'Fraud on the market': judicial approaches to causation and loss from securities nondisclosure in the United States, Canada and Australia

Melbourne University Law Review, Dec, 2005 by Michael Duffy

[Shareholder actions arising from misstatements and nondisclosure have been part of the legal landscape in the United States for some time. The Wall Street stock market crash of the 1920s saw the early development in the United States of strong laws for the protection of investors in the stock market, and the mechanism of the class action meant that large numbers of investors were able to seek remedies for loss caused by fraud, deceit, untrue statements and nondisclosures. This article examines the approach of United States courts to the problems of proving that breaches of the law identified are responsible for losses claimed, and the presumptions that those courts have used to establish this requisite element of causation--principally the fraud on the market' theory of presumed reliance adopted in 1988 by the Supreme Court of the United States in Basic Inc v Levinson. The treatment of the fraud on the market' theory by Canadian courts--which have rejected the theory as a presumption of law but have been open to presumptions of fact in particular cases--is also examined. Finally, there is an examination of causation and loss in shareholder actions for misleading and deceptive conduct in Australia. The effect of the introduction of laws giving statutory force to the continuous disclosure rules of the Australian Stock Exchange is also noted, and the author examines whether recognition of losses from such claims will lead to the adoption of a fraud on the market 'analysis in Australia.]

 CONTENTS   I Introduction  II The Social and Legislative Background to United States Securities


        
    
    
    
    
    Regulation         A The 1929 Stock Market Crash         B Rule 10b-5 III Causation of Loss: The Early United States Cases A Untrue Statements and Causation         B Omissions and Causation

        
    
    
    
    
        C The Post-Affiliated Ute Cases               1 Impersonal Settings               2 Rebutting the Presumption of Reliance  IV The 'Fraud on the Market' Doctrine         A The 'Efficient Capital Markets' Hypothesis         B Basic Inc v Levinson         C Criticisms of the Doctrine         D The Differing Approaches of Law and Economics

        
    
    
    
    
  V The Approach of Canadian Courts to the 'Fraud on the Market'

        
    
    
    
    
  Doctrine         A Carom v Bre-X Minerals Ltd         B Subsequent Decisions         C Presumed Reliance under the Ontario Securities Act  VI The Approach of Australian Courts to Causation and Compatibility

        
    
    
    
    
    of the 'Fraud on the Market' Doctrine with Australian Law

        
    
    
    
    
   A Securities Nondisclosure in Australia               1 Misleading and Deceptive Conduct               2 Continuous Disclosure

        
    
    
    
    
       3 Silence, Misleading Conduct and Nondisclosure         B Action for Compensation or Loss               1 Private Actions

        
    			
       
		
        			
		
	
    
    
    
    
    2 Action Brought by ASIC               3 Recent Decisions: Shareholders as Creditors         C Causation of Loss through Misleading Conduct and           Nondisclosure in           Australia               1 Proving Reliance and Onus               2 Onus where Representation Is 'Calculated to Induce'.               3 Third Party Reliance and Alternative Approaches to                 Causation               4 Causation and Loss from 'Pure Nondisclosure'.               5 Law and Policy VII Conclusion 

I INTRODUCTION

The issue of information disclosure by publicly-listed companies looms as large as ever for the 21st century corporation. The consequences of improper or inaccurate disclosure were illustrated by the collapses of Enron, Worldcom and others in the United States, alongside HIH and One. Tel in Australia. More recent Australian failures have also highlighted the issue, including Harris Scarfe Ltd, Sons of Gwalia Ltd, Pasminco Ltd, Media World Communications Ltd and ION Ltd. In the wake of these corporate failures, legislatures have refocused on the need for proper, accurate and continuous disclosure in financial reporting. (1)

Regulation of the United States stock market to this end has a long history extending back to the enactment of the Securities Exchange Act of 1934 (2) in response to the calamities of the 1929 stock market crash and the ensuing Great Depression. As a result of this long history, the United States is the pioneering jurisdiction in the development of the law in relation to corporate disclosure and particularly in the development of civil remedies for fraud, misleading statements and nondisclosure.

In Parts II and III of this article, I review the development of corporate fraud, misstatement and nondisclosure laws in the United States, primarily in relation to civil recovery class actions by stockholders. Against this background, I discuss in Part IV the 'fraud on the market' theory of causation and its theoretical underpinnings. In Part V, I review the attempts to apply the 'fraud on the market' doctrine in Canadian class proceedings. In Part VI, securities nondisclosure will be considered in the Australian context, including an analysis of the extent to which the 'fraud on the market' theory is compatible with the development of Australian law.