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Shareholder class actions

In legal terminology a tort is a harmful act, other than a breach of contract, which gives the victim the right to sue for compensation or another remedy. Some examples of torts are defamation, trespass, passing off and negligence. Tort law provides a remedy for any person harmed by an act or a failure to act by another person.

Criminal law, on the other hand, is concerned with the punishment of the wrongdoer. The focus of tort law is to compensate or provide another remedy for the victim.

Negligence is the most common tort, and an action can be brought where a careless act by a person causes harm to another. Importantly, there was no intent by the person to cause harm, for example, most car accidents are the result of negligence.

To succeed in a negligence action, the injured person needs to prove that the careless person

  • owed the injured person a duty to take care
  • breached that duty to take care AND
  • the harm suffered by the breach was caused by the breach (causation).

It is the third element, causation, that is the focus of changes to shareholder class actions. A class action is a single legal action that can be brought on behalf of many hundreds or even thousands of victims. Shareholder class actions are brought by groups of shareholders in relation to corporate mismanagement.

Victims’ lawyers and litigation funders are increasingly arguing that a lower test for causation for shareholder’s class actions should be used by courts. Their argument is that the more difficult causation to prove, which is direct or individual reliance is inappropriate in a stock market setting. The traditional test requires each member to prove that they relied on a company’s misleading disclosure when making the decision to buy the securities.

Some lawyers claim that the proper causation standard should be indirect or market reliance. As this lower standard of causation is easier to prove, the recognition of this by the courts would mean a far greater increase in the number of shareholder class actions being brought against companies.

This would have a significant commercial effect, as well as social outcomes, as companies and their directors would be faced with defending more litigation by disgruntled shareholders. Arguably they may not be able to effectively run their business when there is a constant threat of litigation.

Investing in the stock market holds risks for investors and the lower test for causation may be over-protecting consumers – treating them as children instead of as intelligent investors.