Will shareholders win RBS battle?

Royal Bank of Scotland is facing more judicial trouble after a group of shareholders launched yet another multi-million pound lawsuit against the state-owned bank for "misleading investors" into believing it was in good financial health just before it collapsed in 2008.

In April 2008, the bank issued a prospectus asking shareholders to subscribe to shares at 200p to strengthen its situation. RBS raised £12 million when investors flocked in believing the lender was strengthening, but by January 2009 the share price was about 11p.

Where does the law stand?

According to Jonathan Cary and Jo Rickard, litigation associates at law firm Shearman & Sterling, under the Financial Services and Markets Act 2000 (FSMA), a company is required to publish a prospectus when making a rights issue.

This prospectus must contain "all information that investors and their advisers reasonably require and would reasonably expect," for the purposes of making an informed assessment of:

• The assets and liabilities.
• The financial position.
• Profits and losses.
• Prospects of the issuer of the securities.

What is a basis for liability?

Cary and Rickard explain that any person who has acquired securities and suffered a loss as a result of any untrue or misleading statement in the prospectus, or the omission from the listing of any matters required, can make a claim against those responsible for the prospectus.

Backing Royal Bank of Scotland Shareholder Action Group's claim, Cary and Rickart explain a claimant "only needs to demonstrate that he has suffered loss as a result of the misstatement or omission".

In other words, it would be sufficient for the action groups to prove the market price was affected, which would have led shareholders to suffer losses.

Compensation

The shareholder action groups are seeking to recover the difference between the price paid for RBS shares in April 2008 and what a court deems to have been their actual price at the time of the rights issue.

According to sources close to the matter, the action groups claim they could recover "hundred of millions" if successful.

What does the law say?

While the FSMA states the defendant is liable to compensate the claimant for loss they suffered in respect of the securities as a result of the "misstatement" or "omission" of information, it does not outline the measure of damages, or the extent of compensation.

Cary and Rickart explain there could be two results to a successful claim:

• A judicial measure would enable shareholders the recovery of all losses which have flowed naturally from acquiring the securities; or,
• The measure could confine damages to the consequences of the statement being false or misleading.

"It is inevitable that this will be a key battleground between claimants and defendants in early claims as the difference in damages is potentially huge," they added.

Other collective actions against banks

Adding to the number of shareholder action groups filing lawsuits against British banks, Lloyds Action Now also intends to sue Lloyds Banking Group, claiming Lloyds shareholders suffered losses after they were asked to vote for the "disastrous" merger of Lloyds TSB Bank with bankrupt Halifax Bank of Scotland (HBOS) in 2009.

They also claim the prospectus published by Lloyds in November 2008 "deliberately withheld" from shareholders any information relating to Lloyds TSB's £10 billion loan to HBOS, to keep it afloat, before they were asked to vote for the merger.

The group also claims the prospectus did not disclose that HBOS had received emergency funding from a variety of sources.

Lloyds Action Now indicated it was seeking to obtain third-party funding and after the event (ATE) insurance before commencing proceedings.

Precedents

According to data provided by Paul Davies QC, professor of corporate law, the table (Source: Davies Review of Issuer Liability, Paul Davies QC (March 2007); click to expand) shows legal cases where the Financial Services Authority (FSA) made use of its penalty and censure powers under Section 90 of the FSMA.

Davies explains: "The focus of the FSA has been on delayed announcements," pointing to a "relatively modest level of public enforcement activity.

"That the FSA should have made little use of its criminal enforcement powers is not surprising, given the difficulty of proving the elements of intention or recklessness to the required criminal standard of proof," he adds.

"Even so, eight sets of penalties or censures imposed over a period of four years might not seem a high level of enforcement, even though the penalty imposed in the case of Royal Dutch Shell was very large in absolute terms though perhaps less so in comparison with the turnover of that issuer."