Securities litigation given strong Federal Court support

Professor Bob Baxt explains why the recognition of market-based causation means more possible litigation worries for corporations.

Australian law, especially in the context in which litigation is being conducted with modern regulatory legislation in place, is tending to follow precedents developed in the US rather than the UK. While the introduction of class actions some years ago, and the acceptance into the legal Australian scene of the litigation funding phenomenon, has not “put Australian litigation on the same page” as US litigation, it has opened up many opportunities for a broader range of litigation to be pursued in Australia. This is particularly so where there are allegations of company failure, allegedly evidenced by the non-compliance with disclosure and related laws.

In the context of securities regulation, and especially with allegations mounting, almost weekly it seems, against businesses and corporations alleging misleading or deceptive conduct in association with the raising of corporate funds or other market related initiatives, Australian lawyers “are experimenting” more and more with US litigation initiatives which have opened up new opportunities for the use of class actions. The concept of “fraud on the market”, a popular US litigation initiative which relies on providing indirect causation between information being supplied (or not supplied) to the market and alleged loss suffered by investors (often referred to as litigation relying on market-based causation), has been tested in our courts in recent years. There has been mixed success in courts accepting that such a cause of action is arguable in Australia. Earlier cases discuss the concept but the relevant litigation was completed on other grounds without the courts needing to deal with the viability of the concept.

An earlier case

One very interesting high-profile example was the Full Federal Court decision in ABN AMRO Bank NV v Bathurst Regional Council (2014) 224 FCR 1 (ABN AMRO). Massive losses were allegedly suffered by institutions and others that had invested in financial products offered to the market by ABN AMRO. The evidence suggested that a financial market rating issued by a company that was relied on by ABN AMRO was misleading. In a very lengthy judgment, the Full Court upheld the initial decision of the trial judge and ruled in favour of damages being awarded to the plaintiffs.

The plaintiffs were able to establish that the credit rating provided by the rating agency could be used in evidence to establish their loss. The Full Court noted that “there is no bright-line principle that is insufficient for a plaintiff to prove that some other person relied on the alleged misleading conduct and that the person’s reliance led to the plaintiff suffering loss”. [1375-1376]

Babcock & Brown case

In what is arguably a more relevant case, Grant-Taylor v Babcock & Brown Limited (In Liq) (2015) 104 ACSR 195 (Babcock & Brown), Justice Perram discussed whether the establishment of indirect causation was a viable avenue for success. The plaintiffs in that case alleged that their loss was due to breaches by a company of its continuous disclosure requirements. Justice Perram, in obiter dicta, noted that although it was unnecessary to decide whether shareholders were able to recover (because of the defendant company’s failure to fully inform the market, thus “causing” the shareholders to buy shares at an inflated price) he inferred that they would have been likely to rely on such a plea if necessary. He concluded: “While reliance is a sufficient condition for establishing causation it is not a necessary one” (at 219). The plaintiffs failed, not because of arguments related to causation, but because the relevant information was held not likely to have been material to any investment decision.

Caason case

The very recent decision of the Full Federal Court in which the market-based causation argument has been discussed and “accepted”, it seems in principle, is Caason Investments Pty Ltd v Cao [2015] FCAFC 94 (Caason). The relevant interlocutory proceedings in Caason involved the plaintiffs asking the court to allow them to amend their statement of claim in a number of pieces of litigation. This litigation had been initiated as a result of allegations that certain investments they had purchased in relevant companies had not sustained the value that the plaintiffs believed would have been attributed to them, because of the failure of the companies offering the securities to provide appropriate information to the market.

A number of preliminary skirmishes in the Federal Court had led to the dismissal of attempts by the plaintiffs to change the pleadings in the relevant cases. But, as the Full Federal Court indicated, this failure was not because the trial judge did not accept the use of a market-based causation pleading but because the pleadings had not been properly prepared in accordance with the rules of the court. Justices Gilmour and Foster, two members of the Full Federal Court, ruled that there was no reason why a market-based causation argument could not be pleaded. However, they provided no assurance that this would be a sufficient basis for success in the relevant case.

In what, in my view, is a more interesting and quite detailed judgment in the case, Justice Edelman, the third member of the court, provided a detailed discussion of the fraud on the market concept and why it was not one that should be dismissed as relevant for the Australian legislative scene. In his view, the trial judge had not dismissed the market-based causation argument in the pleadings; the courts had simply ruled that pleadings as presented to her were inadequately drafted. The judgment goes into some detail as to how the pleading should have been pursued. At paragraphs 145 and following, Justice Edelman provides a detailed analysis of why a market-based causation plea has a reasonable prospect of success as a matter of law in Australia. It is unnecessary to go into the background of his reasoning. However, paragraphs 154 and 155 contain important legal observations, which, while obiter dicta, will prove influential in my view.

Justice Edelman noted: “[154] The concept of market-based causation involves a causal relationship, albeit one without reliance by the plaintiff investor on the disclosure document. The plea is that a misleading statement or omission in a disclosure document causes the market price for the securities to be inflated so that the investor purchases securities at a price which is greater than the investor would otherwise have paid. The investor then suffers loss, including when the release of the omitted information or the correction of the misleading statement causes the market price of the securities to fall. None of these causal links requires the investor to rely on the disclosure document.

“[155] It is at least arguable that as a technique of causation without reliance, market-based causation is not unusual. A common example of causation without reliance is cases that involve misleading conduct by one trader which leads to customers being diverted from another trader.”

He also suggested that provisions in the Corporations Act 2001 specifically indicate that such an argument is feasible. Section 729(1) is drawn in such a way as to suggest that omissions in the context of the development of investment products can be the subject of reliance in litigation. His Honour further observed that he would not distinguish between what he described as “market-based causation” and a circumstance described as “reliance-based causation”.

He referred with approval to the discussion of the concept in a number of other cases, including those briefly discussed above. Apart from these important observations, his honour discussed the arguments as to whether such a pleading should be permissible by examining academic and other literature as well as a range of other cases dealing with the particular question. His judgment is worth careful study. It is likely to be the subject of further debate, especially if leave to appeal is brought successfully to the High Court of Australia, or because of other cases that may arise. While the case is arguably based on questions of pleadings, with no decision contemplated as to whether damages would be awarded, it provides further incentive for the lawyers advising plaintiffs in cases involving market failure. With the continued reliance on litigation funding to support such cases, the prospects for wide-ranging and interesting decisions, as well as implications for corporations which may face such claims, is a matter of important attention.