An Australian Court has for the first time clearly approved the ‘indirect causation’ approach for shareholder securities claims resulting from misleading and deceptive conduct. Shareholders in such actions are not required to establish their direct reliance on the particular contravening conduct – rather just that the market generally was misled by the conduct. This makes proving loss an easier proposition.

In HIH Insurance (In Liquidation) and others [2016] NSWSC 482, Justice Brereton was hearing an appeal from a decision by the liquidators of HIH to not admit proofs of debt lodged by various shareholders. The shareholders had each bought shares in HIH during a period in which they alleged the market price was artificially inflated due to overstated financial results released by the company.

The shareholders did not allege they had directly relied on the overstatements in making their decision to purchase the shares. Rather, relying on the principle of ‘indirect causation’, they claimed that they purchased the shares in a market which had been distorted by the overstatements, so that the shares were trading at a higher price than would have been the case had the overstatements not been made. They claimed their loss was the difference between what they paid for the shares and what they would have paid in the absence of the overstatements.

Indirect causation differs from the more common approach in misleading and deceptive conduct cases, where a plaintiff claims that they were directly misled by a representation of the defendant and, in reliance on that representation, acted in a way which caused them to suffer loss. The notion of fraud on the market / indirect causation in shareholder claims does not require the individual shareholders to even be aware of the misleading and deceptive conduct. Instead, it only has to be established that the market price was distorted as a result of the conduct and the shareholders purchased shares during the period in which the market was distorted.

The defendant liquidators argued that the shareholders had to establish that they relied upon the contravening conduct (the overstatements in the financial results) and were induced by such conduct to enter into the share purchase transactions.

Justice Brereton agreed with the shareholders, finding that the requirement under s82 of the Trade Practices Act (now the Competition and Consumer Act) that loss be incurred “by” the contravening conduct does not require direct reliance on the conduct to be established. It is only causation that is relevant, and the legislation does not require this to be direct. The Judge stated at [74]:

“If the contravening conduct deceived the market to produce a market price which reflected a misapprehension of HIH’s financial position … then it had the effect of setting the market at a higher level – and the price the plaintiffs paid greater – than would otherwise have been the case. In such circumstances, plaintiffs who decided – entirely oblivious to the contravening conduct – to acquire share in HIH, were inevitably exposed to loss.”

This decision is a significant win for shareholder plaintiffs (and funders) in pursuing continuous disclosure-type class actions in relation to listed companies. Although there had been some approval of this approach at an interlocutory level, this is the first time the issue has been properly tested before Australian Courts. The position aligns Australia with the similar “fraud on the market” approach seen in the United States. It means the key issue to be established in these cases is whether the contravening conduct in fact caused a distortion of the share price.

With the doubt over this issue now removed, and subject to any higher court taking a different view, we expect the HIH decision will see shareholders and funders encouraged to pursue with confidence (if necessary all the way to trial) further such securities claims.