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

HIH Insurance Limited (in liquidation) (“HIH”) was a listed public company and carried on business as a general insurer. Its shares traded on the Australian Stock Exchange (“ASX”) until 15 March 2001 when Messrs McGrath and Macintosh were appointed liquidators provisionally. On 27 August 2001, HIH was wound up by order of this Court, with Messrs McGrath and Macintosh as its liquidators; Mr Honey replaced Mr Macintosh with effect from 1 July 2005. FAI General Insurance Company Limited (“FAI”) and HIH Casualty & General Insurance Limited (“C&G”) are subsidiaries of HIH. They too are in liquidation, and are subject to schemes of arrangement; Messrs McGrath and Honey are their liquidators and the scheme administrators.

In each of these proceedings (respectively, “the Smith Proceedings”, “the Baldock Proceedings”, “the De Bortoli Proceedings” and “the Cuong Ly Proceedings”), the plaintiffs are shareholders in HIH who acquired HIH shares in the period between 26 October 1998 and 15 March 2001. Certain of the plaintiffs acquired shares in HIH during the period 26 October 1998 to 25 August 1999, following publication on 26 October 1998 of a prospectus (“the Convertible Note Prospectus”). Certain plaintiffs acquired shares during the period 26 August 1999 to 2 March 2000, following release by HIH on or about 25 August 1999 of its final results for 1998/1999 (“the FY1999 results”). Certain plaintiffs acquired shares during the period between 3 March 2000 and 17 October 2000, following release by HIH on or about 2 March 2000 of its interim results for the six months ended 31 December 1999 (“the FY2000 interim results”). And some plaintiffs acquired shares during the period 18 October 2000 to 15 March 2001 (when the provisional liquidators were appointed), following release by HIH on or about 17 October 2000 of its final results for 1999/2000 (“the FY2000 final results”).

A case founded on the Convertible Note Prospectus was not pressed at the trial. However, the plaintiffs contend – and the defendants admit – that the FY 1999 results, the FY2000 interim results and the FY2000 final results contained and conveyed representations which were misleading and deceptive, or likely to mislead or deceive; and that by publishing and releasing them, HIH contravened (CTH) Trade Practices Act 1974 (“TPA”), s 52, and (CTH) Corporations Law, ss 995 and/or 999. The plaintiffs contend that FAI and C&G were knowingly concerned in those contraventions so as to incur accessorial liability. [1]

The plaintiffs contended that those who acquired shares during the period 26 August 1999 to 15 March 2001 did so at prices which were inflated by the misrepresentations contained in the FY1999 results, the FY2000 interim results and the FY2000 final results. The plaintiffs do not contend that they read, or directly relied upon reports of the financial results. However, they contend that they acquired HIH shares in a market regulated by the ASX and the Corporations Law, but which was distorted by the admitted misrepresentations of the financial results, so that shares in HIH traded at prices higher than those which would have obtained had the misrepresentations not been made; and that they have suffered loss and damage by reason of having paid more for the shares they acquired than they would otherwise have paid.

The plaintiffs lodged proofs of debt in respect of their claimed losses, in the liquidation of HIH and in the schemes of FAI and C&G. The defendants, as liquidators and scheme administrators, did not admit their proofs. In these proceedings, the plaintiffs appeal pursuant to (CTH) Corporations Act 2001, s 1321, from the rejection of their proofs, and seek orders that the decisions of the defendants not to admit, or to fail to adjudicate upon, their proofs be reversed or modified, and that their claims be admitted.

On an “appeal” of this kind from a liquidator’s rejection of a proof of debt, the issue is whether the liability referred to in the proof of debt is a true liability of the company enforceable against it. [2] As Barrett J (as he then was) observed in Johnston v McGrath, [3] the “appeal” is a vehicle by which the plaintiff seeks to give substance and particularity to a claim it has already advanced in the form of a proof of debt, and a means by which the plaintiff seeks to make a case in support of the acceptance of the proof of debt, so that the court, acting under s 1321, may direct that the claim in question be admitted to proof despite its previous rejection by the liquidators. The court hears the matter de novo and is obliged to reach its own decision on the evidence, including evidence that was not before the liquidators.

