Litigation costs: an oversight in corporate governance?

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Dina Medland argues that litigation costs could be symptomatic of lapses in corporate governance.

The legal bills faced by banks in the last few years over a multiplicity of transgressions continue to be a lot higher than anyone ever anticipated. Yet they have been swallowed by shareholders without too much fuss. There are signs that this might be changing, with implications not only for banks, but for any publicly listed business that finds itself repeatedly paying huge amounts of money in fines to regulators, and redress to its customers.

In January, Deutsche Bank, now Europe’s biggest investment bank, announced a surprise pre-tax loss
of €1.53bn in the fourth quarter of 2013, stating that ‘litigation costs and restructuring had weighed heavily on its financial performance'. Litigation costs mounted up to €528m for the period, while revenue fell
16 per cent.

More recently, it was reported in April that since the financial crisis, Bank of America has paid settlements and set aside legal revenues totaling more than US$58bn. Its shares have been up 32 per cent over the past year, and it has ‘outperformed’ other US banks. But, at the end of last year, Bank of America estimated it could face up to US$10bn in additional costs, and the final sum remains unclear.

This news came just after a dozen large investors filed a class action lawsuit against 12 banks – including Deutsche Bank and Bank of America – for allegedly conspiring to rig global foreign-exchange prices.  Filed in the US District Court in the Southern District of New York, the action was taken by a group of investors across the US and Caribbean, including city and state pension plans. While damages sought are as yet unspecified, the reputational damage of such a case being brought and dragging on to resolution is potentially enormous.

 


‘In-house lawyers are ideally placed to put legal costs into perspective for the boardroom, and to consider how they can be contained in terms of damage to the business’


 

As large investors consider filing cases individually alongside the class action suit, further regulatory investigations around the globe are picking up momentum. These investigations are less a matter of ‘litigation costs’ than of an acute crisis of corporate governance for any business that is paying through the nose for a fundamental failure in its performance strategy.

In-house lawyers are ideally placed to put legal costs into perspective for the boardroom, and to consider how they can be contained in terms of damage to the business. But it’s a fast-moving space.

Earlier this year, the US regulator, the Office of the Comptroller of the Currency (OCC), proposed new rules for tougher standards of risk management in the largest banks, and quicker punitive action. Punishments could involve imposing fines, suspending directors and executives or simply removing them – without going to a judge for a verdict. This proposal is under consultation. While this kind of move might help take litigation costs out of the corporate governance equation, it would place an even greater burden on the board of directors to provide oversight and ensure that a bank is compliant with risk management best practice.

While it is a requirement of the UK Corporate Governance Code that companies with a premium listing of equity shares on the London Stock Exchange arrange adequate insurance cover to deal with any legal action, which may be taken against their directors and officers, insurance is not really the solution to mounting litigation costs.

For the best solution to litigation costs, is to spot the problem before it is allowed to take hold and thus avoid it altogether. In a very different industry sector – entertainment – Robert Kelly, Deputy General Counsel at DreamWorks Animation had this to say in an interview two years ago: ‘The biggest distinction between life as an in-house counsel and as an outside lawyer is that in-house counsel is typically involved in matters much earlier in the process, often at the planning stages… I believe the biggest contribution that in-house counsel can bring is to help shape decisions early in the process that can appropriately minimise legal risks while still achieving the business objectives.’

 


‘I believe the biggest contribution that in-house counsel can bring is to help shape decisions early in the process that can appropriately minimise legal risks while still achieving the business objectives’

Robert Kelly, Deputy General Counsel, DreamWorks Animation


 

And if you work for a bank, this is an extremely urgent consideration.  At the Deutsche Bank annual general meeting (AGM) at the end of May, Union Investment, its 12th-largest shareholder, said it was among investors growing impatient over legal bills and capital increases. Addressing co-CEOs Anshu Jain and Juergen Fitschen at the AGM, fund manager Ingo Speich said: ‘The patience of shareholders and investors is slowly wearing out ... when will this nightmare finally end?’

But the last word on the issue of litigation costs and corporate governance surely comes from Klaus Nieding, a
Vice-President of DSW, a German proxy-voting agent representing shareholders at the Deutsche Bank AGM. ‘We’re beginning to see that not everything that glitters is gold at Deutsche Bank and that the years-long legal disputes leave strong brake marks in our numbers’, he said. ‘This company is not a gigantic legal department with a bank attached.’ But if corporate governance goes wrong, that is how it can seem.

 

Misleading investors

Liam Kennedy, Co-Chair of the IBA Litigation Committee and partner at A&L Goodbody, agrees that references to litigation costs by companies ‘are extremely misleading in that they suggest an issue with costs charged by lawyers. In fact, such references are a euphemism used to refer to liabilities incurred by banks as a result of their actions, including serious regulatory breaches in some cases. It is misleading for banks to use the expression “litigation costs”  when they really mean financial exposures to regulators, customers, counterparties etc, as a result of criminal sanctions or civil liabilities.

‘The key to reducing such exposures rests with the culture and ethos of the financial institution.
The fundamental safeguards are an organisation-wide commitment to good corporate governance
and effective risk management. Businesses need to understand their legal, regulatory and compliance obligations, and the risks, and to take those obligations into account in determining their commercial strategy.

‘In-house (and, where appropriate external) counsel have an important role to play in helping institutions address such corporate governance and risk management issues so as to avoid civil or criminal financial exposure’. 

 

 

Dina Medland is a freelance journalist.