Australia: The US ‘Fraud on the market’ presumption lives: implications for Australian shareholder class actions


The highly anticipated decision of Halliburton Co v Erica P John Fund Inc [2014] WL 2807181 (23 June 2014) (Halliburton), handed down in the United States Supreme Court yesterday, has the potential to significantly alter the shareholder class action landscape in the US and, potentially, Australia. The result, an affirmation of the 'fraud on the market' presumption in the US, will undoubtedly provoke renewed discussions in Australia as to the extent to which Australian courts should consider or adopt this presumption here.

'Fraud on the market'

In Australia, shareholder class actions are typically founded on allegations that a company's disclosure (or non-disclosure) of material information was misleading, deceptive or in breach of obligations. Critically, however, the method for establishing causation in shareholder class actions has not yet been finally determined by Australian courts. Whether each claimant must prove actual reliance on the misrepresentation, or whether a lesser requirement of indirect causation through a general reliance on the market is sufficient, remains an open question.

In the US however, the case of Basic Inc v Leninson (1988) 108 s Ct 978 (Basic) established the 'fraud on the market' theory of causation in response to this issue.

Essentially, the 'fraud on the market' theory establishes the presumption that the price of stock which is trading in an efficient market will incorporate and reflect all material information, including any misrepresentations or contravening statements. Accordingly, investors who buy or sell shares do so in presumptive reliance on any misrepresentations made by the company.

While this presumption is rebuttable, it means that securities fraud plaintiffs in the US need not prove actual individual reliance on the company's misrepresentations, but rather can establish reliance on a class-wide basis.

The Halliburton litigation

The Halliburton litigation commenced in the US more than a decade ago, when a class of plaintiffs invoked the 'fraud on the market' presumption as part of their petition for class certification to demonstrate class-wide reliance on the defendant company's financial statements and projections. The plaintiffs alleged that the company misrepresented material facts to investors by understating its projected liability for asbestos claims, overstating its revenues and exaggerating cost savings in relation to a merger.

The Federal District Court initially prevented Halliburton from introducing evidence to rebut the 'fraud on the market' presumption at the class certification stage, and proceeded to certify the shareholders as a class. This view was affirmed by the 5th US Circuit Court of Appeals, which found that evidence to rebut the 'fraud on the market' presumption could not be introduced prior to a trial on the merits. Halliburton appealed and, in doing so, challenged the presumption in its entirety.

The US Supreme Court decision in Halliburton

In its long-awaited decision, the US Supreme Court declined Halliburton's invitation to jettison the 'fraud on the market' presumption. It held that the original decision in Basic was settled law and that Halliburton had failed to demonstrate the 'special justification' required for overturning such a precedent. The majority noted that Basic rested on the "fairly modest premise that 'market professionals generally consider most publicly announced material statements about companies thereby affecting stock market prices'".

If the presumption had been invalidated, securities fraud plaintiffs would likely have had to establish actual reliance by individual class members, which would have made class certification virtually impossible.

Importantly for defendants, the majority of the Supreme Court did, however, find that defendants are able to introduce evidence at the class certification stage that the alleged misrepresentation did not in fact affect the stock price. This will allow defendants to rebut the 'fraud on the market' presumption and defeat class certification, prior to any trial on the merits.

Impact of the decision in Australia

In recent years, Australian commentators have closely followed the Halliburton litigation in the US and have considered the potential application of the 'fraud on the market' theory to securities class actions in Australia.

Many economists have criticised the theory, arguing that it overstates market efficiency and erroneously presumes that all investors rely on the integrity of stock prices. Companies have also criticised the 'fraud on the market' presumption as contributing to the meritless joining of additional individuals in claims, and the magnification of plaintiff settlement leverage.

However, the adoption of the theory into Australian law is attractive from a plaintiff lawyer's perspective in relation to the convenience of not requiring each shareholder to give evidence to prove that the relevant alleged conduct caused the particular loss. It also allows small investors to have the means to challenge misleading conduct by large corporations, while concurrently supporting securities regulators. This would however be a significant change from the way Australian courts have traditionally viewed actions under s1041I of the Corporations Act 2001 (Cth) (and its predecessor).

The issue remains that the 'fraud on the market' theory does not sit comfortably with existing authority in the Australian courts on causation and reliance. Most recently, in Woodcroft Brown v Timbercorp Securities Limited (in liq) & Ors [2013] VSCA 284, the Victorian Court of Appeal placed importance on the requirement to prove actual reliance on the relevant misrepresentations. In that case, following the High Court ruling in Kenny & Good Pty Ltd v MGICA Ltd1 and the findings of the NSW Court of Appeal in Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Market Ltd2, theCourt of Appeal confirmed that in order to argue a misrepresentation case,

"it was necessary for the appellant to establish that there was reliance placed upon the non-disclosures and the misleading conduct so as to cause entry into the investment product and, therefore, subsequently to cause loss".

However, it should be noted that in this case there were a number of other issues which may be distinguished on the facts, including that the investor's primary motivation in purchasing was to secure a tax benefit; that the securities acquired were under a PDS and not on the open market and that the Court of Appeal considered it open to the trial judge to find on the evidence that the directors were not required to disclose risks, that the risks were not significant, and that the evidence of the plaintiff relating to reliance was not considered credible.

In light of the affirmation of the 'fraud on the market' presumption by the US Supreme Court in its decision in Halliburton, however, it is likely that a new round of debate on the theory will begin in Australia.

The perceived benefits of the doctrine and the extent to which Australian courts should draw guidance from the US doctrine will undoubtedly garner greater attention by commentators, regulators, corporations and investors in the immediate future.

The decision in Halliburton may also embolden Australian courts to consider the theory further, and for plaintiffs to pursue their claims to higher courts for a more definitive declaration in relation to the theory. Potentially, a desire by defendants to avoid a decision on this issue by the High Court may also prompt greater settlement impetus.

In any event, it is important for companies and investors alike to consider their position in relation to shareholder class action claims, and the increased potential for extended litigation on the subject, prior to a determination by higher courts in Australia.


1(1999) 199 CLR 413
2(2008) 73 NSWLR 653

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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