A contentious issue in securities class actions is whether a claimant must demonstrate that their loss was caused by direct reliance on a defendant’s conduct.
In recent times, the question of whether “market-based causation” is sufficient as an alternative basis of showing causation of loss in support of such claims has been considered by Australian judges in interlocutory decisions or in comments made in obiter. The theory of “market-based causation” provides that, in an efficient market, the price of securities will reflect price-sensitive information which is the subject of disclosure obligations. Accordingly, claimants have sought to rely on this theory to establish that their loss was caused by the defendant as a result of the market as a whole trading in a company’s securities at an inflated price because of misinformation attributable to the defendant’s conduct, such as non-disclosure or misstatements to the market.
In Caason Investments Pty Ltd v Cao  FCAFC 94 (Caason), the Full Court of the Federal Court has considered this issue for the first time at the appellate court level and concluded that the concept of “market-based” causation is at least arguable under Australian law. However, the Court was not required to make a final determination as to whether the concept was sufficient to establish causation or what is specifically required to prove causation on these grounds. Nonetheless, Caason represents a significant step towards the general acceptance of market-based causation theory in Australian securities litigation.
Caason involved a shareholder class action in the Federal Court, brought against the directors and auditors of Arasor International Limited (Arasor) by group members who acquired shares in Arasor between 11 October 2006 and 12 May 2008.
The applicants brought claims alleging misleading or deceptive statements or omissions in two prospectuses for the offer of company securities, and certain financial statements. The prospectus claims were brought under section 729 of the Corporations Act 2001 (Cth) (Act).
The applicants sought to amend their claims to rely on “market-based causation”. It was accepted that the judgment of Farrell J at first instance had the effect of “shutting out” the applicants from amending their claims in this way. The applicants appealed this decision to the Full Court.
Details of the decision
On appeal, Gilmour, Foster and Edelman JJ each accepted that the market-based causation case was at least arguable to support the applicants’ claim.
In reaching this conclusion, Gilmour and Foster JJ made the following observations:
- First, their Honours considered recent cases on this issue, acknowledging that that there is, as yet, no decision of the High Court, nor of any other intermediate court of appeal, on the central legal question. A line of single-judge decisions, however, provided sufficient support for the proposition that a market-based causation case is “neither ‘futile’ nor likely to be struck out”. None of the case law to which the respondents pointed precluded the finding that market-based causation was arguable.
- Second, their Honours considered the text of the Act itself. Section 729(1) provides a right to compensation to a person who suffers loss or damage “because” of an offer of securities under a disclosure document that contains a misstatement or omission. The provision makes no reference to actual reliance on the disclosure document. This suggests that while reliance is a sufficient condition for establishing causation, it is not a necessary one. Additionally, their Honours rejected the submission of the respondents that section 729(2) supports the proposition that reliance is required for a claim under section 729(1).
- Third, their Honours found no policy considerations precluding the finding that market-based causation was arguable. In particular, their Honours rejected the respondents’ submission that the policy of Chapter 6D of the Act, to “protect potential investors”, would be undermined if the Court were to allow claims under section 729(1) made on this basis, noting that, arguably, that policy aim was in fact promoted by a market-based approach to causation.
In a separate judgment, Edelman J agreed with the majority that a market-based causation plea has reasonable prospects of success as a matter of law, holding that it is “at least reasonably arguable” that the causal component of a claim brought under section 729 of the Act does not require reliance by the applicants on a disclosure document. His Honourprovided four reasons for this conclusion:
- First, his Honour observed that “reliance is not a substitute for the essential question of causation”. There is nothing about the use of the word “because” in section 729 that confines the causation requirement to a question of reliance by the applicant on a disclosure document.
- Second, his Honour observed that section 729(1) imposes liability in the case of a breach of disclosure obligations by way of omission from the relevant document, and that it would be “at best a strain of language” to contend that an investor could “rely” on omitted content of which it was not aware.
- Third, his Honour observed that market-based causation is “not a special sub-category of causation”, but simply one form of indirect causation. His Honour rejected the distinction between market-based causation and causation established by reliance on specific information (or “reliance based causation”, which could involve an investor relying directly on false information to purchase shares which the investor would not otherwise have purchased). His Honour noted that there is no sharp contrast between these two concepts and that, in reality, both might be “indirect” forms of causation (for example, where an investor directly relies on information to purchase securities and that information is indirectly the reason why loss is suffered “when the market falls”).
- Fourth, his Honour observed that there is no Australian authority expressly rejecting the concept of market-based causation. In fact, the concept has received some support from the courts and in some cases it has been allowed to proceed to trial or implicitly endorsed as arguable.
Implications of this decision
The Federal Court’s decision in Caason clarifies that, in Australia, market-based causation is at least arguable in the context of securities class actions. However, significant questions remain as to what requirements claimants must satisfy in order to establish liability on this basis.