The Impact of the Financial Crisis on Nonfinancial Firms: The Case of Brazilian Corporations and the “Double Circularity” Problem in Transnational Securities Litigation

This Article discusses the impact of the international financial crisis on Brazilian capital markets. While the banking industry was not significantly affected, leading nonfinancial corporations experienced severe financial turmoil. Two Brazilian corporations cross-listed in the United States — Sadia S.A. and Aracruz Celulose S.A. — suffered billion-dollar losses when the Brazilian real unexpectedly plummeted in relation to the dollar. These great losses were found to be the result of their highly speculative trading in currency derivatives, despite earlier disclosure that these companies had engaged only in pure hedging activity. Consequently, several private lawsuits were filed both in the United States and in Brazil.

U.S. lawyers filed federal class actions in New York and Florida on behalf of American Depositary Receipt (ADR) holders, claiming securities fraud on the grounds that the companies were heavily speculating in currency rates in amounts that largely exceeded any prudent hedging. In shareholder meetings, Brazilian shareholders authorized the corporations to file derivative lawsuits against former Chief Financial Officers in São Paulo and Rio de Janeiro. The article compares these types of lawsuits filed and their final outcomes. Despite substantially similar alleged wrongdoing, the outcomes for securities holders in each jurisdiction contrast strikingly.

Only U.S. investors of both companies were able to obtain substantial financial recoveries. The Sadia U.S. suit was settled for $27,000,000 and the Aracruz U.S. suit for $37,500,000.[1] In contrast, Brazilian investors recovered nothing from those companies. This is because, as I discuss, there are no appropriate legal mechanisms in Brazil that enable direct investor indemnification by Sadia and Aracruz. Because of the lack of private class action avenues, investors had to rely on derivative suits, which provided only a small recovery to one of the companies, rather than to its harmed investors.

Even if one considers that the recovery values obtained by U.S. ADR investors were relatively low, the Sadia and Aracruz cases provide concrete examples of the financial value distributions that characterize the current system of transnational securities litigation. They allow a broader assessment of the type of wealth transfers that affect the whole universe of cross border litigation and with implications to much larger and more frequent wealth transfers.

This Article examines the reasons behind these discrepant results and the consequent economic distributional effects on global securities markets, exacerbated by the U.S. Supreme Court decision in Morrison.[2]  I show that Morrison’s rationale of banning U.S. securities law protections to f-cubed claims, contrary to the common academic assessment, raises substantially the costs borne by foreign investors from cross-listing in the United States. These investors, who usually don’t enjoy the same antifraud protections overseas — due to the lack of appropriate law or enforcement mechanisms — are compelled to accept, to their detriment, wealth transfers to U.S. investors.

In this fashion, the Article argues that Morrison aggravates such (i) shareholder cross-border non pro rata compensation and (ii) transfers of company value from foreign to U.S. investors. It identifies a set of costs borne by foreign investors, and so far neglected by scholars, as a consequence of the current status of U.S. and international securities regimes. These costs are the result not only of the typical “circularity problem” in securities litigation, but also of a “double circularity problem” as they fall on foreign shareholders who also suffered equivalent damages to those experienced by the U.S. class being compensated.

In fact, I show that the Brazilian investors bore most of the costs of the settlement payments to U.S. investors. Further, U.S. investors also indirectly benefited from the Brazilian derivative suit in one of the cases, as the financial recovery provided by a derivative suit belongs to the company, and not to the directly harmed investors. In this way, differences between the U.S. and Brazilian legal regimes governing private securities litigation led to a transfer of financial value from the Brazilian companies exclusively to U.S. ADR investors.

This type of wealth transfer not only includes the typical “circularity problem” in securities litigation, which refers to the fact that innocent shareholders who did not contribute to the securities fraud bear the costs of compensation to the investors who lost value. [3] The standard circularity problem supposes that those innocent shareholders who will compensate the class certified by the class action suit were not victims of the same fraud. The problem with the current regime of transnational securities litigation is more severe because, in addition to the classical circularity problem, it comprises an extra level of costs imposed on foreign shareholders who already suffered financial losses from the same fraud, are not being compensated for them, and still bear the pro rata burden of payment to U.S. investors. This scenario constitutes a “double circularity problem” for foreign shareholders who suffered equivalent damages to the U.S. class that is being compensated. Therefore, foreign securities holders bear twice the costs of failures of a company’s corporate governance practices: first, when their shares lose value due to the wrongdoing per se; second when they bear the costs of indemnification paid exclusively to U.S. security holders.

The case-studies of the Brazilian corporations thus shed light on the subsidization costs that foreign investors of foreign issuers bear as an intrinsic component of U.S. cross-listing under Morrison. Furthermore, these foreign-bearer costs are likely to be generalized to foreign investors from all other jurisdictions that do not employ sophisticated systems of aggregate litigation that can provide direct recovery to shareholders through private enforcement.

Although European countries have increasingly implemented new reforms to develop forms of aggregate litigation, there remain serious doubts whether these reforms will provide an effective institutional framework that fully supports collective litigation and financial recovery for collective redress. For example, the trial of alleged securities misstatements involving Deutsche Telekom was the first test of the German reform that introduced aggregate litigation in 2005. A number of procedural problems, especially the lack of effective tools for discovery in Germany, have resulted in a ruling in favor of defendants; meanwhile an equivalent parallel litigation brought by U.S. Deutsche Telekom ADS holders in New York was settled for $120,000,000.[4] German commentators have described the law as “a flop.” This German case also presents the type of double circularity problem discussed above. Likewise, the same problem also affects investors from Asian and Latin American jurisdictions that currently lack an effective legal infrastructure for direct compensation through collective redress.

The Article then discusses potential policy reforms for fixing transnational securities litigation. It reviews reform proposals to assess which could diminish wealth transfers or provide uniformity of legal results and remedies for shareholders who have suffered equivalent harms, thus minimizing distributional effects in international capital markets.

The most recent draft of the article may be found here.


[1] Joint Declaration of Christopher L. Nelson and Joseph E. White, III in Support of Final Approval of Settlement, Plan of Allocation and Application for an Award of Attorneys’ Fees and Expenses and Reimbursement to the Class Representatives, at 19, In re Sadia, S.A. Securities Litigation, 1:08-cv-09528, 2011 WL 6825235, ECF No. 119. Stipulation And Agreement of Settlement and Release at 6, City Pension Fund for Firefighters and Police Officers in the City of Miami Beach v. Aracruz Celulose S.A. et al, 1:08-cv-23317, ECF No.189.

[2] Morrison v. Nat’l Austl. Bank Ltd., 130 S. Ct. 2869 (2010).

[3] The classic “circularity problem” in securities litigation was analyzed by John C. Coffee, Jr., Reforming the Securities Class Action: an Essay on Deterrence and its Implementation, 106 Colum. L. Rev. 1534, 1538 (2006).

[4] See Stipulation and Agreement of Settlement at 11, In re Deutsche Telekom AG Sec. Litig., 229 F. Supp. 2d 277 (S.D.N.Y. 2002) (No. 00-CV-9475 (SHS)), available at See Érica Gorga & Michael Halberstam, Litigation Discovery & Corporate Governance: The Missing Story About “The Genius of American Corporate Law, 63 Emory L.J. 1383, 1488-91 (2014) (discussing the lack of discovery in civil law jurisdictions and its consequences for corporate litigation, such as the German Telekom case).


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