In brief - HIH's conduct misled the market and inflated the share price
By releasing overstated operating profit in its financial results, HIH led the market to believe that it was trading more profitably and had greater net assets than was the case. This artificially inflated the price of HIH shares. Investors who bought shares suffered a loss because they paid the inflated price for the shares they would have acquired in any event.
Court finds that plaintiffs purchased shares at an inflated price
On 20 April 2016, Justice Brereton of the Supreme Court of NSW handed down judgment in four actions against the liquidators of HIH Insurance Ltd (Smith & Ors v McGrath (in his capacity as Liquidator of HIH Insurance Ltd); Baldock & Ors v McGrath (in his capacity as Liquidator of HIH Insurance Ltd); De Bortoli Wines (Superannuation) Pty Ltd & Ors v McGrath (in his capacity as Liquidator of HIH Insurance Ltd); and Cuong Ly  NSWSC 428
His Honour found that the plaintiffs in each of those actions had purchased shares in HIH at an overvalue, as certain financial results documents released by HIH between 1999 and 2000 misleadingly overvalued HIH’s pre-tax profit and inflated its share price during the relevant period.
His Honour assessed the plaintiffs' loss and damage as the amount equal to the difference between the (inflated) price actually paid by the plaintiffs for their shares in HIH, and the amount that they would have paid if HIH had not included the misleading statements in its financial results.
Decision sets precedent in accepting principle of indirect market-based causation
Whilst the case was brought by investors (ie shareholders) whose proofs of debt were rejected by liquidators, the decision is significant for shareholder class actions because it represents the first time that an Australian court in a final decision after trial has accepted the principle of indirect market-based causation.
So long as a shareholder can prove that a corporation’s misleading or deceptive conduct (or material omission) artificially inflated the price of that corporation’s securities, the shareholder may be entitled to recover the loss and damage suffered by reason of that fact, even if the shareholder did not rely upon the relevant conduct.
Prior to Justice Brereton’s decision in HIH
, several courts accepted that a misleading and deceptive conduct claim based on market-based causation had at least some prospect of success. (See for example Caason Investments Pty Limited v Cao  FCAFC 94
; and Camping Warehouse Australia Pty Ltd v Downer EDI Limited  VSC 357
Australian law moves closer to US position on share market fraud
now brings Australia’s law concerning shareholders' ability to recover from corporations that cause the price of their shares to be artificially inflated one step closer to the US, which has recognised the doctrine of "fraud-on-the-market" since 1988.
Under that doctrine, reliance can be presumed if certain facts are established. Direct reliance is not required, although defendants can lead evidence to rebut the presumption.
Australian law does not authorise any rebuttable presumption and the decision in HIH analyses causation as the ultimate issue posed by the statutory causes of action for misleading and deceptive conduct.
His Honour found that direct reliance need not be established and that indirect causation was available on the facts of the case. Even so, the plaintiff still had to establish by evidence or inference that the contravening conduct did inflate the market (HIH
This article will examine Justice Brereton’s decision and identify some of the questions that will need to be addressed by future courts if His Honour’s decision is not subsequently overturned on appeal. This article will not consider the accessorial liability aspect of His Honour’s decision or His Honour’s approach to the expert evidence and quantification of the plaintiffs’ respective claims.
Results documents released by HIH found to be misleading or deceptive
Between 26 August 1999 and 15 March 2001, HIH released the following documents to the market:
- final results for 1998/1999;
- interim results for the six months ended 31 December 1999; and
- final results for 1999/2000
(collectively, "the Results Documents").
Each of the shareholders acquired shares in HIH after the publication of at least one of the above documents. None of them alleged reliance upon any of the Results Documents.
HIH found to have misrepresented its reinsurance arrangements
His Honour found that each of the Results Documents was misleading or deceptive within the meaning of section 52
of the Trade Practices Act 1974 (Cth)
("TPA") and section 1005 of the Corporations Act
(Cth) ("CA") (which section was in force at the time HIH shares ceased trading on the Australian Stock Exchange) because:
- HIH purchased whole account insurance through Hannover Re;
- HIH had separately but contemporaneously entered into a Letter of Credit Agreement and Letter of Credit Authority Agreement, which had the effect of transferring a substantial part of the risk back to HIH; and
- In the Results Documents, HIH accounted for its arrangements with Hannover Re as if they were conventional reinsurance arrangements, when they were in fact financial reinsurance arrangements.
Profit representations made by HIH found to be overstated
Accordingly, the Results Documents represented that HIH’s operating profit before abnormal items and income tax was substantially higher than what it would have been had HIH correctly accounted for its arrangements with Hannover Re ("the Profit Representations").
Each of the plaintiffs lodged proofs of debt in the winding up of HIH on the basis that HIH had breached the above provisions of the TPA and CA. HIH’s liquidator did not admit the plaintiffs’ proofs. The plaintiffs appealed the liquidator's non-admission to the Supreme Court of NSW pursuant to section 1321
of the CA.
