Do plaintiffs in a shareholder class action have to show they relied upon misleading or deceptive conduct, or is it enough that the market in general relied upon them, which then affected the share price?
This has been a question that the courts, litigators and commentators in Australia have been grappling with for a long time. At first blush the decision in In the matter of HIH Insurance Limited (in liquidation)  NSWSC 482 has given the answer.
But the chatter about this case can be itself misleading ‒ a closer examination reveals a more nuanced situation, and some obstacles for plaintiffs and their funders. In short, it's not all bad news for ASX-listed companies.
The shares, the representations, and the litigation
The claimants were investors who had bought shares in HIH Insurance Limited, at that time a company listed on the ASX, after HIH released its full year and interim results. HIH then went into liquidation not long after.
The claimants alleged that HIH had engaged in misleading or deceptive conduct with respect to many of the representations made in the results. They lodged proofs of debt based on loss and damage which they say they suffered because the contravening conduct caused them to pay more for the shares than they otherwise would have paid. Importantly, the claimants did not contend that they read, or directly relied upon, the results.
Although they admitted that many of the representations made in the results were misleading or deceptive, the liquidators (defendants) did not admit the claimants’ proofs of debt. The claimants therefore sought from the NSW Supreme Court an order that their proofs be admitted.
In order to recover damages, the claimants needed to show that that they suffered loss or damage "by" the representations ‒ did they cause their loss or damage?
Did the claimants suffer loss "by" the misleading or deceptive conduct?
The court had to decide how it must approach causation in the context of statements made to the ASX-regulated market by listed companies.
The liquidators contended that the claimants needed to show that they relied upon, or would have acted differently but for, the results.
By contrast, the claimants contended that they only needed to show that:
- the representations materially contributed to their loss by misleading the market into attributing an artificially inflated value to the shares;
- they acquired the shares in that inflated market; and
- this resulted in them suffering loss and damage by paying more than they otherwise would have paid for the shares.
It would not matter that they had not relied upon the representations themselves. The Court called this type of causation Indirect Market Causation.
The Court agreed with the claimants; reliance need not be established and Indirect Market Causation could be enough. The claimants had shown that the effect of the representations on the market had caused them loss or damage.
The Court said that evidence the claimants knew about or were indifferent to the misleading conduct but proceeded to nevertheless buy the shares would break the chain of causation between the misleading statement and the loss suffered. The Court noted that there was no such suggestion in this case.
How much loss had the claimants been caused by HIH's misrepresentations?
The claimants argued that each plaintiff would be entitled to recover the difference between the price paid for the shares and their value in that plaintiff’s hands at the date of trial (referred to as the “left in hand” approach to valuation) ‒ an argument rejected by the Court.
Instead, the Court said their loss was the difference between the price the claimants paid and the price they would have paid if there had been not been the misleading representations. This involved taking into account other factors which had influenced or distorted the true value of the shares. Thus, the measure of damages is not based on the difference between the price the claimants paid and the “true value” of the shares.
Subject to certain cases reserved for further argument, it determined the claimants were entitled to damages of between 6%-13% of the price they paid for the shares, depending on when they bought them.
Significance of the HIH decision: not all plain sailing for shareholders
The decision in HIH is a first instance decision by a single judge, and other judges are not bound to follow it. Furthermore, given the significance of the issue, it is likely that the decision will be reviewed at an appellate level. But until it is, what should listed companied take from this when making statements to the market, including statements are made or not made under the continuous disclosure regime?
First, the bad news: if this case is followed and its reasoning accepted:
- shareholders may only need to prove that the listed company's misleading statement misled the market by artificially inflating the share price, and that this inflation in share price caused them financial loss;
- shareholders may not be required to show that they relied upon, let alone read, the misleading statement; and
- while not a shareholder class action, the decision might be more significant in opt-out shareholder class actions. As no evidence of reliance may be required, causation may be dealt with as a common question.
As for the good news, the Court itself in HIH put some obstacles in any shareholders' path:
- shareholders will need to bring evidence to show that the inflation in share price occurred because of the misleading statement. This means that shareholders will have to prove much more than showing merely that the inflation in share price occurred following a misleading statement;
- the Court won't look at the value of shares in a vacuum. Expert evidence will be needed to isolate the impact of the alleged contravening conduct on the purchase price of the shares, rather than evidence of the "true value" of the shares at the time they were purchased. This means the liability of a listed companies will be capped at the degree of impact that the particular misleading statement had on the inflation of the share price at the time the shareholders bought the shares; and
- if shareholders knew about or were indifferent to the misleading statement, that may sever the required connection between the statement and a shareholder's financial loss.
However future courts decide the issue of causation, listed companies should continue to be careful about statements that they make, or do not make, to the market, particularly in the context of the continuous disclosure regime.