In 2006, many shareholders who lost money after investing in shares of Enron received a total of $7.2 billion in the U.S. after a probe revealed that officials of the company presented false accounts to investors and hid losses before going bankrupt.
Around the same time, those who had invested in the shares of WorldCom received $6.2 billion after it emerged that its CEO had indulged in manipulative activities to pump up the share price.
Both these cases saw eligible shareholders in the U.S. getting back their money only because they had recourse to a class action suit. Interestingly, homegrown Satyam Computer Services, whose investors in India did not get any compensation even after founder Ramalinga Raju said that accounts were inflated and falsified, agreed to pay $125 million in the U.S. to settle suits filed by shareholders.
Such cases assume significance currently as India Inc. recently saw the sudden resignation of Infosys’s CEO Vishal Sikka and the ensuing exchange of allegations between the board of directors and founder N.R. Narayana Murthy that led to almost ₹23,000 crore of investor wealth being wiped off in a single day.
At least three U.S. law firms — Pomerantz LLP, Bronstein, Gewirtz & Grossman, and Rosen Law — have reportedly said that they would initiate class action proceedings against the Indian software major, which is also listed on the New York Stock Exchange.
The origins of class actions suits in the U.S. — where such cases are the most common — go back to 1842 when Equity Rule 48 gave individuals the right to file such cases. After multiple revisions, it gained its current shape in 1966.
Since then, the legal recourse has been used on numerous occasions in the U.S., the most famous and biggest of the lot being a whopping $206 billion being paid out by tobacco companies over a period of time.
This would be a good time for Indian policy makers as well to mull why such class action suits have not been able to take off in the country even though it has been more than four years since such recourse has been made possible in India.
The concept of class action was introduced in the Indian legal system when the Companies Act, which has its origin in 1956, was revised in 2013.
Section 245 of the revised Act lays down that shareholders or depositors can file a suit in the Tribunal if “they are of the opinion that the management or conduct of the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or depositors.”
The Act further states that a minimum of 100 individuals is required to file a class action suit. The Tribunal, if it deems fit, could restrain the company from certain activities while also directing the company and the auditor as well to pay damages or compensation.
‘Non-starter’
Sandeep Parekh, founder, Finsec Law Advisors, was of the view that class action suits have been a non-starter in India primarily due to two reasons: “First, lawyers should be allowed to charge contingency fees in class suits as is the case in the U.S. where such suits have seen shareholders get hefty compensation when cheated by companies,” he said. “Second, Section 20A of SEBI Act bars a civil court from having jurisdiction on any matter that is under the regulatory purview of SEBI,” said Mr. Parekh, who has earlier worked with SEBI as an executive director in charge of the legal department.
Contingency fees refer to the practice wherein the lawyer gets a fee only if the case is won. Indian regulations bar lawyers from charging such fees.
Meanwhile, the Companies Act lays down that the Investor Education and Protection Fund will be used for “reimbursement of legal expenses incurred in pursuing class action suits under sections 37 and 245 by members, debenture-holders or depositors as may be sanctioned by the Tribunal.”
According to Mr. Parekh, class action suits cannot be managed with a government-controlled fund as they could be misused and one might even suspect that people are using political influence to target rival companies. Interestingly, the California-based law firm that managed the class action suit for Enron shareholders got more than $700 million in fees.
Rajesh Narain Gupta, managing partner, SNG & Partners, said that while Section 245 had been introduced in the Companies Act, class action suits are still rare though there have been a few instances of people coming together or a common cause being addressed at consumer forums or in the form of a public interest litigation.
“The reasons include lack of a push mechanism. In U.S., law firms and lawyers become the catalyst for class suits as they get a share in the compensation granted by the Courts and the aggrieved persons get legal help and assistance without paying anything upfront,” said Mr. Gupta.
“The lawyers and law firms are highly incentivised to ensure success to such actions as they can legitimately recover their costs and fee from the award/compensation given to the claimants. It’s a highly-skilled and developed industry. In India, a commoner has to first think, ‘which platform do I go to; how do I get a lawyer; and how do I pay the lawyer,’ as there is no recognised back-ended system for payment of legal charges,” he added.
In the absence of such recourse to a class action suit, interested entities, including individual and institutional shareholders, have been left with no option but to approach the company itself or the Securities and Exchange Board of India (SEBI) to ensure that the organisation is managed in the best possible manner so as to safeguard their investments.
In a joint letter addressed to the board of Infosys, 12 mutual funds wrote that they were concerned about the recent developments and that co-founder Nandan Nilekani should be brought back. This was before the company announced the appointment of Mr. Nilekani as the chairman last week.
Incidentally, UTI Mutual Fund also sought clarification from the Infosys board as to whether the company was “committed to a transformation strategy aimed at rebuilding its business” and whether it would “continue to invest in attracting and rebuilding human capital” to aid such a strategy.
Bringing SEBI in
Post the sudden resignation of Mr. Sikka, a few shareholders even wrote to SEBI to check if there were any lapses related to corporate governance or disclosure requirements by the IT major.
“Under Companies Act, 2013 investors can approach the Tribunal for a class action suit if they think that company’s affairs are being conducted in a prejudicial manner to the shareholders or depositors. While there is no proven success of class action suits in India as it has its own limitations, there are precedents of relief from SEBI where stakeholders have sought quality in financial reporting, transparency and corporate governance,” said Sumit Agrawal, founder, Suvan Law Advisors, a law firm specialising in regulatory matters.
Mr. Sikka, in his resignation note, had said that the last few months and quarters saw “false, baseless, malicious and increasingly personal attacks” and allegations “that have been repeatedly proven false and baseless by multiple, independent investigations.”
“But despite this, the attacks continue, and worse still, amplified by the very people from whom we all expected the most steadfast support in this great transformation,” he said in his letter to the board.
Interestingly, if the framework for class action suits is revised to remove practical hindrances, one could see such suits being filed over non-corporate issues as well, such as those related to the general lack of proper civic amenities or even those concerning public health facilities.
