Pension funds don’t really value right to sue for fraud – new study

January 30, 2015

A year ago, when the U.S. Supreme Court was considering whether to all but erase shareholder fraud class actions brought under the Securities Exchange Act of 1934, pension funds were strong voices in the chorus defending shareholder fraud litigation. The Council of Institutional Investors and an ad hoc group of nearly three dozen public pension funds submitted amicus briefs in Halliburton v. Erica P. John Fund, arguing that private shareholder suits deter corporate wrongdoing, recoup investors’ losses and are a critical supplement to Securities and Exchange Commission enforcement actions. That was a familiar refrain: Since Congress amended the securities laws in 1995, empowering institutional investors to lead shareholder fraud class actions, pension funds have become outspoken advocates of their right to sue the corporations they invest in.

But a forthcoming paper in the Journal of Legal Studies by a Berkeley law professor says that pension funds don’t seem to be putting their money where their mouths are. According to study author Robert Bartlett, there’s an apparent gap between institutional investors’ adamant advocacy for shareholder class actions and their actual trading decisions.

Bartlett came up with an ingenious way to test whether pension funds actually value the right to sue for securities fraud. As you surely remember, the 2010 Supreme Court ruling in Morrison v. National Australia Bank abruptly stripped investors of the ability to sue non-U.S. corporations based on shareholders’ stock purchases on foreign exchanges. Trial judges interpreting Morrison quickly reached a consensus, however, that investors who held American Depository Receipts in cross-listed foreign companies (basically, the U.S.-traded equivalent of non-U.S. common shares) could still bring fraud class actions in U.S. courts. Bartlett’s hypothesis was that if pension funds truly believed in the value of their right to sue, their trading after the Morrison decision would reflect a reallocation toward U.S.-traded ADRs, rather than common shares, in non-U.S. companies.

He obtained pre- and post-Morrison trading data for about 197 pension plans and 181 money managers from the trading analyst Ancerno. Bartlett pulled out information about their investments in about 420 non-U.S.-based companies cross-listed on major U.S. exchanges. Before he ran the numbers to see how trading patterns had changed, he told me in an interview Friday, he expected to find that after Morrison, pension funds stepped up their investment in U.S.-traded securities instead of shares traded on foreign exchanges.

The data showed otherwise, as Bartlett recounts in “Do Institutional Investors Value the 10b-5 Private Right of Action? Evidence from Investor Trading Behavior Following Morrison v. National Australia Bank.”

Bartlett crunched the numbers a few different ways, looking at the funds’ week-by-week percentage of trades on U.S. exchanges in cross-listed companies as well as side-by-side assessments of how investors traded in the same company before and after the Morrison ruling. (His data included trades between April 2009 and September 2011.) Bartlett also ran numbers on how funds allocated their investments in non-U.S. companies between foreign and U.S. exchanges, though that analysis won’t be in the published version of the paper. In all of his models, the Berkeley prof tested whether pension funds and money management funds differed in their response to Morrison.

No matter how Bartlett ran the numbers, the conclusion was the same: Pension funds, like money management funds, didn’t change trading venue decisions after Morrison, even though where they bought shares determined whether they surrendered the right to sue for fraud in the U.S. “If you were investors before Morrison who bought in London, you still bought in London,” Bartlett told me. “None of these investors changed the allocation of trades.”

That outcome surprised Bartlett, who isn’t in the academic camp that believes securities class actions are fundamentally flawed. Barnett said he “thought there would be something in the data” to back what pension funds said about the value of their right to sue. “I expected it wasn’t just cheap talk,” he said.

As part of his research, he talked to traders to find out how they made trading venue decisions. They gave him all kinds of reasons, from liquidity and timing to concerns about marketing themselves as global investors. None of the traders he talked to, Bartlett told me, said they considered their fund’s right to sue for fraud when they decided where to execute a trade.

Bartlett’s paper includes some caveats. It could be that there is simply a disconnect or time lag between pronouncements by pension funds’ policymakers and day-to-day decisions by traders. His information only dates to September 2011, about 15 months after the Supreme Court decided Morrison, and investors might not by then have understood the difference, for the purposes of fraud claims, of trading in common shares and ADRs. Or there could be some distortion in the data because the trading analyst that supplied it provided information about only a subset of pension funds.

As Bartlett points out in the paper, at least one previous study of Morrison’s impact concluded that investors did sell off shares of foreign companies in response to the Supreme Court ruling. (A second event study, however, reached the opposition conclusion.) “To be sure,” Bartlett wrote, “there are a number of reasons to be cautious in interpreting this paper’s findings.”

Bartlett’s caveats aside, his findings are provocative. NERA, Advisen and Cornerstone all reported this month that securities class action filings and settlement amounts declined in 2014, even though the Supreme Court’s Halliburton ruling assured investors’ ability to bring fraud class actions. If Bartlett is right about the value institutional investors place on their right to sue, it makes sense that over the long run, they won’t bother to exercise it.

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