On 28 October 2019, the High Court dismissed Tesco’s strike-out application in relation to two group litigation actions brought by its shareholders relating to false and misleading statements made by Tesco regarding the overstatement of its profits.
The judgment is available here.
Background
In 2016/17, two groups of institutional investors, also known in the proceedings as the SL Claimants and the MLB Claimants (together “the Claimants“), issued proceedings for a substantial sum against Tesco Plc (“Tesco“) pursuant to section 90A and Schedule 10A of the Financial Services and Markets Act 2000 (“FSMA“).
The claims arise out of false and misleading statements made by Tesco, in relation to its trading profits. The statements, which surfaced in September 2014, also led to civil and widely publicised criminal actions by the SFO against three former executives. In the civil proceedings, the Claimants seek to recover losses arising out of investment decisions made in relation to Tesco shares, after having relied on the misleading statements published by Tesco.
The shares were held in dematerialised form in a computer-based system called the Certificateless Registry for Electronic Share Transfer (“CREST“), the only central securities depository in the UK approved by HM Treasury. CREST uses custodians (or nominees) via which the shares are acquired, held or disposed of. The Claimants’ shares, in both proceedings, were registered via third party custodian banks or financial institutions – such as State Street Bank & Trust Company, JPMorgan Chase and BNY Mellon – which provided custodian services. This meant the Claimants never directly acquired, held or disposed of a legal interest in any of the shares.
Furthermore, most of the shares in Tesco held by custodians are held for another intermediary in a “custody chain”. The registered legal owner of the shares was, therefore, the custodian (or nominee). The use of custodian services in this manner is commonplace.
Where there is only one intermediary in a custody chain, a claimant may have a direct beneficial or equitable interest. However, if the custody chain is longer, such as in these proceedings, the claimant at the end of the chain is only the beneficiary of a sub-trust, not of the trust to the legal title. Ultimately, as highlighted at paragraph 19 of the judgment, the key feature of intermediated securities held in custody chains is that the ultimate investor is given the benefit of a right without holding the right itself.
In its application, Tesco applied to strike out both claims on the basis that, where there was more than one intermediary in a custody chain, the Claimants were not persons to whom it, as an issuer, could be held liable under section 90A and Schedule 10A FSMA for any untrue or misleading statement it had published.
Section 90A and Schedule 10A FSMA
Section 90A and Schedule 10A FSMA have been in force since 2010, with the aim of regulating the liability of issuers of UK securities for fraudulent reporting. These claims are the first to be brought under section 90A and Schedule 10A FSMA.
Pursuant to section 90A FSMA, an issuer of securities is liable to pay compensation to “persons who have suffered loss as a result of (a) a misleading statement or dishonest omission in certain published information relating to the securities or (b) a dishonest delay in publishing such information.”
Under paragraph 3(1) Schedule 10A FSMA, compensation is to be paid to “a person who acquires, continues to hold or disposes of the securities in reliance on published information to which this Schedule applies, and“ who has “suffered loss as a result of any untrue or misleading statement in [it], or the omission [from it] any matter required to be included in it…“
Further, paragraph 8(3), Schedule 10A FSMA, relating to the interpretation of the schedule, states that the acquisition or disposal of securities includes “(a) acquisition or disposal of any interest in securities, or (b) contracting to acquire or dispose of securities or any interest in securities.”
Tesco’s arguments
The court considered two arguments put forward by Tesco in relation to the construction of the above statutory provisions.
First, Tesco argued that the Claimants did not have an “interest in securities” on the basis that they did not acquire an equitable interest in the shares. Tesco submitted that, whilst the investor at the end of a chain of intermediaries had an economic interest in the shares, they had no proprietary interest, as they can only assert their legal rights against the individual immediately preceding them in the custody chain.
To further aid its argument, Tesco emphasised that the words “in the securities” show that the proprietary interest necessary must be in the securities themselves, not in other property and that the ultimate beneficial investor at the end of a chain of intermediaries has no equitable or other proprietary interest in the shares held by the first custodian. In support of this, Tesco relied on paragraph 226 of Briggs J’s (as he was then) decision in re Lehman Brothers International (Europe) [2010] EWHC 2914 (Ch).