The main issues are:

If the plaintiffs fail on issue (2), the proceedings – other than the Baldock proceedings, in which there is an additional claim for reliance-based damages which has been deferred – will be dismissed. If the plaintiffs succeed, then there remain some other issues raised by the defendants pertaining to individual plaintiffs and the orders to be made; as indicated at the trial, it seems likely that many of those remaining issues will become capable of agreement (and, if not, then speedy resolution) once the above three questions of principle are resolved. Accordingly, this judgment addresses those three questions of principle.

Each of those three main issues requires careful identification of the contravening conduct: the first because accessorial liability depends, inter alia, upon involvement in “the contravention”, and the second and third because the entitlement to damages is in respect of damage caused by the contravening conduct. As the plaintiffs did not ultimately press any claim founded on the Convertible Note Prospectus, their case was confined to the overstatement, in the reported financial results, of operating profit (and, as a consequence, net assets) for each of the three periods to which those results related.

HIH released the FY1999 results (which were for the 18-month period 1 January 1998 to 30 June 1999) on or about 25 August 1999. The profit and loss statement contained in its 1998/99 Annual Report stated that the operating profit for that period, for the consolidated entities, was $102 million before abnormal items and income tax. [4] In the Annual Report, the “Chief Executive’s Review”, by the Chief Executive, Mr Ray Williams, appeared the following statement:

The reference to “decisive action, through the purchase of whole account reinsurance protection” was to reinsurance arrangements into which HIH had entered during the period with Hannover Ruckversicherungs Aktiengesellschaft (“the Hannover Re arrangements”). [5] There were two such arrangements:

Although the theory was that the Managed Funds would grow at a sufficient rate to meet claims in ten years’ time, on the face of the insurance binders, Hannover Re carried the risk that they would not. However, in a separate but contemporaneous Letter of Credit Agreement and Letter of Credit Authority Agreement, HIH effectively guaranteed the performance of the Managed Fund, so that despite initial appearances on the face of the binders, the risk that the Managed Fund would be insufficient to meet claims was ultimately borne by HIH.

In the financial statements of FAI and C&G, and consequently in the HIH consolidated financial statements, the Hannover Re arrangements were accounted for as conventional reinsurance contracts. However, they were not conventional reinsurance contracts, but so-called “financial” reinsurance contracts. By accounting for them as if they were conventional reinsurance, each of FAI and C&G, and the consolidated entity HIH, were enabled to report an operating profit significantly greater – in the case of the consolidated entity, by $92.4 million – than would have been the case had they been treated as “financial” reinsurance, as proper accounting practice and standards required. As a consequence, reported net assets of HIH were also inflated by $92.4 million.

HIH released the FY2000 interim results – for the six months ended 31 December 1999 – on or about 2 March 2000. The FY2000 interim results reflected the same treatment of the Hannover Re arrangements as the FY1999 results.

HIH released the FY2000 final results on or about 17 October 2000. In the HIH Insurance Ltd & Controlled Entities General Purpose Financial Report 1999/2000, the Hannover Re arrangements were again accounted for as conventional reinsurance contracts. As a result, HIH was enabled to report a consolidated operating profit of $61.9 million for the financial year ended 30 June 2000, whereas had they been treated as “financial” reinsurance, HIH would have reported a loss.

The defendants admit that the reported financial results of HIH and its controlled entities wrongly accounted for the Hannover Re contracts as (conventional) reinsurance contracts, and thereby overstated operating profits and did not give a true and fair view of the financial position of the consolidated HIH group; and that by releasing them, HIH engaged in conduct that was misleading or deceptive or likely to mislead or deceive, and thereby contravened TPA, s 52 and Corporations Law, ss 995 and/or 999.

