In Bonham v Iluka Resources Limited  FCA 713, the Federal Court of Australia refused an application for preliminary discovery by a prospective securities class action applicant related to a decline in the share price of Iluka Resources Limited (Iluka).
The applicant alleged that he purchased shares in Iluka at an inflated price in reliance on misleading or deceptive statements made by Iluka and submitted that preliminary discovery would likely assist him to decide whether or not he had a cause of action. This was against a background where the applicant’s solicitor had earlier publicised the fact that a class action was going to be commenced against Iluka as a result of its alleged market misconduct.
The Court refused the application, finding that there was not an objective basis for the applicant to reasonably believe either that Iluka’s representations were requisitely misleading or deceptive or that Iluka breached its continuous disclosure obligations.
In so finding, the Court was critical of the applicant’s solicitor’s conduct in promoting the class action. The Court held it was wrong for the applicant’s solicitors to “book-build” for the purpose of recruiting potential group members by making statements that they had determined to commence a class action, while simultaneously and inconsistently contending to the Court that the lead plaintiff needed the assistance of the Court by way of preliminary discovery to enable him to make a decision whether to commence the proceeding.
Iluka is a major Australian mining company listed on the ASX. Iluka provided regular quarterly production reports and half-yearly financial reports to the ASX. In addition, Iluka adopted the practice of publishing notices from time to time, commonly under the title “Key Physical & Financial Parameters”. The updates were published with the disclaimers that they were provided to assist sophisticated investors with the modelling of the company and that Iluka did not provide pricing forecasts and that any guidance was subject to supply and demand dynamics and that the updates should not be relied upon as a predictor of future performance.
On 8 May 2012, Iluka published an ASX notice “Key Physical & Financial Parameters Iluka 2012 – May Update” in which it downgraded its profit guidance. Iluka’s downgrade was modest, in the case of zircon, its main product, it forecast a fall in production of about 16% and a fall in sales of about 12%.
On 15 May 2012, the applicant purchased shares in Illuka.
On 9 July 2012, Iluka published an ASX notice “Forecast Sales Volumes – Update”, said to be “in accordance with its continuous disclosure obligations”, revealing that it now predicted significantly lower sales volumes, reflecting second quarter sales below expectations and a deteriorating economic outlook. The revised guidance forecast annual sales of zircon to between 50% to 75% of that forecast in May 2012. Iluka's stock price fell by 24% following this announcement.
On 24 March 2014, ACA Lawyers issued a media release under the title “Shareholder Class Action Against Iluka Resources” which stated it had obtained funding to commence a class action against Iluka alleging Iluka failed to comply with its continuous disclosure obligation and engaged in misleading or deceptive conduct. The action was to be commended on behalf of shareholders who acquired shares between 8 May and 8 July 2012. The action was to allege that Iluka’s zircon sales forecast in May 2012 was overly optimistic and not achievable and that the company had information prior to July 2012 that it could not achieve its forecast and did not keep the market informed. ACA Lawyers sought expressions of interest from shareholders to join the class action.
No proceedings were immediately instituted. Instead, in November 2014, ACA Lawyers wrote to Iluka advising that they were investigating commencing a class action proceeding. It was asserted that the applicant was in the position of having a reasonable cause to believe that he may have the right to obtain relief in the Federal Court from Iluka, but after making reasonable inquiries of all available material did not have sufficient information to decide whether to start the proposed class action proceeding.
ACA Lawyers asked Iluka to provide access to internal Iluka documents that were said to be necessary to enable a decision to be made whether to commence the proposed proceeding. Iluka declined the invitation to voluntarily provide documents.
On 24 December 2014, the applicant filed his application seeking preliminary discovery.
THE LAW GOVERNING PRELIMINARY DISCOVERY
The relevant law, pursuant to which an application for preliminary discovery may be made in the Federal Court of Australia, is r 7.23 of the Federal Court Rules 2011 (Cth). That rule requires the prospective applicant to demonstrate:
- a reasonable belief that he or she may have the right to obtain relief from a prospective respondent;
- after making enquiries, he or she does not have sufficient information to decide whether to start a proceeding to obtain that relief;
- a reasonable belief that the prospective respondent has or is likely to have documents directly relevant to the question whether the prospective applicant has a right to obtain the relief; and
- a reasonable belief that inspection of the documents by the prospective applicant would assist in making the decision.
Whether the applicant’s belief is or is not reasonable must be assessed objectively.
CONCLUSIONS BASED ON REASONABLE BELIEF
The Court disposed of two threshold issues. The first was whether the Court was entitled to, or must, have regard to the circumstances of prospective class members who purchased shares in Iluka between 8 May and 9 July 2012. The Court accepted Iluka’s submissions that the Court cannot.
The second was the applicant’s submission that the May 2012 update statements conveyed misleading or deceptive “express representations”, to the effect that Iluka would achieve certain full year sales of zircon (and certain other products). The Court held that no such express representations were conveyed in the document.
Implied representation and reasonable grounds
What the applicant’s counsel referred to as Iluka’s “implied representation”, that Iluka had a reasonable basis for making projections of future volumes, stood in a different position.
