Australia: Fraud On The Market: Paving The Way For Market-Based Indirect Causation In Securities Actions?

Last Updated: 16 May 2016
Article by Gareth Horne and Malcolm Wood

The recent decision of Re HIH Insurance Ltd (In Liq) [2016] NSWSC 482 seeks to address a number of questions concerning the onus of proving causation in securities actions. The case may influence the future direction of securities actions in Australia and specifically, whether Australia moves towards principles of market based indirect causation to more closely align with the 'fraud on the market' theory of causation utilised in securities actions in the United States.

On 20 April 2016, the Supreme Court of New South Wales handed down its decision in Re HIH Insurance Ltd (In Liq) [2016] NSWSC 482 (HIH Case). 

The HIH Case may well prove to be a significant waymark on the road to determining questions of causation in securities actions in Australia, particularly in relation to the application (or otherwise) of market-based indirect causation principles, a close relative to the 'fraud on the market' theory of causation utilised in securities actions in the United States.

Fraud on the market/indirect causation vs direct causation 

A common feature in securities actions in Australia (whether they be of the class action type or otherwise) is that a plaintiff(s) alleges that:

  • an ASX-listed defendant has engaged in misleading and deceptive conduct by failing to disclose information or the ASX listed defendant has inaccurately and/or incompletely disclosed information to the market and thereby caused loss to the plaintiff; and
  • an ASX-listed defendant has not complied with its disclosure obligations and thereby caused loss to the plaintiff.

For a plaintiff to be entitled to damages in respect of the above types of action, it is fundamental that the plaintiff establishes causation – that is, that the defendant's misleading and deceptive conduct and/or non-compliance with disclosure obligations caused the plaintiff(s) loss.

In the United States, causation in securities actions is determined by reference to the 'fraud on the market' theory. The fraud on the market theory was embraced by the US Supreme Court in Basic Inc v Levinson 485 US 223 (1988) (Basic).  It is a theory of causation which assumes the following:

  • The market price of shares traded in well-developed markets reflects all publicly available information, including any material misrepresentations and non-disclosures.This is known as the 'efficient market hypothesis';
  • Investors purchase stock on the understanding that the market price of shares reflects the company's true value.Investors are accordingly presumed to have relied on any misrepresentations; and
  • Undisclosed, inaccurate and/or misleading information has the effect of distorting the price of shares by artificially deflating or inflating the market value of a company's stock; accordingly, investors who purchase a company's shares under those conditions may suffer loss.

The presumption of reliance in the fraud on the market theory is rebuttable,1 but critically, actual reliance by the investor need not be established in order for a cause of action to persist.  In Basic, the United States Supreme Court observed that:

'The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the available material information regarding the company and its business...misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements'.

Contrary to the United States position above, the position in Australia was traditionally thought to be that insofar as securities actions were concerned, a plaintiff had to prove actual reliance (and therefore, direct causation) on the misrepresentations/contravening conduct. 

However, there has been a lack of judicial consideration in relation to securities actions and seemingly inconsistent decisions by Australian Courts in other types of matters as to the appropriateness of principles of indirect causation (which is a principle of causation that does not require actual reliance). This inevitably has raised concerns about whether an American-style fraud on the market/indirect causation approach may infiltrate Australian law and render it easier for plaintiffs to make out a claim for damages in securities actions.  

The HIH Case  

The Facts

The HIH Case involved four sets of proceedings brought by four sets of plaintiffs premised on breaches of the Corporations Law (the predecessor to the Corporations Act 2001 (Cth)) for misleading and deceptive conduct and associated damages.  The proceedings arose out of the rejection of the plaintiffs' proofs of debt by the liquidators of HIH.

The Court found in the HIH Case that towards its end, HIH incorrectly and inappropriately accounted for certain reinsurance arrangements with Hannover Re in a manner that misleadingly and artificially inflated the operating profit of HIH.  This was identified as the 'contravening conduct'.

There was commonality in the allegations made by the plaintiffs in the HIH Case insofar as:

  • they each acquired HIH shares on the ASX at the then prevailing market price;
  • the market price was said to have been artificially inflated by reason of the contravening conduct, namely the overstated operating profit caused by the inappropriate accounting of HIH's reinsurance arrangements; and
  • the above contravening conduct caused the plaintiffs to suffer loss because the investors paid more than they otherwise would have for those shares.

The plaintiffs also contended that they need not prove any reliance on the contravening conduct to make out causation.   

On the other hand, the liquidator of HIH, the defendant, contended that:

  • actual reliance (i.e. direct causation) was a requirement in cases where a person claims to have suffered loss by reason of their entry into a transaction;
  • indirect causation is only available in cases where the investor is passive and a third party has been induced by the contravening conduct to act to the investor's prejudice;
  • in the present case, the plaintiffs had actively made a decision to enter into the transactions to purchase the HIH shares and accordingly, it was necessary for the plaintiffs to establish that they relied upon the contravening conduct – namely, the artificially inflated operating profit; and
  • in the absence of proving actual reliance on the artificially inflated operating profit when deciding to purchase the HIH shares, the plaintiffs did not establish a 'causative bridge' between the contravening conduct and the alleged loss.

