but the quantum going to the institutions illustrates how important they are to the creation of a profitable suit.  Slater & Gordon represented the bulk of group members, about 5000 mum and dad investors, but recovered only $50m of the $200m settlement.  The other $150m goes predominantly to institutional investors.

Institutional investors are important participants in shareholder class actions because of the volume of shares that they hold.  Institutional investors, particular those acting as a trustee for superannuation or investment funds, are now formalising their processes for evaluating class actions as this type of litigation becomes a recurring part of their business.  The Centro pay-out will encourage institutional shareholders to be part of shareholder class actions.

Efficient Conduct of Class Actions

The Centro class action also raises important issues as to how class actions can be efficiently conducted.    In the early stages of the case, when it was being case managed by Justice Ray Finkelstein, the question was raised as to whether the class actions should be formally consolidated, one stayed or some further novel approach adopted relying on learning from the US, such as the appointment of a litigation committee or the use of auctions.  Justice Finkelstein subsequently stepped down from the proceedings due to a motion arguing that there may have been a reasonable apprehension of bias due to him holding shares in the respondents.  As a result, these novel case management techniques did not come to pass and three class actions have been allowed to progress together. 

Whether this is the most effective way in which to run a class action should be questioned.  It carries with it a high risk of duplication and the possibility of increased cost and delay in relation to the resolution of the proceedings.  Even in relation to a settlement there becomes the need for additional parties to be consulted.  There must be better ways in which multiple class actions can be dealt with and this will be a future challenge that the Federal Court will need to meet because it seems likely that further funders and class action lawyers will be attracted to claims against corporations who cause major losses meaning that the issue will persist. 

Private v Public Enforcement

The last issue for consideration is how the private class action stacks up against public enforcement by ASIC.  ASIC took a long look at the conduct of Centro and determined that it would bring proceedings against the directors with a view to having them disqualified and be required to pay pecuniary penalties. ASIC was intent on clarifying the law as to a directors responsibility in relation to financial accounts and deterring similar future conduct.  However, its action did not look at the conduct of the auditors.  Further, ASIC did not feel the need to seek compensation for the shareholders that had suffered loss. 

The class action, on the other hand, was very much focused on compensation as it is only a monetary payout that results in a recovery for the funder.  However, shareholder class actions have also been advocated on the basis that they promote corporate governance and the efficiency of the market by allowing for the enforcement of statutory requirements such as continuous disclosure and prohibitions on misleading conduct.  The mere fact that Centro got hit with a $200m class action sends a message to other corporations.

Further, the class action looked closely at what the auditors did.  The size of their contribution to the settlement may be some indication as to their relative responsibility for the losses, or a return to the 1980's where auditors were the deep-pockets of choice for litigation - remember AWA v Daniels.  However, the class action does not appear to have obtained any pay out from the directors who were parties to the class action at PwC's behest, as presently disclosed.  Maybe their insurance policies were exhausted or maybe they have contributed confidentially.

What does this all tell us? 

From a deterrence perspective ASIC bolstered the law and obtained declarations that supposedly lifted the requirements for directors.  However, it obtained little in terms of directors being required to pay fines but apparently seriously harmed their reputations. 

The class action secured the payment of serious money but whether the pay-out is truly effective at achieving deterrence  requires the payment to be in line with the harm done.  Class actions do not have clarifying the law as a major objective unless it assists in improving the prospects of recovery.  As a consequence, the class action was unlikely to address the issues of directors duties the way in which ASIC's case did.  Indeed, the fact that class actions almost always settle means that the development of the law was unlikely to take place.

ASIC appears ready to leave compensation to the class action promoters.  Whether class actions are effective at compensation requires an assessment of the losses suffered.  It also remains to be seen whether the public is content to be required to utilise privately run class actions where they are required to give 25-30% of their recovery to a funder plus repay legal costs.  If compensation is to be out-sourced by government then it should consider further regulation.  At present there is little oversight.

It seems that there is a role for both public and private enforcement of the securities laws, but exactly how they fit together and whether they may help or hinder each other is a matter for further analysis.