Importantly, in determining whether a person had reasonable grounds for making a representation in respect of a future matter, the question must be judged as at the date of the representation. Iluka presented evidence relevant to the reasonableness of its grounds for making the representations in the May 2012 update, including statements which the Court considered appeared plausibly to explain why, notwithstanding deteriorating market conditions, Iluka continued to stand by its May 2012 forecasts of future volumes for some time thereafter; until well after the applicant had purchased his shares on 15 May 2012.
The Court held that the relevant circumstances did not give rise to a reasonable suspicion, let alone an objective reasonable belief, that by 8 May 2012 Iluka would or should have known that its forecast could not be met.
The Court did not overlook the possibility that notwithstanding the want of persuasiveness of each of the individual propositions advanced by the applicant, that taken together they could amount to an objective basis for the applicant to have held the required belief. However, in rejecting this possibility also, the Court commented that “a cable of belief cannot be woven exclusively from threads of mere speculation or conjecture, nor do unfocussed feeble rays add up to illumination”.
The Court held that none of the facts or circumstances put forward by the applicant amounted to more than conjecture, suspicion or speculation that Iluka breached its continuous disclosure obligations or engaged in misleading or deceptive conduct by the making of future representations without reasonable grounds.
The Court refused the application.
Is evidence of the applicant’s own belief required?
It was strictly unnecessary to consider this issue, however in recognition that the question was fully argued, the Court also made findings on this issue.
The Court referred to and adopted the conclusions of Perry J in ObjectiVision v Visionsearch  FCA 1087 at , where it was concluded that in the absence of higher authority, it is prudent to proceed on the basis that evidence of an applicant's subjective belief is necessary. In reaching this view, the Court also considered that this construction accords with the ordinary meaning of the phrase "reasonably believes" which suggests that the prospective applicant must have a subjective state of belief which is reasonable.
The applicant’s counsel submitted that evidence of the applicant’s solicitor, Mr Lewis of ACA Lawyers, satisfied this requirement.
The Court held that what was stated in Mr Lewis’s affidavit did not establish the fact in issue. It advanced a conclusion based on a logical fallacy. It asserted that because the applicant relied upon Mr Lewis for advice in the proceedings, Mr Lewis's views were the views of the applicant.
If the Court had not already determined that the application should be refused, it would also have done so on this basis.
The discretion and ACA Lawyers conduct in “book-building”
Similarly, it was not necessary for the Court to consider whether the application would have been refused on discretionary grounds, however, the Court observed that it would have, based on the conduct of ACA Lawyers.
As noted above, ACA Lawyers had issued a media release announcing that it had obtained funding to commence a class action proceeding in the Federal Court against Iluka. Furthermore, statements listing the Iluka class action as one of ACA Lawyers’ current class actions, remained on ACA Lawyers’ website until they were removed some time after the first day of the hearing.
However, at the hearing, Mr Lewis gave sworn testimony that “... it was likely that we would [commence legal action] but no decision had been made [at the time of the media release] whether we would”.
Although, under cross-examination, Mr Lewis denied that ACA Lawyers’ 24 March 2014 media release had conveyed a misleading and deceptive picture, he accepted that the statement that “Shareholders are commencing legal action against Iluka for failing to inform shareholders that it would not achieve its sales forecasts for the calendar year 2012” was not a true statement.
The Court was not prepared to find dishonesty on Mr Lewis’s part. However, the corollary of the Court accepting Mr Lewis’ evidence was that the Court was compelled to conclude that the statements made by ACA Lawyers conveyed at least inaccurate and false impressions.
For his part, Mr Lewis conceded that the purpose of the website, at least in part, was to “book-build” – that is to recruit potential members of a class for whom litigation is in contemplation.
The Court considered it was wrong for ACA Lawyers to “book-build” for the purpose of recruiting potential members of a class action through statements that they had determined to commence a class action, while simultaneously and inconsistently contending to the Court that the lead plaintiff needed the assistance of the Court by way of preliminary discovery to enable him to make a decision whether to commence the proceeding.
The Court stated that ACA Lawyers’ conduct cannot be accepted to be usual practice in this area of legal practice. Even if it be usual practice, that practice may nevertheless be wrong and require correction.
The Court referred its reasons to the Office of the Legal Services Commissioner (NSW).
Fraud on the market
The applicant’s draft pleading invoked the doctrine of “fraud on the market” as a basis to satisfy the requirements of causation and proof of loss and damage. The Court briefly discussed the doctrine, which is premised on the “efficient market hypothesis” and the idea that shareholders rely on the integrity of the market price in making their investment decisions, such that individual reliance does not need to be proved.
The Court noted there has been no instance where the doctrine has been given effect in Australia to establish causation and it goes too far to treat the obiter remarks of Perram J in Grant-Taylor v Babcock & Brown (In Liquidation)  FCA 149 (discussed here) as doing more than endorsing the efficient market hypothesis as an available mechanism to measure loss.
The Court did not have to make any findings on the issue as the applicant made an alternative claim based on actual reliance.