For the first time, a Judge of the Federal Court of Australia has accepted that investors who buy shares in a listed company, in circumstances where that company has breached its obligation to disclose non-public price sensitive information to the market, could recover damages without proving a direct causal link between the non-disclosure and their decision to invest in the company.
Although Justice Perram’s comments on this issue were obiter, the decision in Grant-Taylor v Babcock & Brown Limited (In Liquidation)  FCA 149 is significant. Although, in the result, the plaintiffs were unsuccessful for reasons anterior to the consideration of causation, the judgment represents an important step in the ongoing debate concerning the basis for liability in complex securities litigation and class actions.
The plaintiffs were a group of over 70 people or entities who had purchased shares in Babcock & Brown Limited (BBL) in about a twelve-month period spanning 2008 and 2009. When the plaintiffs first purchased their BBL shares, they were trading at $16.76 per share. Before trading was suspended, the shares were trading at $0.33. These shareholders sued BBL alleging that BBL failed to disclose important information to the market, in breach of its continuous disclosure obligations. Those obligations – arising under the Corporations Act 2001 (Cth) (Corporations Act) and the ASX Listing Rules – required BBL, once it became aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of its securities, immediately to tell ASX that information.
The plaintiffs alleged that BBL should have disclosed the following information to the market:
- that its final dividends for the financial years 2005, 2006 and 2007 had been unlawfully paid out of capital contrary to section 254T of the Corporations Act as it then stood;
- that BBL’s financial reports for 2005, 2006 and 2007 did not give a true and fair view of its financial position because they failed to show that the final dividends had been paid out of capital in the 2005, 2006 and 2007 financial years;
- that on 29 November 2008 BBL was insolvent; and
- that the final dividend for the 2007 year had been paid out of funds borrowed on the back of an asset revaluation.
Why did the plaintiffs lose?
Although Justice Perram found that the final dividends declared for the years 2005-2007 “each had a significant component… which was not paid out of profits” and that this “was a contravention of s 254T, a breach of article 29.1 of BBL’s constitution and also had the effect of being an unauthorised reduction of capital contrary to s 256D of the Act”, the plaintiffs were unsuccessful in their attempt to recover damages.
This was because his Honour found that the fact that BBL had partially paid the dividends out of capital was “economically irrelevant to the value of the traded BBL shares” on the basis that:
“The financial realities of the Babcock and Brown group were concerned with its consolidated position and not the stand alone position of BBL. Insofar as the consolidated position was concerned, there were more than enough profits within the group to meet the dividend and the group did not, on a consolidated basis, undergo any reduction in its capital.”
This meant that people who commonly invest in securities would not likely be influenced by such information in deciding whether to acquire or dispose of securities in BBL. (Rather, his Honour noted that such information “was likely to be of interest only to those who study accounting standards”.)
In any event, the fact that the dividends were larger than the retained earnings of BBL was “a fact that was able to be deduced from” material that had been provided to the market. The fact that the payment of dividends would, therefore, amount to an unauthorised reduction of the capital of BBL could also be deduced from publicly available information. Furthermore, even though his Honour went on to find that the 2005-2007 financial reports did not give a true and fair view of the position of BBL by reason of technical issues concerning the accounting standards, “this fact did not need to be disclosed to the market because it had no financial consequence for the value of BBL shares”.
As to BBL’s insolvency, Justice Perram found that BBL was not aware of this at the relevant time: “its directors did not know that it was insolvent on that day and there was no opinion to that effect…of which its directors ought reasonably to have come into possession and of which they should have thereby become aware”.
Nevertheless, the Court turned its mind to market-based causation
Notwithstanding the failure of the plaintiffs’ case, as set out above, and the fact that his Honour held that the plaintiffs had suffered no loss in relation to the non-disclosures (as distinct from the global financial crisis and the collapse of BBL), Justice Perram considered (in obiter dicta) “whether plaintiffs could recover when it is alleged they bought shares at an inflated price caused by a listed company’s failure to disclose information to the market”. His Honour found that they could, indicating that he likely would have agreed with the submissions of the plaintiffs in this regard.
The relevant statutory provisions (sections 1317HA and 1325 of the Corporations Act, concerning damage resulting from contraventions or conduct) import a notion of causation. His Honour remarked that, although “reliance is a sufficient condition for establishing causation it is not a necessary one”. The basis for this suggestion was the line of authorities concerning misleading or deceptive conduct by trade competitors, the causative chain there being that a plaintiff’s competitor publishes misrepresentations to the market, by reason of which the competitor gains a larger share of a finite market, and the plaintiff therefore recovers for loss notwithstanding the fact that it was not the plaintiff who relied on the misrepresentation but, rather, the plaintiff’s pool of potential customers.
The next step in the Court’s reasoning was to consider cases, including Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd  NSWCA 206, in which it was held that a plaintiff may not recover where it knows of the misleading nature of the alleged conduct. Justice Perram, however, considered that those remarks by the Court of Appeal did not preclude a case where “A misleads B and B in consequence misleads C”, so that C could recover against A on the basis of A’s misleading or deceptive conduct. An example of this was the recent litigation in which councils recovered from a ratings agency who had communicated misleading information to the financial services arm of a council association, after the councils had relied on what the financial services arm had said.
The allegation in this case was that BBL misled the market (which was characterised in the judgment as “many B’s”), which then caused loss to investors by “bidding up” the price. His Honour considered that this case was analogous to that successfully brought against the rating agency. It is not clear, however, what “representation” the market – which is not an animate being (despite comprising a multitude of sentient persons and autonomous entities) – could be said to have made to the plaintiffs.
In summary, his Honour found that in misleading or deceptive conduct cases, although a plaintiff generally must show that they would have acted in a particular way but for the conduct alleged, “it is artificial to speak of reliance in non-disclosure cases”. This comment suggests the formulation of an additional category of case (like the trade competitor cases mentioned above) in which proof of reliance is unnecessary. An alternative view may be that this dictum flows from policy considerations that are unique to the statutory obligation of continuous disclosure (namely, the need to ensure that a securities market is properly informed of non-public price sensitive information in a timely way), and which do not necessarily apply to the distinct cause of action founded on the statutory prohibition against misleading or deceptive conduct.
The decision was handed down only yesterday: it is yet to be seen whether the plaintiffs file an appeal.