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Expert Blog

Damages in Securities Class Actions

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Our look at recent developments in Class Action litigation continues in this post with an examination of damages awards in class action securities cases.

Trying to ascertain the exact loss that a class of plaintiffs has suffered owing to an adverse share price movement is not an easy task. It is very difficult to differentiate between the deterioration in a stock’s price owing to normal market conditions and deterioration due to failure on the part of the company. This problem is worsened by the fact that there is little judicial guidance on the correct method to adopt for damages assessment. Of course, this is because securities cases, being as complex as they are, often settle.

Nonetheless, courts have adopted complex expert evidence, usually from forensic accountants and valuers, to assist in determining compensable loss. These assessments can be broken into two categories. First, ‘transaction cases’ where the defendant’s conduct caused the plaintiff to pay for shares that they would have acquired in any event and second, ‘no transaction’ cases where, but for the defendant’s conduct, the plaintiff would not have purchased the shares at all.

Transaction Cases

Damages in ‘transaction cases’ are commonly assessed by reference to the rule in Potts v Miller. That is, the price a unitholder actually paid compared with the price they would have paid had the impugned conduct not occurred.

Recently, this formulation has received judicial approval in the case of Re HIH Insurance Ltd (in liq) [2016] NSWSC 482. There, a group of plaintiffs brought a class action against the failed insurer, HIH, alleging that profits and assets were overstated leading to an artificially inflated share price which later plummeted. Brereton J applied the rule in Potts v Miller in finding that the plaintiffs were entitled to be compensated:

“[79] Measure of a plaintiff’s damages is closely related to their causation case. Where the defendant’s conduct caused the plaintiff to pay for shares that they would have acquired in any event at a price which was inflated above that which would otherwise be obtained the damages are the price they paid and the price they would have paid had the contravening conduct not occurred but all other factors remained constant”.

It is the last phrase of that reasoning, “all other factors remaining constant”, that makes things problematic. How is it to be determined that the contravening conduct, as opposed to natural market events, caused a fall in the stock price?

Often this is resolved by forensic accountants and valuers engaging in event study analysis. An event study is ‘an econometric technique that seeks to resolve the impact of specific events on a company’s share price by removing other unrelated events such as market wide movements. The event study seeks to determine how much of a share price movement on a particular day is due to a specific event such as a disclosure of an hereto undisclosed piece of information. The events study methodology invites the conclusion that if a disclosure causes a statistically significant fall in the share price it follows that the information disclosed was material and it enables an estimate to be made of the extent of the price inflation present in the share price as a consequence of an earlier non-disclosure’: Taylor v Telstra Corporation Ltd [2007] FCA 2008 at 21 per Jacobson J.

Although courts in Australia have not formally adopted the term ‘event study’, the methodology and reasoning used in class actions is consistent with this. For example, Brereton J in HIH constructed a table setting out the actual share price compared against the hypothetical price suggested by the expert witness:

Table 3 30 June 99 31 December 99 30 June 00
Reported $M 946.400 962.600 939.100
Adjusted $M 887.264 871.592 816.220
Adjusted/Reported % 93.75 90.54 86.90

After preferring one expert’s view to another’s, the damages award was then expressed as equivalent to a percentage of the price paid (“plaintiffs are entitled to damages equivalent to 6.25% of the price they paid”).

No Transaction

Where parties plead their case on the basis that they would not have entered into the transaction but for the contravening conduct, a successful plaintiff is entitled to recover the entire amount of a failed transaction. At first glance, awards in no transaction cases are higher.

It is prudent to remember, however, that proving causation in a no transaction case is much harder. The plaintiff must prove the only reason they entered the transaction was the contravening conduct.

Awards in this type of case can also include consequential losses. In the case of Wealthsure v Selig [2014] FCAFC 64 that included loss of the initial investment, transaction costs, borrowing costs, refinancing costs and compound interest.