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As global investors seek new opportunities beyond their traditional markets, regions like central and eastern Europe are drawing increased attention.
The Polish stock market, in particular, has become more appealing to foreign investors thanks to a combination of a strong, growing economy, an increasingly sophisticated regulatory environment and a steady push towards improved corporate governance standards.
But as investors look to access the promising opportunities available across the continent, companies in markets like Poland are also finding themselves more exposed to legal risks – particularly from the US.
European businesses have often long looked across the Atlantic with a sense of relief, believing they are largely insulated from the more litigious culture of the US. While this sentiment has been somewhat justified, times are changing and companies outside of the US are increasingly being involved in costly legal disputes.
Of the more than 200 securities class actions filed every year in the US, around 20% target companies headquartered outside of the US. The fact that any company listed in the US can fall victim to a US class action via American Depository Receipts (ADRs) is often overlooked by foreign businesses.
If ADRs are unfamiliar to you, you’re not alone.
First introduced by J.P. Morgan in 1927 to facilitate trading shares of the British retailer Selfridges, ADRs enable foreign companies to access US capital markets. The so-called ‘sponsored’ ADRs are issued with the involvement or cooperation of the foreign company and are divided into three categories:
Beyond these, there is a lesser-known category: Level I Unsponsored ADRs. These can be initiated by banks without the foreign company’s involvement or consent. Although the existence of such ADRs is publicly disclosed, many companies remain unaware that their shares are being traded in this way – leaving them unknowingly exposed to potential US class action lawsuits.
While ADRs are very useful for increasing a non-US company’s potential investment pool, they can also create often misunderstood risks, which many companies have fallen foul of.
CD Projekt Red (CDPR) is a Polish gaming firm that came under fire following the bungled launch of its much-anticipated Cyberpunk 2077 game in 2020. Owners of unsponsored ADR shares in the firm launched a class action law suit alleging that the developer had misled investors and customers about the game’s compatibility with certain consoles.
Initially, the company played down its earlier promises about the game’s console compatibility. However, as pressure mounted, the firm started honouring refunds, leading to a hit in revenue. As a listed company in Poland that was potentially unaware it had unsponsored ADR shares trading in the US, investors started getting involved.
The stock dropped significantly and its hidden unsponsored ADRs left it exposed to a US class action. By 2023, CDPR settled for $1.85m. Since then, another class action has been raised against it for the same issue.
CDPR was not involved in the placement of the ADR shares and, like many businesses, may have been unaware of the extent to which ADRs left it exposed.
Other top brands have been caught out too. In 2015, UK grocer Tesco faced an ADR-based class action for overstating its profits by £250m. The following year, Volkswagen faced a similar class action due to a sharp drop in share value after the car manufacturer’s emissions scandal. While these have been settled, for Toshiba, which also faced a class action in 2015, the case continues a decade later.
Underestimated exposure
With US investors currently trading ADRs for an estimated 1,000 European companies, it is only a matter of time before more firms wander into the crosshairs of the US judicial system.
Even if a company is aware of the exposure, short of asking the bank issuing the ADRs to stop what they are doing, there is not much a business can do. This is where directors and officers insurance (D&O) comes in.
It offers the necessary financial protection should a company find itself on the receiving end of a US class action. While directors are familiar with the cover a D&O policy can provide, awareness of its scope, particularly in response to US class actions, is not always fully appreciated.
A D&O policy will pay out on the defence costs and possible settlement in cases like these and, while the settlement for the first class action was relatively low for CDPR and its insurer, the legal costs would likely have been significantly more than the $1.85m settlement.
With the average settlement for class actions in the US estimated at approximately $15m, insurers must exercise heightened diligence in assessing their underwriting exposures. It is imperative that every US exposure is accurately evaluated and appropriately reflected in the insurance premium. However, the market often neglects this critical practice when conditions soften and overall premiums decline.
ADRs are not a new risk, but as cases only hit the headlines when a big brand is involved, it can often be forgotten or overlooked. With every case filed and settlement made, new precedents are set for the next class action, increasing the risk for everyone.
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This article was originally published by Commercial Risk Online and is reproduced here with permission. You can access the original article here.
