Another decision of the Federal Court of Australia has commented on causation in market non-disclosure cases, fuelling further debate on the use of an indirect causation theory to prove damages in misleading conduct claims by shareholders.
On 4 March 2015, Perram J of the Federal Court of Australia dismissed a claim by shareholders of Babcock & Brown Limited (in liquidation) (BBL) who alleged a failure by BBL to disclose material information to the market in breach of its continuous disclosure obligations. Notwithstanding the dismissal of the plaintiffs’ claim, Perram J briefly considered the requirements for proof of loss and damage, concluding that shareholders do not need to prove direct reliance to recover compensation for losses arising from a failure to comply with continuous disclosure laws.
The plaintiffs purchased shares in BBL in the period between 21 February 2008 and 13 March 2009. After reaching a high of $34.63 on 19 June 2007, shares in BBL plummeted to a low of $0.33 before trading was suspending on 7 January 2009. In this period, the plaintiffs alleged that BBL failed to disclose that:
- dividends had been paid out of the company’s capital, not the profits of the company as required by the Corporations Act 2001 (Act) at the time;
- the company’s financial reports for the 2005, 2006 and 2007 financial years did not provide a true and fair view of the company’s financial position;
- BBL was insolvent on the day that it became insolvent; and
- the final dividend for the 2007 year had been paid out of funds borrowed on the back of an asset revaluation.
It was not alleged by the plaintiffs that this information was material to their decision to acquire BBL shares; rather, they claimed that the failure to disclose caused them to acquire their shares at an overvalue (because of the presence of misinformation in the market generally) and that they were entitled to recover the difference between what they paid for the shares and what the shares were worth when acquired. Unsurprisingly, BBL argued that the plaintiffs should be required to prove reliance on the allegedly misleading conduct before recovering any loss.
LOSS AND DAMAGE
The plaintiffs failed in their claims because the Court found that the information that was the subject of their allegations did not satisfy the standard of materiality required to engage BBL’s continuous disclosure obligations, meaning that there was no breach of sections 674 and 675 of the Act.
Although this was sufficient to dispose of the proceedings, Perram J briefly considered the plaintiffs’ claim for damages, determining that, had they successfully demonstrated a breach of continuous disclosure laws, the plaintiffs were entitled to recover the value of the inflation of the share price caused by the failure to disclose. While this conclusion was obiter, Perram J noted that reliance is not a necessary condition for proving causation in misleading conduct cases, particularly because the terms of section 674 of the Act assume that the information the subject of the claim is price sensitive.
Interestingly, Perram J also compared claims of this kind to Bathurst Regional Council v Local Government Financial Services Pty Ltd (No 5), which involved a claim by local Councils against a ratings agency (and others) in relation to the purchase of financial instruments given a AAA credit rating and which ultimately became worthless. This decision was referred to as authority for the proposition that where a party engages in misleading conduct that misleads another party, and that second party then misleads a third party, the third party is not precluded from recovering from the party who made the original representations.
In claims involving breach of continuous disclosure laws, the relevant “middle party” is the market, which sets share prices. Although the “middle party” in Bathurst was a financial services agency (which made recommendations to the plaintiff Councils) and not the market, Perram J did not consider this to be a relevantly distinguishing feature.
However, this analysis presumes that the market is capable of interpreting and processing information as efficiently and accurately as a financial services agency staffed by professionals. Perram J did not elaborate on his view, although he did accept the general proposition that an efficient market hypothesis could be applied in these circumstances.
We have previously explained the relevance of the efficient market hypothesis to the fraud on the market theory of reliance used in US securities class actions. Much like the fraud on the market theory, indirect causation is based on an assumption of market efficiency. Perram J’s reasons did not turn to consider whether the market for BBL securities was truly efficient, and the implications of any inefficiency for the indirect causation theory. Nonetheless, this decision moves us one step closer to a resolution of the difficult issues surrounding causation and loss in shareholder claims.
WHERE DOES THIS LEAVE US?
This Federal Court decision is the second within the last four months to provide tacit approval of indirect market causation theory. Additionally, an interlocutory decision in the Victorian Supreme Court has held that a claim based on indirect market causation theory is not “plainly hopeless or bound to fail.”
Although these comments (being interlocutory or obiter) are not determinative, they do suggest a willingness to facilitate shareholder claims in misleading conduct cases by simplifying the requirements for proof of causation and damages. Whether these approaches stand up to scrutiny remains to be seen.