The decision

After having referred to a large volume of case law on direct causation and indirect causation, Brereton J stated that principles of causation in the context of contraventions of provisions against misleading and deceptive conduct have never required reliance to complete the cause of action.  Brereton J cited a number of supportive cases on this point.2

According to Brereton J, actual reliance/direct causation is not a requirement in cases where the chain of causation is complete without any act or omission on the part of the plaintiff (e.g. such as circumstances when the decision to purchase or sell shares is not a necessary act/omission in the cause of the loss).  One would assume therefore that actual reliance/direct causation will be an important element in establishing causation where the conduct of the plaintiff forms a link in the chain of causation.

Brereton J considered the submission of the HIH liquidator that the Digi-Tech3 and Ingot4 cases were authority for the proposition that actual reliance was a requirement to make out causation.  However, Brereton J considered that these cases were not helpful to support that position because:

  • Digi-Tech involved an element of inducement in misleading and deceptive conduct.  Where there is an inducement, the plaintiff's reliance is a critical link in the chain of causation and must therefore, be established;5 and 
  • Ingot could be distinguished on the basis that it was not a case about market-based causation, but rather a case where the contravening conduct was said to contribute to the opportunity for the relevant transactions to take place and where the plaintiffs potentially knew or were indifferent to the true position.6  Brereton J observed that in ABN AMRO Bank NV v Bathurst Regional Council,7 the Full Court held that Ingot did not stand for any 'bright line principle', but merely stood for the proposition that an 'investor will not be entitled to recover where the investor knew the truth of the underlying misrepresentation or was indifferent to its truth.'8   

After having considered these and other applicable cases, Brereton J determined that the plaintiffs were not required to prove direct causation/actual reliance on the contravening conduct to prove causation.

The Court considered that notions of indirect causation, premised on the assumption that the market for shares had been distorted by misleading and deceptive conduct (and thereby causing loss), were sufficient to make out causation.  In particular, Brereton J held that:

[73] ...Investors who acquire shares on the ASX may reasonably assume that the market reflects an informed appreciation of a company's position and prospects based on proper disclosure.  The notion that a market may be deceived, manipulated and distorted by misrepresentation is well established...

[74]  ...If the contravening conduct deceived the market to produce a market price which reflected a misapprehension of HIH's financial position...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... [the plaintiffs] were inevitably exposed to loss...

...[77]  In those circumstances, I do not see how the absence of direct reliance by the plaintiffs on the overstated accounts denies that the publication of those accounts caused them loss, if they purchased shares at a price set by a market which was inflated by the contravening conduct: the contravening conduct caused the market on which the shares traded to be distorted, which in turn caused loss to investors who acquired the shares in that market at the distorted price.  In the absence of any suggestion that any of the plaintiffs knew the truth about, or were indifferent to, the contravening conduct, but proceeded to buy the shares nevertheless...[it is concluded] that 'indirect causation' is available and direct reliance need not be established'.  

Implications of the HIH Case

Although not binding in other Australian jurisdictions, the decision in the HIH Case does provide an important contribution towards the jurisprudence on the scope of the causation onus placed on plaintiffs in Australian securities actions.  If the reasoning in the HIH Case were to be accepted by Federal and Victorian courts in particular and ultimately in appellate jurisdictions, it would provide strong domestic support for the fraud on the market theory. It will also permit plaintiffs in securities actions to prove causation by the mere purchase of a security on a well-developed exchange, where the value was artificially deflated or inflated by misleading and deceptive conduct, unless that plaintiff knew the truth about, or was indifferent to, the misleading and deceptive conduct. However, questions of onus in causation will continue to be passionately contested, including in securities class actions, until such time as this area is more fully considered by appellate courts in Australia.  

One issue that was not decided by the court was whether the plaintiffs were indifferent to the value of the shares when they were purchased at the 'market price'. This raises further issues about whether such indifference (if it existed) could constitute a novus actus interveniens that breaks the chain of causation (i.e. a break which notions of indirect causation could not cure). The question of what constitutes 'indifference' in this context therefore remains open, providing an important further focal point for future litigation considering causation questions in securities actions. 


1. Brereton J in the HIH case at [41] citing Fine v American Solar King Corp 919 F 2d 290, 299 (5th Cir, 1990)

2. Including in particular Jansen-Cilag Pty Ltd v Pfizer Pty Ltd (1992) 37 FCR 526, Hampic Pty Ltd v Adams [1999] NSWCA 455, Australian Breeders Co-operative Society Ltd v Jones (1997) 150 ALR 488, Smith v Noss [2006] NSWCA 37 and Campbell v Backoffice Investments Pty Ltd [2009] HCA 25

3. Digi-Tech (Australia) Ltd v Brand [2004] NSWCA 58

4. Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd [2008] NSWCA 206

5. HIH Case, [52] and [53]

6. Ibid. at [63]

7. (2014) 309 ALR 445

8. Above n 5, [65]

Fraud On The Market: Paving The Way For Market-Based Indirect Causation In Securities Actions?

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Gareth Horne
Malcolm Wood
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