BlackBerry stock-drop lawsuit raises the question: What’s the point?

Share

Most jobs on Bay Street require you to check your "BlackBerry." And, when asked to "check your BlackBerry," most Bay Street types will pull out an iPhone or Android. That is nice for BlackBerry Ltd. because it means it has achieved the status of Kleenex or Band-Aid : a thing most commonly known by a brand name.

But it's also not nice because it means that people are using iPhones and Androids instead of BlackBerrys. This is reflected by a stock price that is now about $240 off its peak price of $250 or so.

When share prices fall, secondary-market, stock-drop class-action suits follow. BlackBerry is in the very early stages of one of these right now. This is unfortunate for BlackBerry, but it also raises a more important question: what, exactly, is the purpose of these lawsuits?

Secondary-market, stock-drop class-action lawsuits allow investors to sue a company for making an "untrue statement of material fact" in its public disclosure. The theory is that the lawsuits are both preventative and compensatory. They are preventative because they stop companies from making inaccurate disclosures, and they are compensatory because they provide a monetary reward to investors who lose money when the company's stock falls due to the misrepresentation being corrected.

Swisscanto Fondsleitung AG is a European investment fund that is suing BlackBerry for alleged untruths in its public disclosure. It will likely serve as the lead plaintiff if its lawsuit is certified as a class action. (Before a lawsuit becomes a class action, a court must "certify" it as such, finding enough commonality among the plaintiffs for them to sue as a class.) Swisscanto just won its first victory – obtaining "leave," which is a relatively low hurdle that allows it to continue the lawsuit by showing that it has a "reasonable probability" of proving its case.

What is Swisscanto's case? It comes down to an accounting issue.

Back in 2013, BlackBerry had just released the BB10, a touchscreen phone meant to compete with the aforementioned iPhones and Androids. This product did not sell very well, leaving BlackBerry with much unsold inventory. This led the company, in September of 2013, to change from sell-in accounting – which, roughly, allows a company to recognize revenue if it can reasonably estimate the price and costs of a product that will be sold that quarter – to sell-through accounting – which defers the recognition of revenue until the product is actually sold to the end user. This change led to a writedown of about $1-billion. BlackBerry's shares dropped 15 per cent.

The test for leave requires both a misrepresentation and a public correction. To make this case, Swisscanto argued first that BlackBerry's use of sell-in accounting constituted a material misrepresentation, as sell-in accounting should only be used when a company can reasonably estimate future adjustments to the cost of selling a product, and BlackBerry could not do that for the BB10. As such, although BlackBerry used an established accounting technique, it used that technique in the wrong circumstance and, therefore, it allegedly materially misrepresented its revenue.

Second, Swisscanto argued that the press release announcing the accounting change constituted a "public correction."

The court found that Swisscanto had a reasonable chance of proving at trial that sell-in accounting constituted a material misrepresentation and that the announcement of the changed accounting technique constituted a public correction. The suit will go on, BlackBerry will pay more legal fees and, very likely, reach a large settlement with Swisscanto and any potential class of investors.

So, to recap: BlackBerry is accused of misapplying an accepted accounting technique, correcting that technique after it turned out to be inappropriate during a single quarter and, as such, BlackBerry now faces millions of dollars of potential liability.

To some extent, such class actions can give investors – to tweak the proverb – a second bite at the blackberry, and remove the onus on them to get the analysis right the first time.

A sophisticated investor like Swisscanto could have recognized that the BB10 was an uncertain proposition and adjusted its assessment of BlackBerry's revenue accordingly – management discussion and analysis of the pre-September financial statements explicitly stated that revenue recognition determinations are made at the time of shipment or delivery (and that increased revenue was due to shipments of the more expensive BB10), not at the time of sale.

Which brings us back to the original question: What, exactly, is the point of secondary-market stock-drop litigation?

Any payment by BlackBerry – be it in the form of damages or a settlement – will come from BlackBerry's coffers (i.e. its shareholders) and go to its former shareholders, with the lawyers taking a big cut in the middle. Oddly enough, many times in these lawsuits the stockholders who pay damages end up being the same stockholders who receive damages – large buy-and-hold funds that were stockholders at the time of the alleged misrepresentation and who are stockholders at the time the company pays damages or a settlement.

Diversified investors, meanwhile, will be largely indifferent to the result of secondary-market litigation. On average, their wins and losses will net out across all class actions, meaning that large funds making one-way bets have the most to gain in these lawsuits. Cast in this light, the compensation rationale isn't great.

Neither is the deterrence rationale. Even if held liable, directors and officers are shielded from liability by insurance, indemnification, statutory limits on damages and their own due diligence defence (which is particularly strong in this case, given that their auditors signed off on the impugned financials). These are old criticisms, but salient ones.

The current BlackBerry lawsuit is an example of how our secondary-market liability regime is getting increasingly abstract. It's not a battle over false figures, bold-faced lies or even misleading language; it's a battle over whether BlackBerry's management and their professional advisers reached the wrong conclusion when choosing between standards in the absence of clear accounting rules.

Public disclosure is important. But it is worth considering whether lawsuits over ambiguous accounting standards that may result in large payments by the current shareholders of struggling companies to former shareholders, with limited recourse against actual decision makers, are the best way to accomplish this goal. I'm not sure what a better regime looks like, but I'm sure that class-action victories under the current regime will pay for a lot of new "BlackBerrys" on Bay Street this year.

Adrian Myers is a lawyer at Torkin Manes LLP