Picking up the pieces
15 July 2002
24 September 1996
4 June 2012
11 June 2007
8 May 1997
15 March 1999
Enronitis is the epitome of colossal failure of corporate governance and the consequences that follow. WorldCom is one of the latest to exhibit the disease, and there are more collapses to come. Investment banks, analysts, accountants and others who are perceived to have inflated the investment bubble are the subject of increasing excoriation and claims. The UK has its own financial problems: Equitable Life, endowment misselling, Independent Insurance, split cap investment trusts and underfunded pension schemes generally. It is pay-up time for the "irrational exuberance" that Federal Reserve Board chairman Alan Greenspan warned about more than three years ago, and for worse sins.
Misleading financial promotion is an enduring human frailty exploited over the centuries by inducing desires as eclectic as tulips, the South Sea and guano. The common law would be the poorer without the large volume of misleading prospectus cases decided in the half-century of so before World War I - the legal flotsam of victims of the heady entrepreneurial optimism of late empire.
Much of the reasoning remains of enduring relevance, not least Lord Halsbury's observation in Aaron's Reefs v Twiss (surely a first for an exotic case name) in 1896: "I do not care by what means it is conveyed, by what trick or device of ambiguous language: all those are expedients by which fraudulent people seem to think they can escape from the real substance of the transaction. If by a number of statements you intentionally give a false impression and induce a person to act upon it, it is not the less false if one takes each statement by itself [so] there may be difficulty in shewing that any specific statement is untrue."
The last sentence provides eloquent rebuke to US auditors who were happy to pass dodgy accounts so long as they complied with the strict letter of overprescriptive US accounting rules. In this country, we claim superiority by virtue of the overriding 'true and fair' requirement for financial statements. But as audit negligence practitioners are too often reminded, there are widely differing perceptions of 'true and fair' presentations. Bull markets test the extremities of the criterion and encourage its transgression. Bear markets reveal the transgressions, as a surging tide of new claims promises to reveal.
Pay-up time requires lawyers to focus on targets, especially deep pockets and potential liabilities. Deep pockets include banks, directors, accountants and actuaries, investment advisers and managers, lawyers, valuers, insurers and regulators. Expect not only conventional breach of contract and negligence claims, but also claims based on various species of participatory liability: dishonest assistance, conspiracy to injure by unlawful means and regulatory liability on the part of persons "knowingly concerned".
US practice is of comparative and salutary interest. Salutary because the US response to Enron's collapse is a harbinger of the litigation response in this country to like collapses. This is not only a function of legal and cultural affinity; it is more directly a function of increasing holdings in UK companies by US interests, especially holdings in apparent recovery stocks by US-dominated hedge funds. When collapses occur, expect them to be far more determined and financially able to pursue all avenues of recovery, as seen in the Barings audit negligence litigation.
The increasing incidence of claims arising from corporate collapses will in due course lead to a new body of case law and what will increasingly be recognised as a common law of corporate governance. This will be a symbiotic product of best practice, regulatory initiatives and judicial inventiveness. It will also draw heavily on principles developed in professional liability contexts, especially related to scope of duty, standards, causation and contributory negligence. Expect some complex issues increasingly to arise related to forum choice/shopping and conflict of laws. It is already a familiar feature of practice in this area.
For a long time the courts were resistant to claims related to bad investment. The perspective was that investment was synonymous with speculation. Change the word from investment to savings or pensions and the perspective changes. Thanks in part to regulatory legislation, concepts such as suitability and the understanding, assessment and allocation of risk are defining new frontiers of liability.
The legal legacy of Enronitis will be an increased emphasis on independence. The price of good governance, both corporate and professional, is eternal vigilance. For those called upon to exercise vigilance, there are three one-word commandments: probity, care and independence. Each of these is vital, but perhaps the greatest of the three is independence. Its centrality will be the main lesson derived from the inevitable judicial and regulatory scrutiny of Enronitis victims. Expect it to be reflected in a key area for future legal development, breach of fiduciary duties and managing conflicts of interest. Expect also new selection requirements for auditors, non-executive directors and audit committees.
For corporate and investment litigation lawyers, the next few years promise to be an exceptionally busy time. We are the carrion of corporate corpses.
John Powell QC is a barrister at Four New Square