For the purpose of these proceedings, the following facts were agreed:

Thus, the only relevant contravening conduct is the overstatement by HIH of its operating profit (and consequently, net assets) in the FY1999 results, the FY2000 interim results and the FY2000 final results, resulting from the incorrect accounting treatment of the Hannover Re arrangements.

A person who suffers loss or damage by conduct of another person done in contravention of a provision of TPA, Part IV or V (and s 52 is a provision of Part V) may recover the amount of loss or damage by action against that other person or against any person involved in the contravention. [6] A person is relevantly “involved” in a contravention of a provision of Part V if the person: (a) has aided, abetted, counselled or procured the contravention; or (b) has induced, whether by threats or promises or otherwise, the contravention; or (c) has been in any way, directly or indirectly, knowingly concerned in, or party to, the contravention; or (d) has conspired with others to effect the contravention. [7]

Similarly, a person who suffers loss or damage by conduct of another person that was engaged in in contravention of Corporations Law, ss 995 or 999, may recover the amount of the loss or damage by action against that other person or against any person involved in the contravention. [8] A person is involved in a contravention if and only if that person: (a) aided, abetted, counselled or procured the contravention; (b) induced the contravention, whether by threats or promises or otherwise; (c) was in any way knowingly concerned in or party to the contravention, whether by act or omission or directly or indirectly; or (d) conspired with others to effect the contravention. [9]

To incur accessorial liability under these provisions, the alleged accessory must have, with actual knowledge of the essential facts which made what was done by the principal contravener a contravention, in some way participated in, assisted or encouraged the contravention. [10] A director is not a party to the corporation’s contraventions merely by being a director; to be party to a contravention, the alleged accessory must be an intentional participant, the necessary intent being based upon knowledge of the essential elements of the contravention. [11] Thus, there are two elements of accessorial liability: knowledge, and participation.

In respect of the “participation” element, what is required is merely the doing of something which acted to help, encourage or induce the contravention. [12] The accessory “must merely have done something to assist or encourage the bringing about of the contravention”. [13] With the abandonment by the plaintiffs of their pleaded claim against CIC, the accessorial liability case is now confined to FAI and C&G. The plaintiffs contend that FAI and C&G sufficiently participated in HIH’s misleading conduct – the overstatement of its operating profit in the reported financial statements – to incur accessorial liability.

Both FAI and C&G were parties to the Hannover One contract. Both wrongly accounted for the Hannover Re arrangements as (conventional) contracts of reinsurance in their own financial statements for the relevant financial periods, thus reporting operating profits that were overstated as a result of the incorrect accounting treatment of the Hannover Re arrangements.

The consolidated HIH financial statements incorporated, in the results of the consolidated entity, those of its subsidiaries. Thus, the misleading information ultimately contained in the reported financial results was originally generated by FAI and C&G, included in their financial statements, and carried forward into the consolidated HIH financial statements. The misstatement in the subsidiaries’ financial statements was the genesis of the misrepresentations in the reported financial results of HIH. In this way, the treatment of the Hannover Re arrangements by FAI and C&G in their financial statements was a fundamental input to the contravening conduct. “Participation”, in the relevant sense, is established.

But mere participation, though essential, is insufficient to attract accessorial liability; such participation must be accompanied by knowledge by the participant of the essential matters that constitute the contravention (whether or not he or she knew that those matters were in law a contravention). [14] This means actual knowledge of the putative accessory, and not such knowledge as might be postulated of a hypothetical person in his or her position, although actual knowledge may be established by inference from the surrounding circumstances. [15] The knowledge of a corporation can be established by the knowledge of a director, servant or agent by whom the relevant conduct was engaged in within that person’s actual or apparent authority. [16]

In a case of misleading and deceptive conduct such as the present, the essential matters constituting the contravention, of which knowledge by the alleged accessory must be established, are (1) the making of the representation that constitutes the contravention, and (2) that the representation is misleading. [17]