At trial, there was no dispute that the Profit Representations were made and were overstated.
Contravening conduct by HIH found to have deceived the market
Justice Brereton regarded the key question to be determined as whether the publication of the Results Documents, which included the Profit Representations, materially contributed to the plaintiffs incurring loss.
His Honour analysed a long line of authority concerning section 82(1) of the TPA (the operative language of which is substantially identical to section 1005 and section 1041I of the CA) to the effect that the provision was concerned with causation and not reliance. Propositions that emerged are:
A [plaintiff] does not have to prove that it relied on the contravening conduct - only that somewhere in the chain of causation someone relied on the contravening conduct - that someone was misled or deceived and such a deception brought about prejudice to the [plaintiff] (HIH at ).
The entitlement to recover loss or damage in a case of misleading and deceptive conduct was not confined to persons who relied on the conduct, and a plaintiff need not establish that the plaintiff directly received and relied upon the misrepresentation made by a defendant (HIH at ).
Here, whilst "the contravening conduct did not directly mislead the applicants, it deceived the market (constituted by investors, informed by analysts and advisors) in which the shares traded and in which the plaintiffs acquired their shares" (HIH
Laws of market inevitably led to investors paying inflated price
In particular, His Honour cited the judgment of McHugh J in Henville v Walker
to the effect that for the purposes of section 82(1) of the TPA, courts have recognised two scenarios of causation: the first is where the defendant engages in certain conduct that sets in motion (or in the case of an omission, fails to set in motion) a chain of events such that "the laws of nature dictated the result".
The second scenario was where damage was suffered not because of the laws of nature, but because the person acted to their own detriment following the conduct of the defendant.
His Honour stated that the HIH case is analogous to the first scenario described by McHugh J: "…though it is the laws of the market rather than those of nature which dictated that the inevitable consequence of the contravening conduct would be that the share purchasers would pay an inflated price" (HIH
His Honour also cited the first instance decision in Grant-Taylor v Babcock and Brown Ltd (in liq)
 FCA 149, where Perram J accepted that a party which acquires shares on a stock exchange could recover compensation for price inflation arising from a failure to disclose material required to be disclosed, so long as they were not aware of the non-disclosed material.
That finding was obiter and the Full Court of the Federal Court in delivering its decision on the appeal on 21 April 2016, said that given its reasons for dismissing the appeal, it was "unnecessary in this case to deal with the important question of causation in connection with a posited failure by a listed company to disclose market sensitive information" (see Grant-Taylor v Babcock & Brown Limited (in liquidation)  FCAFC 60
Investors did not have to prove direct reliance on misleading representations
In finding that "indirect causation" is available and direct reliance need not be established, Justice Brereton held that the chain of causation was -
- HIH released overstated financial results to the market;
- the market was deceived into a misapprehension that HIH was trading more profitably than it really was and had greater net assets than it really had;
- HIH shares traded on the market at an inflated price; and
- investors paid that inflated price to acquire shares, and thereby suffered loss. Thus the contravening conduct materially contributed to that outcome (HIH at ).
In trying to defeat indirect market-based causation, the evidentiary burden falls upon the defendant to prove that a plaintiff knew the truth about or was indifferent to the contravening conduct but proceeded to buy the shares nevertheless. Absent that, Justice Brereton has held that direct reliance need not be established.
Court establishes chain of causation leading to investors suffering loss
His Honour cited Perram J's reasoning in Grant-Taylor:
…while on the authority of Digi-Tech and Ingot, a plaintiff may not recover where it knows of the misleading nature of the alleged conduct, those authorities did not mean that C was necessarily precluded from recovering from A where A misled B, and B in consequence misled C (as ABN AMRO established), and a case in which A misled the market (comprised of many Bs) which then bid up the price and thus caused loss to C, was not relevantly different (HIH at ).
Applying that reasoning to the facts of this case, His Honour held that HIH (A) misled the market (B) by making the Profit Representations. Those representations caused the market to react in a way that increased the price of HIH’s shares. Consequently, the plaintiffs (C) suffered loss and damage when they purchased HIH’s shares after those representations were made.
Justice Brereton has found that market-based causation is entirely consistent with a substantial line of authority concerning causation under section 82(1) of the TPA.
High Court to have the final word on market-based causation in Australia
It will be interesting to see how courts develop this principle in future cases, including in any appeal from this decision.
Clearly each case must turn upon its facts and it is likely to fall to the courts to articulate carefully the circumstances in which market-based causation will apply.
The formal recognition of indirect market-based causation is likely to be welcomed by funders and plaintiffs' lawyers in the shareholder class action space - but it is still for the High Court ultimately to resolve the position in this country.