investigation into the embattled retailer, inviting for shareholders past and present to register their interest in participating in a possible class action against SurfStitch and its directors. In the week since Gadens called for expressions of interest, more than 100 shareholders have registered their interest in the action. “My assessment is that there is a fair bit of anger amongst the mum and dad investors,” Glenn McGowan QC, chief counsel at Gadens, told Inside Retail Weekly. “The investigations are at very early stages, but what we know so far raise some questions that you think should be answered.”   The investigation focuses on several significant events in SurfStitch’s short life as a publically listed company, beginning with questions about the company’s prospectus. Gadens is concerned as to why two capital raisings were necessary within a year of floating when none were forecast in the prospectus. The law firm is also seeking answers as to why there was no mention in the prospectus of the company’s transformation program, such as rebranding to Swell globally, or the major acquisitions outside the businesses core capabilities – for example, media company Garage Entertainment and Product, which the retailer bought for $15 million in November 2015. Gadens is also looking for explanations about why the businesses acquired by SurfStitch have not been integrated as quickly as anticipated. The investigation will also focus on reports that 30 private briefings were conducted with some shareholders between April 25-29 of this year, prior to the May 3 profit downgrade, and whether SurfStitch complied with its continuous disclosure obligations and properly kept the market informed of matters affecting its share price or value. In particular, it will focus on issues with a perpetual licence which lead to a $20.3 million revenue shortfall June 9, causing the company to forecast a loss for the 2016 financial year. McGowan said he hasn’t been able to track down what happened at the private briefings or what the details or that perpetual licence are as yet. SurfStitch shares floated at $1.00 in December 2014, rose to a high of $2.13 in November 2015, and have since declined dramatically, sitting at 33¢ on June 10, 2016. As a result, the market value of SurfStitch stock has dropped by over $500 million. “I can’t remember another case where there have been three downgrades in six months,” McGowan said. “And I can’t remember another case where there have been two capital raisings within 12 months of the initial float. All those things are quite unusual. It tends to give a picture of unduly hurried expansion, and then, unduly hurried pullback from forecasts.” Gadens is currently speaking with litigation funders for the potential class action. “It is progressing as one would expect,” McGowan said. “SurfStitch is playing its cards close to its chest, as it’s entitled to do, and we are making our best efforts to investigate the circumstances. But there seems to be a fair bit of interest on the part of the shareholders.” Despite strong shareholder interest, the investigation may not lead to the official filing of a class action. “There are lots of questions that beg for answers, but it’s conceivable that all my questions have perfectly innocent answers,” McGowan said. “It will take one or two months, I imagine, before we can make some hard decisions about whether to issue proceedings.” Waiting game for Dick Smith shareholders In the case of the now collapsed Dick Smith Holdings (DSH), law firm, Bannisters Law, is leading a potential class action, but is waiting to make its next move. A spokesperson for the law firm said it had strong demand from shareholders to join the class action and that pre-filing numbers are going well. However, they are waiting on a report from Dick Smith’s administrators, McGrathNicol, before making a move to file any class action. If a class action is filed, it is expected that more shareholders will join the action. aIn particular, Bannister Law is currently investigating whether sufficient information was provided in the DSH 2013 prospectus on the basis of the sale of certain assets of the company and non-disclosure of certain sub-holding accounts, which may have affected investors’ ability to make an informed decision. “Bannister Law are also investigating disclosure and declarations of directors and auditors of the 2015 annual report for the company.” Initiating a shareholder class action isn’t related to the amount of money an individual shareholder loses. Rather, the questions to ask, according to Michael Legg, associate professor, UNSW Law, are, “Is there sufficient loss that it’s worthwhile a lawyer and a litigation funder getting involved and is there money to pay out the compensation? And, following the commence the class action, how long will it take before it reaches a settlement?”. “All shareholder class actions have settled,” Legg said. “So there is no court judgement, and in a settlement there is no full or complete recovery [of money lost]. You always get only a percentage of your losses back.” Further, legal fees and the litigation funder’s fees also take a bite out of the amount of money shareholders will recoup. “If you are thinking you will recover 60 or 70 per cent of your loss in the settlement, which means you have a very strong claim, you are then going to give up 30 to 40 per cent of that to funders or lawyers,” Legg said. “If you get a half or a quarter of your money back, then you are actually doing pretty well as far as shareholder class actions go.” Legg acknowledged that the less attractive alternative is that shareholders don’t recover any of their losses. A remedy for institutional investors Legg noted that shareholder class actions can also be attractive for institutional or medium-sized investors, which can join a class action without having to take on the burden of being the plaintiff. “In some ways it is quite an effective remedy for institutional investors because they can combine with investors of all shapes and sizes, but they don’t necessarily have to be the plaintiff on the record. So they can’t be part of the class action without being in the media spotlight,” Legg said.   “The idea is often it’s the smaller investor that will be the plaintiff or the representative party and the institutional investors all sort of hide behind that party and remain anonymous. The reason they do it? It’s not necessarily good for business to be seen to be suing a company that you’ve invested in.” Shareholder class actions are becoming more common, and they could become easier to bring and succeed, Legg said. The increase in shareholder class actions is in part driven by the capacity of the plaintiff’s lawyers and the litigation funders. “It’s one thing for there to be potential breaches of the law, but you’ve got to have lawyers and funders that can actually bring the claim and I think what’s happening in the Australian market is there are more lawyers starting to see themselves as being able to bring shareholder class actions. There are certainly more funders, quite a number from outside of Australia, foreign funders, entering the market and being prepared to fund this type of class action.” A recent decision in the Supreme Court of NSW may also make shareholder class actions easier to bring – and win. “When you bring your claim, you’re saying, ‘this company hasn’t complied with the continuous disclosure regime or it has engaged in misleading conduct’,” Legg explained. “Okay, but to recover you also need to demonstrate that that breach of the law or conduct caused the shareholders to suffer loss. So there is no recovery unless you can show a causal link between their breach of the law and your loss.” It used to be that the plaintiff needed to show that the individual shareholder relied on the conduct or the statements made by the company. However, a single judge in the Supreme Court of NSW accepted that you could have indirect causation, or what’s called ‘market-based causation’. “The way that works is you don’t need to show that the shareholder individually relied,” Legg said. “What you need to show is that the market as a whole was mislead, in other words the share price was incorrect, and that’s sufficient. “If that change in the law continues, it makes shareholder class actions easier to bring and easier to succeed on.” Access exclusive analysis, locked news and reports with Inside Retail Weekly. Subscribe today and get our premium print publication delivered to your door every week.