The plaintiffs sought to attribute the requisite knowledge to FAI and C&G through their directors Messrs Williams and Fodera. Mr Williams was Chief Executive Officer of HIH, and Mr Fodera was its Chief Financial Officer; both were also directors of C&G and FAI. I have found that FAI and C&G “participated” in the contravening conduct by the release of their own financial statements. For the purposes of attributing knowledge to FAI and C&G under s 84, that participatory conduct is the relevant conduct. Thus, the plaintiffs must establish that directors or agents of FAI and C&G who authorised and released the subsidiary’s financial statements did so with knowledge (1) that they would be reflected in the consolidated HIH accounts, and (2) that by doing so the HIH accounts would be rendered misleading.

Publication of the subsidiaries’ accounts was authorised by Mr Fodera – in both relevant years, he signed the directors’ declaration in the accounts of C&G and FAI – and accordingly, it is Mr Fodera’s knowledge that is relevant. Mr Fodera was a man of considerable business and accountancy experience. He was described in the HIH 1998/999 Financial Report as a member of its investment, reinsurance and due diligence committee, a chartered accountant with 20 years’ experience in the financial services industry, formerly a partner in Arthur Anderson’s National Financial Services team, and Chief Financial Officer of HIH since September 1995.

As to knowledge that the subsidiaries’ reported financial results would be reflected in the consolidated HIH accounts, it is inherent in the concept of consolidated accounts that they include the results of subsidiaries so as to report the outcome of the entire group, and any accountant – let alone one of Mr Fodera’s experience – would know and understand that. Moreover, the accounts of each of FAI and C&G were in fact included in the consolidated financial statements of HIH each year, and as Chief Financial Officer of HIH, Mr Fodera must have known that. I am satisfied that Mr Fodera actually knew that the financial statements of FAI and C&G would be carried forward into the consolidated results for HIH, with the consequence that the reported operating profits of FAI and C&G would be reflected in the consolidated results of HIH.

As to knowledge that inclusion of the reported operating profit of the subsidiaries would render the HIH consolidated results misleading: while the agreed facts establish that the Hannover Re arrangements were wrongly accounted for, with deceptive results, that does not of itself mean that Mr Fodera knew that to be so. Moreover, there is no direct evidence that Mr Fodera knew that the Hannover Re arrangements were incorrectly treated and thus that operating profits were overstated.

However, in the absence of admission, knowledge must usually be ascertained by inference. The plaintiffs submit that once one appreciates the true nature of the Hannover Re transactions, with the associated Letter of Credit transferring the risk back to HIH, the only sensible inference is that they were implemented to create an appearance of profitability which the financial statements would not otherwise bear – in other words, to deceive. I have described above the effect of the Hannover Re arrangements, which was to create an appearance of reinsurance – such as to enable Mr Williams in his Annual Review to describe it as “decisive action” by HIH to protect its business “from claims development uncertainties including potential underwriting exposures” – while in truth, the separate but related Letter of Credit transactions had the consequence that the Managed Fund was funded by HIH and the risk that it would ultimately prove insufficient was retained by HIH. Mr Fodera executed several of the critical documents which constituted the Hannover Re arrangements, including the Letters of Credit. That supports an inference, particularly in the absence of evidence to the contrary, that he understood their effect to be as I have described.

Moreover, in the absence of evidence to the contrary, it can and should be inferred – from his qualifications and experience as an accountant, from which he must have been familiar with accounting standards, and his position and responsibilities as Chief Financial Officer of HIH, from which he must have been familiar with accounting practice and standards in the insurance industry – that he knew that the treatment of the Hannover Re arrangements was incorrect according to proper accounting practice and standards, and would create a misleading appearance of profitability.

These inferences are reinforced, though they do not depend on, the circumstance that Mr Fodera was not called by the defendants to deny such knowledge: although the defendants protested that he was not “in their camp”, he was, as a former officer, obliged to assist the liquidators, and he would much more naturally be called by the defendants to deny that he had guilty knowledge than by the plaintiffs to confess that he did.