The second argument put forward by Tesco was that, in any event, even if the Claimants did have an “interest in securities” they could not have “acquired” or “disposed” of that interest or contracted to have acquired or disposed of securities of that interest. At most, the ultimate investor may have a beneficial interest which, upon transfer, may be created or extinguished, but could not be acquired or disposed of.
Moreover, whilst Tesco accepted that its interpretation of the provisions would render section 90A and Schedule 10A FSMA ineffective for claims in the intermediated securities market, it put forward that this was a consequence of the law failing to keep up-to-date with developments in the securities market, whereby transfers in certified securities are replaced with computerised share dealings and that this gap should not be legislated by the court.
Judgment
The court dismissed Tesco’s application, rejecting both limbs of its argument for the following reasons.
Tesco’s submissions: first limb
Hildyard J agreed with the arguments put forward by Tesco, however, disagreed with the conclusions from its analysis. Hildyard J held that the “‘right to the right’ which the investor has via the custody chain is, or can be equated to, an equitable property right in respect of the securities, and this is sufficient” [79].
Unsurprisingly, Hildyard J further elaborated that it would be “odd to deny that the ultimate investor has such an interest. No one but the investor can claim any right of ownership beneficially…” [83].
Therefore, the Claimants in both proceedings have a sufficient “interest in the securities” enabling them to maintain proceedings under section 90A and Schedule 10A FSMA.
Tesco’s submissions: second limb
As regard to Tesco’s second argument, which covers the position of Claimants who do have an “interest in securities”, Hildyard J found that Tesco relied on a narrow interpretation of “acquisition” and “disposal”, as stipulated in Schedule 10A FSMA. Ultimately, the Claimants’ interests in the securities were a result of them instigating to enter into the transactions themselves. Therefore, the Claimants themselves entered into a transaction in reliance on an untrue or misleading statement or omission in information published by Tesco.
Hildyard J reiterated “The whole purpose of the relevant provisions of FSMA is to confer a statutory cause of action in respect of a transaction entered into in such circumstances. Unless the wording was without any semantic doubt entirely deficient to apply in such circumstances, ordinary principles of statutory construction require the court to ensure that the statutory purpose is not thwarted” [117].
Hildyard J also considered Lord Neuberger’s approach in Akers and others v Samba Financial Group [2017] UKSC 6 in which he expressly acknowledged at paragraph 66 that the “disposals” or “dispositions” are “capable of extending to a transaction which involves the destruction of termination of an interest” and therefore should be interpreted broadly. Similarly, Hildyard J held that it is only logical that the words “holdings” and “acquisition” are interpreted broadly to ensure they are given the meaning intended, namely to encapsulate the creation and termination of an interest in a security.
Comments
Hildyard J’s judgment recognises that the nature of the issues raised by Tesco’s application is “a systematic one of considerable importance“, particularly given that a large number of transactions in publicly held shares in listed companies in the UK are held in a dematerialised form through CREST. Further, paragraphs 40 and 41 in Hildyard J’s judgment suggest academic commentators may have anticipated the potential difficulties arising out of the FSMA regime for intermediated securities, which go far back as 2004.
Interestingly, had Tesco’s submissions been accepted by the court, it would have highlighted a “fundamental hole in FSMA” [10]. This perhaps highlights the failure of the law to keep pace with the development of a dematerialised securities market, particularly if paper shares are due to be phased out by 2025.
In his judgment, Hildyard J comments that it is “unsettling that the expression providing the touchstone of standing to make a claim for compensation in respect of untrue or misleading statements or omissions in listing particulars or a prospectus should be open to such legitimate disputation and doubt in its application to market norms” [73]. Undoubtedly, it will become more common for intermediated securities in the UK market to be held through CREST. Therefore, as expressed by Hildyard J, it is “surprising that this was not expressly recognised and provided for in FSMA“, raising the question of whether it was ever intended for FSMA to accommodate future developments within the intermediated securities market.