The recent decision of HIH Insurance Limited (in liquidation) & Others  NSWSC 482 (the HIH decision) highlights the importance of both timely and accurate disclosure to the market, and represents a shift in the Australian legal landscape towards recognising indirect “market-based causation” in actions to recover losses allegedly arising from trading in the shares of companies, which have made inadequate or misleading market disclosure.
In American jurisprudence there may be no need to show a direct causal connection between a plaintiff’s loss and the defendant’s misconduct where the action relies on the “fraud on the market” theory: reliance is presumed by virtue of the fact that the quoted share price reflects all publicly available information (including misrepresentations), and investors presumably rely on such public information (misrepresentations) when trading at the market price.
In the HIH decision, the plaintiffs were seeking damages for causes of action established under section 82 of the Trade Practices Act 1974 (Cth) for misleading and deceptive conduct (replaced now by section 18 of the Australian Consumer Law), and sections 995, 999 and 1005 of the Corporations Law (repealed).
The issue was really whether or not the plaintiffs could establish that they suffered loss “by” HIH’s conduct – in this case the misrepresentations contained in the HIH FY1999 results, the HIH FY2000 interim results and the HIH FY2000 final results, which effectively inflated HIH’s results . The Court noted that the “word “by” expresses the notion of causation without defining or elucidating it”.
The plaintiffs did not plead that they had actually read, or directly relied upon those reports of the financial results. Instead they argued that the market “was distorted by the admitted misrepresentations of the financial results, so that shares in HIH traded at prices higher than those which would have obtained had the misrepresentations not been made; and that they have suffered loss and damage by reason of having paid more for the shares they acquired than they would otherwise have paid”.
In the HIH decision, the question was not whether HIH had contravened the relevant statutory provisions, but whether or not those contraventions could be said to have caused the plaintiffs’ losses. Reliance per se was not the issue.
“Market-based causation” can be briefly summarised as follows:
- an ASX listed company provides inadequate or inaccurate disclosure (or fails to make disclosure at all), such that the market price for securities is “inflated”;
- as a result of this inadequate disclosure, an investor purchases securities at a price which is greater than the investor would otherwise have paid (had the correct information been disclosed); and
- the investor then suffers loss when the release of the correct information causes the market price of the securities to fall.
Key to the concept of market-based causation is that the conduct of the company must have caused the loss suffered by the investor.
The HIH decision makes it clear that previous decisions on claims for damages “caused by”, for example, the misrepresentation of another, do not establish that:
“the applicant must necessarily prove that it relied on the contravening conduct, but that the applicant must establish that somewhere in the chain of causation, someone relied on the contravening conduct – in other words, that someone was misled or deceived, and that such deception brought about prejudice to the applicant. Unless someone in the chain of causation is deceived, it cannot be said that the ultimate loss to the applicant is “by conduct of” the respondent, because the conduct would be immaterial to the ultimate loss unless it impacted somehow on the causative process.”
In other words direct or individual reliance by the applicant is only one possible way of establishing the causal link. As Edelman J stated in Caason Investments Pty Ltd v Cao  FCAFC 94 (the Caason decision), a “market based causation case is not a special sub-category of causation. It is, simply put, an example of indirect causation.”
Therefore the HIH decision, like the Caason decision, represents somewhat of a departure from, or at least a clarification of previous Australian decisions, which have been interpreted as authority for the proposition that the investor must prove actual reliance on the conduct of another. Unsurprisingly, this was the position argued by the defendant liquidator in the HIH decision.
The corollary of this is that if an investor is shown to have acquired shares knowing that the results were overstated, or is indifferent to that overstatement, then that knowledge or indifference will break the causal chain.
In summary, Brereton J held that:
- while the individual investors did not directly rely the company’s misrepresentations, the market as a whole (which is constituted by investors, informed by analysts and advisors) was deceived;
- investors who acquire shares on the ASX may reasonably assume that the market reflects an informed appreciation of a company’s position and prospects which are based on proper disclosure;
- the inaccurate information disclosed by the company formed part of the matrix of information that influenced the trading price of the shares from day to day (including relevantly, when the investors bought their shares – at a price greater than would otherwise have been the case); and
- the investors would have acted differently if the contravening conduct had not occurred, in that they would have paid a lesser price for their shares than they did;
Brereton J concluded that:
…I do not see how the absence of direct reliance by the plaintiffs on the overstated accounts denies that the publication of those accounts caused them loss, if they purchased shares at a price set by a market which was inflated by the contravening conduct: the contravening conduct caused the market on which the shares traded to be distorted, which in turn caused loss to investors who acquired the shares in that market at the distorted price. In the absence of any suggestion that any of the plaintiffs knew the truth about, or were indifferent to, the contravening conduct, but proceeded to buy the shares nevertheless. I conclude that “indirect causation” is available and direct reliance need not be established.
It should be noted that Brereton J decided that “indirect causation” was available on the facts before him, and that direct reliance need not be established.
However, as His Honour was quick to point out, it was still for the Plaintiffs to establish that as a matter of fact, HIH’s misstatements of its financial results did actually cause the market to be inflated (that the shares in question traded at an inflated price as a result of the misrepresentations.
After an extensive analysis of the expert evidence that had been presented to the Court, His Honour concluded that “the contravening conduct did inflate the price for HIH shares, and that indirect causation in fact is established”. His Honour found that:
“subject to issues affecting particular cases which are reserved for further argument – plaintiffs who acquired their shares during the period 25 August 1999 to 2 March 2000 are entitled to damages equivalent to 6.25% of the price they paid; those who acquired their shares during the period 3 March 2000 to 17 October 2000 to 9.5% of the price paid, and those who acquired their shares after 17 October 2000 to 13% of the price paid.”
The HIH decision should highlight the need for ASX listed companies to be vigilant to ensure that both timely and accurate disclosure is consistently made, or to otherwise risk (in addition to regulatory investigation and action) facing class action from shareholders arising from indirect “market-based causation”.
While not binding on other Australian courts, the HIH decision will likely be persuasive should the courts be faced by a similar issue. The HIH decision is currently on appeal.