Managing banking industry exposure to class action lawsuits
KPMG's Research Results for Bank Class Actions
KPMG recently (between March 15 and April 30, 2010) conducted research on bank class actions. Here is what we found:
- Number of Canadian banks identified as currently defending class actions – 12
- Identified class actions currently being defended – 81
- Number of provinces in which class actions started – 5
- Claims where stated in filings – $4.9 billion
- Estimated claims extrapolated to include actions with no stated claimed damages – $8.8 billion to $12.4 billion
- Subjects of bank class actions:
- Credit cards – 41 percent
- Mortgages and loans – 28 percent
- Fraud – 7 percent
- Overtime wages – 5 percent
- Securities – 5 percent
- Other – 14 percent.
It is not surprising that Canadian banks continue to be popular targets for class action lawsuits. Not only are Canadian banks among the world's largest and most profitable corporations, but they also provide most of the population with a set of essential and complex services.
In the absence of readily available statistics to measure industry exposure to class actions in Canada, KPMG embarked on a research project of its own. Our investigation, mentioned in the sidebar at left, found that Canadian banks currently face at least 81 class actions.1 The amounts claimed, where reported, amount to almost $4.9 billion. When this known amount is extrapolated to include actions with no reported financial claim,2 the total estimated claims swell to between $8.8 billion and $12.4 billion.3 More specific research findings are published in the sidebar article (at left).
It is important to remember that the ultimate liability of banks to class actions will most likely be significantly less than the aggregate amounts claimed. However, the costs of settlement are substantial, and significant operating costs are also incurred to defend class actions. Perhaps one of the greatest concerns in the process is damage to the bank's reputation. It is common for the announcement, progress, and settlement of class actions to be reported in the media, with plaintiffs portrayed as David and defendant banks portrayed as Goliath.
Class action litigation can also raise public policy or regulatory issues that create uncertainty and can have major operational consequences. For example, one highly contentious class action involving nine banks has raised constitutional arguments over the role of provincial legislation in governing aspects of a bank's operations.4
A Proactive Approach to Class Action Risk
Given the costs and other potential ramifications of class actions, are there real and practical steps that banks can take to reduce their risk? There is no question that with increased risk will come increased litigation.
An emerging concept called class action avoidance is a proactive approach designed to identify the major risk areas for class action, and to take deliberate steps toward remediating known issues.
Identifying Risk Areas
The obvious starting point for a class action avoidance program is discovering where the biggest class action risks lie. The first step can be as simple as an environmental scan:
- What actions are competitors facing?
- What actions are banks facing in the US?
- Are there regulatory issues or actions that could attract the attention of class action litigators?
Regulatory actions or compliance issues have been known to spawn class actions. Also, if litigators experience any success with one bank in a class action that deals with an industry-wide issue (Canada and/or the US), many other banks may be served in turn before the process is complete.
It is also worthwhile to consider whether specific class action issues apply to other bank products or services. For example, several bank class actions have been related to foreign exchange policies and fees, making the area a particular hot spot. Are the policies that govern foreign exchange also applied to any other products or services offered by the bank?
Finally, it is worthwhile examining the issues involved in current class actions to determine what products and services of the bank—or even human resources policies—may be particularly vulnerable to a class action. As noted above, credit cards and loan products are especially popular targets for class actions. Other than the matters already targeted by class actions, are there other "ticking time bombs" built into the design of such products?
Examining Risk Areas
The goal of reviewing identified risk areas is to:
- Assess the merit of the concern
- Estimate the size of a potential exposure
- Develop approaches to remediation, where required.
For effective class action risk management, the bank should develop an approach for reviewing each risk and allocate sufficient resources that can ultimately render the review effective. On one hand, the approach will be tailored to each risk, but, on the other hand, it will also need to be consistent with the overall scope of the desired review.
As an example, if one identified risk issue is the charging of fees in specific situations,5 the fees and products that fall within the scope of the review will need to be determined. The testing parameters will need to be defined, which involves determining what constitutes an acceptable fee. In this example, the benchmarks for testing will likely be found within customer disclosure agreements, as well as regulatory and legislative documents.
The skill sets required will usually be available from appropriate legal, information technology, and operations staff. The involvement of external expertise is also a valid consideration if independence and objectivity is desired, or where demonstrated and special expertise and experience is required.
In many situations, a thorough approach will involve the development of test models that will be applied to large data sets extracted from the bank's IT systems. This approach can to ensure that a full range of variations in relevant transactions is considered by the testing regime.
Dealing with Identified and Examined Risks
In KPMG's experience, a class action avoidance program will expose some very tangible issues. In some cases, the identified matters are marginal and may be an issue of interpretation; but in others, a fairly obvious and material risk can be defused before it is discovered by, or brought to the attention of, a class action litigator. Depending on the nature and size of identified problems, various responses or combinations of responses are required to address concerns:
- Change disclosure documents
- Revise a formula or calculation in the bank's systems
- Provide voluntary restitution to parties who may have been harmed by a specific error or policy.
The Final Word
Regardless of the required action, a successful class action avoidance program does more than reduce the likelihood of a class action and, with it, a lower financial liability due to litigation. It will strengthen the compliance and risk profile of the bank, and project the image of a corporate citizen that values fairness for its customers and other stakeholders.
Consider Tax Consequences
If a claim is made, it is important to consider the Canadian income tax implications of payments made under class action lawsuits or settlements. Are the amounts paid with respect to a class action suit or settlement deductible for tax purposes?
There are no specific rules dealing with the tax treatment of damages, settlements, and class action judgments. However, general tax principles can be applied to the facts of the particular circumstances. The payments must be considered from the point of view of whether they relate to the operation of the business or to capital property used in the business. For example, settlements or class actions related to employee wages or lost profits may be deductible, as the payment should be considered to be incurred to earn income. On the other hand, payments related to capital or intangible property may be considered to have been paid to acquire such property, and may therefore form part of the cost of the particular asset.
In addition to the actual class action settlement amounts, the tax treatment of costs, such as legal costs incurred to defend class action suits, should also be considered. The tax treatment will depend on the underlying nature of the matter being litigated. For example, costs related to an employee compensation matter should generally be deductible, whereas costs related to the purchase of a capital asset may have to be added to the cost of the asset.
1 We have included as multiple class actions, cases where more than one bank has been sued under a single statement of claim.
2 Many class actions do not indicate the amount being claimed from the defendants.
3 Our high estimate of claims eliminated the highest and lowest known claims as potential outliers. Our low estimate of claims excludes all known claims that are greater than $100 million.
4 Marcotte and Laparé v. Bank of Montreal et. al., Superior Court of Quebec. This class action was decided against the defendants and is under appeal.
5 Bank fees have been a popular topic for class actions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.