Invoking Pereira v DPP, [18] the defendants submitted that such an inference could be drawn adversely to them only if it was the only available inference in the circumstances. However, this is not correct: in Pereira, the notion that knowledge must be the only rational inference available was stated in the context of a criminal prosecution, where proof beyond reasonable doubt requires that, in a circumstantial case, all rational hypotheses consistent with innocence must be excluded. The proof required in a civil case is not so demanding; an inference may be drawn if the court is comfortably satisfied, having regard to the gravity of the allegation, that more probably than not it is the true explanation of the circumstances.

The defendants submitted that alternative available inferences were that the directors had a mistaken understanding of the Hannover Re arrangements or did not understand their proper accounting treatment, or that they passively acquiesced in them without forming any considered view as to their effect. Given the position and role of Mr Fodera in both HIH and the subsidiaries, his accountancy background and experience, the manifest purpose of the Hannover Re transactions in enhancing the appearance of HIH’s financial statements but not in fact removing the risk from HIH, and his involvement in executing critical transaction documents, I consider these explanations highly improbable. I am therefore comfortably satisfied on the balance of probabilities that Mr Fodera knew that the treatment of the Hannover Re arrangements in the FAI and C&G financial statements would be replicated in the consolidated HIH results, and so replicated would create a misleading and deceptive appearance of HIH’s operating profit for the relevant periods.

It follows, pursuant to TPA, s 84, that FAI and C&G had the requisite knowledge of the essential facts constituting HIH’s contraventions, and by publication of their own financial statements were knowingly concerned in and/or party to the contraventions, so as to incur liability in respect of them as persons involved in the contraventions.

A material fact in the statutory causes of action for damages under TPA, s 82(1) and Corporations Law, s 1005(1), on which the plaintiffs sue, is that the plaintiffs have suffered loss or damage “by” the contravening conduct. The word “by” expresses the notion of causation without defining or elucidating it. [19] It is not necessary that the plaintiffs establish that the contravening conduct was the sole cause of any relevant loss; it suffices if the conduct was a cause of the relevant loss, in the sense that it materially contributed to that loss. [20] In this case, the question is whether the publication of HIH’s financial results, including overstated operating profit due to the treatment of the Hannover Re arrangements materially contributed to the plaintiffs incurring loss.

The plaintiffs did not essay to prove that they were induced to acquire their shareholdings in HIH by the contravening conduct, or that they did so in direct reliance on the contravening conduct. Rather, the plaintiffs contended that they acquired HIH shares on the ASX at the then prevailing market price, and that that market price was artificially inflated by reason of the overstated reported financial results – which conveyed to the market an overoptimistic impression of HIH’s financial position and prospects. Thus, it is said that the contravening conduct resulted in the prices at which HIH shares traded on the ASX being higher than those which would otherwise have obtained, and that a person who acquired shares in that inflated market suffered loss because he or she paid more than would otherwise have been paid for the subject shares. In other words, it is said that loss was incurred because the contravening conduct – the release of the overstated accounts – distorted the market on which HIH shares were traded, and the causation requirement is satisfied by the facts that (1) the contravening conduct misled the market into attributing an inflated value to HIH shares, (2) the plaintiffs acquired their shares in that inflated market, and (3) the plaintiffs thus paid more than they would otherwise have paid for the same shares. This has been described as “indirect causation.” The plaintiffs contend that the law does not preclude such a claim.

