+ What is it?
In a securities class action, a plaintiff is required to establish that their loss was caused by the conduct of a defendant. Until recently in Australia, causation was typically proved by a plaintiff demonstrating that it relied on the defendant’s conduct, such as a misleading statement or breach of continuous disclosure obligations, when entering into a transaction such as the purchase of securities.
A recent decision in the NSW Supreme Court, HIH Insurance Ltd (in Liq) & Ors  NSWSC 482, provides support for an alternative view with respect to the requirement to prove causation, namely market-based causation. An acceptance of this type of causation may lead to plaintiffs not being required to demonstrate that they actually relied on the defendant’s conduct when entering into a transaction, but rather that they transacted in a market where the price of securities had been artificially inflated by the defendant company’s conduct (typically an alleged misleading statement or failure to disclose material information to the market) and suffered loss when the price corrected following disclosure of the true position.
Market-based causation is reminiscent of (but distinct from) the rebuttable presumption of reliance long accepted by US Courts in securities fraud class actions in that both are based on the “fraud on the market” theory which assumes that:
- established capital markets efficiently incorporate all available information, including misleading statements but not undisclosed information, into the price of securities; and
- investors purchasing securities in such markets do so in reliance on the market and therefore it may be presumed in reliance on any misleading statements made to the market and without the benefit of any undisclosed information.
+ How is it applied?
To date, the NSW Supreme Court’s 2016 decision of HIH Insurance Ltd (in Liq) is the only Australian decision applying market based causation. In that case, Brereton J found in favour of the investors who had purchased securities in HIH Insurance Ltd (HIH). The Court found that HIH had included misleading or deceptive representations in its financial results which caused its shares to become inflated. His Honour stated the following with respect to the issue of direct reliance on the financial information:
"I do not see how the absence of direct reliance by the plaintiffs on the overstated accounts denies that the publication of those accounts caused them loss, if they purchased shares at a price set by a market which was inflated by the contravening conduct: the contravening conduct caused the market on which the shares traded to be distorted, which in turn caused loss to investors who acquired the shares in the market at the distorted price. In the absence of any suggestion that any of the plaintiffs knew the truth about, or were indifferent to, the contravening conduct, but proceeded to buy the shares nevertheless, I conclude that “indirect causation” is available and direct reliance need not be established."
On that basis, the Court made an award of damages in favour of the investors despite the investors not being able to demonstrate that they directly relied on the financial information when purchasing the HIH securities.
We note that this case related to a prohibition on misleading and deceptive conduct in the former Trade Practices Act. However, similar prohibitions are now contained in the Competition and Consumer Act, Corporations Act and ASIC Act. On that basis, we anticipate that the reasoning adopted in HIH would also apply to claims for compensation under these Acts.
+ Will courts continue to apply market-based causation?
Although market-based causation has only been applied in the Australian context on the one occasion, and not in relation to a class action, we anticipate Courts will increasingly apply this theory – particularly to securities class actions involving allegations of misleading or deceptive conduct and breaches of continuous disclosure obligations.
The examples below suggest that members of the Federal Court are inclined to support the application of a market based theory of causation to claims based on breach of market disclosure obligations, including in relation to a misleading prospectus or other disclosure document.
- In Caason Investments Pty Ltd v CAO (2015) 236 FCR 322, the Full Federal Court upheld an application for leave to amend a pleading by deleting a paragraph restricting group membership to persons who acquired the relevant shares ‘in reliance upon’ representations made by the respondents. This ruling reflected a market causation theory applied to s 729 of the Corporations Act (which establishes a right to recover for loss caused by a misleading market disclosure document). Gilmour and Foster JJ held it could not be said that these amendments were incapable of succeeding. Justice Edelman (in dissent) also expressed the view that it may be possible to argue reliance is not a required element of a claim for damages.
- In Grant-Taylor v Babcock & Brown Ltd (in liq) (2015) 322 ALR 723, the plaintiffs submitted that shareholders who had purchased shares at an inflated price should be able to recover the amount of the price inflation where the inflation was caused by the listed company’s wrongful failure to disclose information to the market. Although the Court stated that it wasn’t necessary to decide this particular question, Perram J stated that he would have accepted these arguments and found in the plaintiffs’ favour. This was not reexaminned on appeal in Grant-Taylor v Babcock & Brown Ltd (in liq)(2016) 245 FCR 402.
These examples strongly suggest that if the Federal Court were asked to rule on market based causation (for example, in relation to a claim for misleading or deceptive conduct under either the Competition and Consumer Act, Corporations Act or the ASIC Act), the Court would find that it is available as an option for establishing causation. Justice Edelman’s recent elevation to the High Court means this view may also find favour with at least one member of that Court.
+ How will market based causation effect class actions
In our view, judicial acceptance of market-based causation will be a factor in driving a gradual increase in the value of settlements and the prevalence of securities class actions, particularly actions based on breach of market disclosure obligations, since the principle will make it easier for plaintiffs to establish the necessary connection between the wrongful conduct and their loss. In addition, it will be easier for class action law firms to identify potential claims, as any significant fluctuation in the price of listed securities, coupled with a delayed or misleading market disclosure, could conceivably form the basis of a claim.
However, it is important to recognise that, even with the courts’ recognition of market-based causation, class action plaintiffs will still face a number of hurdles in establishing a securities claim. In particular:
- Market based causation will not be relevant to all causes of action. It is likely to apply to market manipulation (and would have in any event without the support of decisions like HIH) and misleading or deceptive conduct, but its application to actions such as unconscionable conduct is less obvious;
- Even where it does apply, the plaintiffs must still show that the defendant has engaged in conduct which gives rise to a recognised cause of action (such as a misleading or deceptive conduct claim); and
- Plaintiffs must also still show that the wrongful conduct caused their loss, for example, by establishing that the wrongful conduct led to prices in the market being inflated, and that the plaintiffs suffered a loss as a result of transacting in the inflated market. In addition, the court would need to be convinced that the plaintiffs were not indifferent to the wrongful conduct in the sense that, had the plaintiffs been aware of the true position, they would not have traded.
We would further caution against concluding that Australia is on the precipice of a proliferation of high-value, US-style securities class actions or that class actions will now be pursued to judgment. Indeed, notwithstanding an established class action culture and lengthy judicial acceptance of the rebuttable presumption of reliance, it is still rare for securities class actions in the US to proceed to trial and judgment.