What is Market-based causation and why should business owners care?
A recent case heard in the NSW Supreme Court has upheld the concept of Market-based causation and this has significant implications for Directors of businesses and their shareholders.[1]
In essence, this principle holds that, when shareholders purchase shares in a company at a certain price they may be able to recover damages from the company if those shares were inflated at the time of purchase, on the basis of misleading or deceptive information.
Let’s break this down further.
In HIH Insurance Limited, the company released information through a variety of documents which did not reflect the truth of various financial arrangements entered into by the Company. As a result, the Company overstated its profit margins.
Consequently, investors believed the company had greater net assets than it really had and this drove the share price up. By paying this inflated price, the Court held that the investors suffered loss and could claim against the company for that loss.
Do the shareholders need to rely on the misleading statement to claim damages for their loss?
No! This is crucially important because the concept of Market-based causation is that the ‘laws of the market’ ensure that the misleading conduct would flow through and affect the price of the shares. The plaintiff shareholders do not need to establish that they relied on the misleading information, merely that the misleading information distorted the market price. The Court stated,
"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"[2]
To defend themselves from this claim, the defendant must prove that the shareholder plaintiffs knew the truth about or were indifferent to, the misleading or deceptive information.
To summarise, the Court held that plaintiffs’ do not need to establish direct reliance.
How can I protect my company from such an occurrence?
It is extremely important to ensure that all information published is accurate, truthful and in accordance with all financial laws and regulations.
If you have further questions, please contact us at frank@franklaw.com.au
This is not legal advice.
[1] In the matter of HIH Insurance Limited (In Liquidation) (ACN 008 636 575) and others; Smith and Others v Anthony Gregory McGrath (in his capacity as Liquidator of HIH Insurance Limited (in liquidation)) and Others; Baldock and Others v Anthony Gregory McGrath (in his capacity as Liquidator of HIH Insurance Limited (in liquidation)) and Others;; De Bortoli Wines (Superannuation) Pty Ltd and Others v Anthony Gregory McGrath (in his capacity as Liquidator of HIH Insurance Limited (in liquidation)) and Others; Cuong Ly and Others v Anthony Gregory McGrath (in his capacity as Liquidator of HIH Insurance Limited (in liquidation)) and Others [2016] NSWSC 482.
[2] Ibid [73].