Against that, the defendants contended that, on the authority of the decisions of the Court of Appeal in Digi-Tech (Australia) Ltd v Brand [21] and Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd [22] and of the Full Court of the Federal Court in Ford Motor Company of Australia Limited v Arrowcrest Group Pty Ltd, [23] where a person claims to have suffered loss by reason of entry into a transaction, they must establish reliance. They argue that “indirect causation” is available only in cases where the applicant is passive and a third party has been induced by the misleading or deceptive conduct to act to the applicant’s prejudice; whereas in this case, the plaintiffs are seeking to mount an indirect causation case where the third party is “the market” rather than an identifiable individual, and where they have not been passive but have themselves actively entered into the transactions by which they claim to have suffered loss. In such circumstances, the defendants submitted, it is necessary for the plaintiffs to establish that they relied on (or would have acted differently but for) the contravening conduct, and that absent such reliance there is no “causative bridge” between the contravening conduct and the loss. In this case, that would mean that in order to demonstrate a relevant causal connection between the contravening conduct and the alleged loss, each plaintiff would have to establish that he, she or it was induced by the contravening conduct to enter into the transactions whereby he, she or it acquired HIH shares, in the sense that he, she or it relied upon the overstated financial results when making a decision to acquire those shares, or would have acted differently but for those overstated results.

Two questions arise from these competing positions of the parties. The first is whether, as the defendants contend is dictated by authority, “indirect causation” is not available in a case such as the present, and reliance must be established. The second is whether – if indirect causation is available – it has been established; as will be seen in the context of this case, that second question is intertwined with the quantification of the plaintiffs’ damages.

In the United States, any requirement for evidence of direct reliance might be dispensed with by the “fraud-on-the-market” theory, under which reliance can be presumed: the market price of shares traded on well-developed markets reflects all publicly available information – and hence any material misrepresentations – so that it can be assumed that an investor relied on public misstatements whenever he or she buys or sells stock at the price set by the market. [24] To invoke the presumption, it must first be established that: (a) the alleged misrepresentations were publically known; (b) the stock traded in an efficient market, and (c) the relevant transactions took place after the misrepresentations were made and before the truth was revealed. [25] A stock’s listing on a national market is probative evidence of the second factor, but if efficiency is disputed, courts consider the characteristics of the individual stock, including its weekly trading volume, and any expert evidence demonstrating a cause and effect relationship between unexpected, material disclosures and changes in stock prices. [26] Once a plaintiff has successfully invoked the presumption, he or she is presumed to have relied on the non-disclosure. Defendants may rebut this presumption by establishing that: (a) the non-disclosures did not affect the market price; or (b) the plaintiffs would have purchased the shares at the same price had they known the information that was not disclosed; or (c) the plaintiffs actually knew the information that was not disclosed to the market. [27] However, this doctrine does not avail the plaintiffs because Australian law does not authorise any rebuttable presumption of this kind. [28]

The ultimate issue posed by TPA, s 82 (and its equivalents) is one of causation, not one of reliance, and reliance is not a substitute for the fundamental question of causation. [29] The word “by” signifies no more than that the loss or damage has to have been brought about by virtue (or reason) of the contravening conduct. [30] As a matter of principle, if causation – “by conduct of” – can otherwise be established, it cannot matter that reliance is not established. Thus, the statutory cause of action does not, per se, include reliance as a necessary material fact (although that is not to say that it will not be one, as a matter of fact, in the context of many, if not most, individual cases).

In Janssen-Cilag Pty Limited v Pfizer Pty Ltd, [31] Pfizer had made misleading and deceptive representations to consumers through an advertising campaign. Janssen-Cilag, a competitor, claimed that it had suffered loss and damage because, as a result of the misrepresentations, the public and pharmacists had purchased Pfizer’s product instead of a Janssen-Cilag product. Lockhart J held that there was no general requirement under TPA, s 82, that damage could be recovered only where the applicant itself relied on the contravening conduct, and that applicants may claim compensation where the contravener’s conduct caused other persons to act in a way that led to loss or damage to the applicant. [32] Having observed that the word “by” in s 82(1) required that there be a sufficient causal link between the contravening conduct and the recoverable loss, and that the loss or damage directly result from or be caused by the contravening conduct, such that the conduct must be the “real or direct or effective” cause of the loss, his Honour proceeded to hold that the entitlement to recover damages under s 82 was not confined to cases in which the applicant had relied upon or personally been influenced by the contravening conduct: [33]

