This post is our third in a series looking at recent developments in class actions. The earlier two examine competing class actions and common fund orders.
2016 saw a significant development in class action practice owing to the decision of Brereton J in HIH Insurance Limited (in liquidation) and others  NSWSC 482. This case concerned causation and is extremely useful in clarifying when a defendant’s conduct will be held to have ‘caused’ a plaintiff to enter into a purchase of securities.
HIH was a publicly listed insurance company that spectacularly crashed in 2001. The company’s demise is considered to be the largest corporate collapse in Australia’s history, with losses around a staggering $5.3 billion. Unsurprisingly, a raft of litigation ensued against the company and its individual directors. Amongst this litigation was a securities class action launched against the company by plaintiffs who had purchased shares between 1998 and 2001.
The primary allegation was that the company engaged in misleading and deceptive conduct, thereby breaching the former prohibition under the Trade Practices Act. That breach was an overstatement of operating profits and net assets causing loss and damage to the plaintiffs by reason of them having paid more for shares than they otherwise would have.
In a rare move, the defendants took the step of formally admitting liability but denying causation. Therefore, the matter proceeded to the Supreme Court, where the question of causation was decided.
Direct vs Indirect
The Defendants argued that although they engaged in misleading and deceptive conduct the plaintiffs could not prove that the conduct directly caused them to suffer a loss (purchase the shares). Put another way, the defendants stated that causation will only be established where there is a direct causal link between the non-disclosure and the loss.
In reply, the plaintiffs argued that causation could be proved “indirectly” on the basis that they had paid an inflated price for the shares with loss being the price paid as against the price the shares would have been but for the conduct.
At the hearing, Brereton J sided with the plaintiffs and affirmed indirect causation as the appropriate way of looking at a loss. In essence, this case affirms the earlier obiter of Perram J in Grant-Taylor v Babcock & Brown Limited (in liquidation)  FCA 49 where His Honour noted that an investor could potentially recover without the need to prove a “direct causal link” between the conduct and the loss.
According to Brereton J’s reasons, indirect causation is to be preferred because it accurately describes a situation in which plaintiffs have purchased shares at an inflated price with knowledge of true market conditions. His Honour states:
“If the contravening conduct derived the market to produce a market price which reflected a misapprehension of HIH’s financial position (which is a factual question to be resolved in conjunction with the quantification of damages), 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 shares in HIH, were inevitably exposed to loss. Moreover, they were members of the class who would obviously be affected by the contravening conduct”
The decision also provides a simple factual analysis to be used in determining indirect causation. That analysis is relevantly whether:
- There has been an overstatement of financial results to the market;
- The market was deceived into a misapprehension that the market was trading more profitably that it really was;
- The shares were traded at an inflated price; and
- Investors paid the inflated price to acquire the shares and thus suffered loss.
This decision is important because it finally clarifies the standard required for causation in securities class actions. This provides more litigation certainty for litigation funders and insurers who can adjust their risk appetite to take on a clearly broader class of potential risk.
For companies, the decision will increase the likelihood of more securities class actions. The indirect causation standard is lower and therefore added emphasis needs to be placed on the accuracy of information going to the market and internal governance.