The United States is a popular location for securities class actions, due in large part to its reputation as a generally plaintiff-friendly system. A key contributor to that reputation is the acceptance of the “fraud-on-the-market” presumption of reliance. However, in the wake of a recent decision by the Supreme Court of New South Wales, Australia is poised to become another popular location for “fraud on the market” actions.
In In the Matter of HIH Insurance Ltd (In Liquidation) and others (“In re HIH”), the Court considered for the first time whether to apply a “fraud on the market” theory of recovery. There, the plaintiffs were shareholders in HIH Insurance Limited (“HIH”), a publicly listed company that was in liquidation. The plaintiffs had all purchased their shares between October 26, 198, and March 15, 2001, during which time HIH released several relevant documents: a prospectus, final results for FY 1999, interim results for FY 2000, and final results for FY 2000. HIH admitted that the documents overstated its operating profit and net assets, rendering them misleading and deceptive.
While there was no question as to HIH’s wrongdoing, the issue was that the plaintiffs admitted that they had never seen any of the misleading documents. Reasoning that the plaintiffs did not rely on HIH’s misrepresentations in purchasing their shares, HIH’s liquidators thus rejected the proofs of debt submitted by the plaintiffs, and an appeal of that decision followed.
On appeal, the plaintiffs argued that they suffered loss under a theory of indirect causation. Essentially, their position was that HIH’s misrepresentations artificially inflated the market price of its shares by misleading those investors who did directly rely on the fiscal reports. Thus, when the plaintiffs bought their shares at that inflated market price, they paid more than they otherwise would have absent HIH’s conduct. HIH argued in response that there was no such cause of action for indirect causation under these circumstances in Australian law. Previously, according to HIH, indirect causation only applied where a passive applicant was harmed when a third party was induced to act to the prejudice of the applicant. Here, it argued, the “third party” was the market itself, and the plaintiffs actively sought and purchased the HIH shares.
After a thorough analysis of prior case law, the Court agreed with the plaintiffs and, in doing so, adopted a “fraud-on-the-market” theory in Australia. The Court concluded that, while the plaintiffs admitted that they were not directly misled, the market as a whole was. The Court reasoned that an investor is inherently induced to enter into an investment transaction on the terms under which it does by the state of the market. The Court recognized that an investor should be able to “reasonably assume that the market reflects an informed appreciation of a company’s position and prospects, based on proper disclosure.” If an investor opts to buy shares in a company at market value, without knowledge that the market value is wrong because of that company’s fraudulent actions, then direct reliance on the company’s actions need not be necessary. The Court aptly summed up the situations as follows:
The chain of causation was: 1) HIH released overstated financial results to the market, 2) 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, 3) HIH shares traded on the market at an inflated price, and 4) investors paid that inflated price to acquire their shares, and thereby suffered loss. Thus, the contravening conduct materially contributed to that outcome.
The Court’s decision in In re HIH has obvious international implications. Under the U.S. Supreme Court’s Basic v. Levinson decision and its progeny, including the recent Haliburton decision, in the United States the “fraud-on-the-market” theory leads to a rebuttable presumption of reliance. Thus, if the HIH case were decided in the United States, presumably, the plaintiffs’ admission that they did not see the allegedly fraudulent statements could be enough to rebut the presumption. The HIH decision indicates that Australia could be adopting a more plaintiff-friendly application to the “fraud-on-the-market” doctrine. As a result, it is likely to see an influx in securities class action claims which would not have been permissible before this decision. This influx, as well as decisions to come which could expand upon this decision, bear watching for any institutional investors purchasing securities from Australian issuers.