28 September, 2015
Prospectuses don't offer safe harbour from "fraud on the market" claims
Caason Investments Pty Ltd v Cao [2015] FCAFC 94
WHAT YOU NEED TO KNOW
- In the US, the "fraud on the market" doctrine is an accepted principle used to overcome the need for shareholders in class actions to prove direct reliance on misleading or deceptive statements.
- In Australia, the "fraud on the market" doctrine is controversial. The decision of the Full Federal Court in Caason Investments Pty Ltd v Cao is the latest and most authoritative in a series of recent cases that confirm the doctrine is at least arguable.
- More specifically, the Full Court has accepted that it is open to investors to plead the doctrine in claims for misleading or deceptive conduct relating to disclosure documents, such as prospectuses and profile statements.
Background
A shareholder class action was brought against directors and auditors of Arasor International Limited (Arasor), regarding allegedly misleading or deceptive statements or omissions in financial statements, a prospectus for the initial public offering of Arasor shares, and a short form prospectus.
The applicants sought leave in the Federal Court to amend the statement of claim to introduce claims based on the "fraud on the market" doctrine. The doctrine presumes that information disclosed in an efficient market is incorporated into the price of securities and is therefore taken into account by investors trading in that market. The purpose of the doctrine is to overcome the need to prove direct reliance by shareholders on allegedly misleading or deceptive statements, which is instead replaced by market-based causation.
Leave to replead refused at first instance
At first instance, in Caason Investments Pty Ltd v Cao [2014] FCA 1410, Farrell J considered the "vexed question" of whether reliance is required to establish causation. Her Honour concluded that it could not be said that a claim based on the "fraud on the market" doctrine had no reasonable prospect of success.
Despite this, Farrell J did not grant leave to amend the statement of claim to include market-based causation claims in the terms proposed by the applicants.
The applicants appealed to the Full Court.
Leave to replead granted on appeal
In the majority judgment, Gilmour and Foster JJ allowed the appeal and granted leave to amend the statement of claim. Their Honours held that Farrell J had wrongly refused leave on the basis that market- based causation was not arguable as a matter of principle, at least in relation to a claim under s 729(1) of the Corporations Act 2001 (Cth) (the Act) regarding an allegedly misleading or deceptive prospectus.
In dissent, Edelman J held that there was no error in Farrell J's orders or reasons and would have dismissed the appeal. His Honour considered that Farrell J had rightly refused leave to amend on the basis of specific defects in the applicants' proposed pleading, which were only subsequently addressed in the version of the proposed statement of claim put forward on appeal.
All members of the Court agreed that market-based causation is arguable in Australia, including in relation to allegedly misleading or deceptive prospectuses and profile documents.
The majority judgment
In seeking to resist the proposed amendments, the respondents submitted that:
- market-based causation is not arguable as a matter of law in Australia;
- section 729(2) of the Act (which provides that a person who acquires securities as a result of an offer accompanied by a profile statement is taken to have relied on both the profile statement and the prospectus for the offer) indicates that individual reliance is a precondition to claims made under s 729(1); and
- the policy of Chapter 6D of the Act "to protect potential investors" would be undermined by allowing market-based causation claims under s 729(1).
Gilmour and Foster JJ were not sufficiently persuaded by any of these contentions to conclude that marked- based causation is inarguable under s 729(1).
Their Honours noted that, while there is no decision of the High Court or any intermediate Court of Appeal on the central legal issue, there are single judge decisions that demonstrate that the applicants’ case is neither "futile nor likely to be struck out".
The majority found no textual support in s 729(1) for the proposition that reliance on a disclosure document is an essential element for a successful claim; and found s 729(2) of limited assistance in that regard.
Their Honours considered it at least arguable that the policy aim of the Act would not be undermined by allowing market-based causation claims.
Edelman J's dissent
While Edelman J would have dismissed the applicants' appeal for procedural reasons, his Honour agreed with the majority that market-based causation claims under s 729(1) of the Act are at least arguable.
His Honour's four principal reasons were:
- reliance is not a substitute for the essential question of causation;
- s 729(1) permits claims in respect of alleged omissions, in relation to which the concept of reliance is "at best a strain";
- there is no sharp contrast between market- based causation and the more traditional reliance-based causation because both types of causation might be indirect; and
- the concept of market-based causation has not been expressly rejected in any Australian case and in some cases it has been allowed to proceed to trial or implicitly endorsed as arguable.
However, his Honour noted that the applicants faced further challenges in making out their claim. He commented "[e]ven if those legal arguments are ultimately accepted (which need not be determined in this appeal) there will remain significant questions of fact, including some which will require expert evidence, before liability can be established".
Implications
Caason is the latest in a series of cases indicating that market-based causation is legally arguable in Australia. It is the first decision by an intermediate appellate court confirming that this is the case. It also erases any doubt that might have existed regarding whether such a claim can be argued in relation to an allegedly misleading or deceptive prospectus or profile document.
However, as noted by Edelman J, this is not the end of the story. Even if market-based causation is ultimately established as a principle of law in Australia, there will remain significant questions of fact, including some which will require expert evidence, before liability can be established in any given case.
For further information, please contact:
Ashley Wharton, Partner, Ashurst
ashley.wharton@ashurst.com