Thus, his Honour held that where a corporation engaged in conduct which misleads consumers, the natural and direct result of which is to cause the public to buy more of its product and less of a rival’s, the loss to the rival was direct and immediate, not remote and indirect. [34] His Honour’s judgment – and specifically the observation that there was no general requirement that damage could be recovered only where the applicant personally relies upon the contravening conduct – was cited, with apparent approval, by Gummow J in the High Court, in Marks v GIO Australia Holdings Limited. [35]

In Hampic Pty Ltd v Adams, [36] Ms Adams (an employee) suffered injury while using a cleaning product acquired by her employer from Hampic. The tin in which the product was supplied bore a warning label, which was deceptively inadequate. Ms Adams’ supervisor read the label and gave her the product to use, in a different (smaller) tin than that provided by Hampic. Ms Adams therefore never read the label, and could not have relied upon the contravening conduct of Hampic. Nonetheless. her entitlement to recover of damages under TPA, s 82, was upheld, on the basis that but for the deceptive warning, the supervisor would have acted differently and, in consequence, so too would Ms Adams. Mason P and Davies AJA found that the failure adequately to label the substance contributed to the plaintiff’s injury, and held that this was sufficient to sustain her claim for damages, there being no requirement that damages could be recovered only where the applicant relied directly upon the contravening conduct. Their Honours said:

In Australian Breeders Co-operative Society Ltd v Jones (“ABCOS”), [37] a Full Court of the Federal Court applied these principles in the investment context to uphold a finding that causation was established where, but for a misleading valuation, a third party would not have completed a transaction, with the consequence that the applicant investors would not have made the investments which occasioned their claimed loss – notwithstanding that there was no evidence that they relied on the misleading valuation. In a passage which I set out at length because it helpfully collects some of the relevant authorities and demonstrates the application of the principles to the facts, Wilcox and Lindgren JJ, with whom Lee J agreed, said: [38]

Stockland (Constructors) Pty Ltd v Retail Design Group (International) Pty Ltd [39] was an interlocutory appeal from a decision to allow a cross-claim to be amended so as to plead a cause of action under the TPA. The cross-claimant Retail Design (a firm of architects) claimed damages for misleading conduct by Stockland Constructors, said to be constituted by representations made by Stockland Constructors to Stockland Properties (and other companies associated with the Stockland Group), in particular that the architects were the cause of a third party’s claim against Stockland and were liable in negligence for the losses of Stockland Constructors and Stockland Properties arising from that claim. Retail Design pleaded that those representations were false, that in reliance on them Stockland Properties and other companies in the Stockland Group formed the belief that the architects were not competent and that, as a result, Retail Design suffered loss in that, whereas previously it had been making substantial profits from work for the Stockland Group, from March 1997 onwards it no longer had that work and those profits. One of the objections to the cross-claim was that it included no allegation of reliance by Retail Design. Hodgson JA, with whom Sheller JA and Davies AJA agreed, held that for a plaintiff to recover damages under the TPA for misleading and deceptive conduct, it was not necessary that the plaintiff itself had been misled, and it may be able to recover loss suffered by it because others were misled. His Honour said:

The importance of focussing on causation rather than reliance was highlighted by Giles JA (with whom Beazley JA and Ipp JA agreed) in Smith v Noss. [40] His Honour said:

That statement was emphatically endorsed by the High Court in Campbell v Backoffice Investments Pty Ltd, [41] in the following terms:

The above authorities establish that proof of reliance on the contravening conduct is not an essential element of a cause of action for damages under TPA, s 82. A sufficient causal connection can be established in ways that do not involve the applicant directly relying on the contravening conduct. However, the defendants submit that decisions of intermediate appellate courts [42] compel the conclusion that, in a case such as the present in which the causal chain includes steps taken by the plaintiffs themselves to enter into the transaction, reliance is indeed an indispensable element.

In Digi-Tech (Australia) Ltd v Brand, [43] the plaintiffs were investors in a scheme based on Digi-Tech’s products. Digi-Tech had provided misleading forecasts concerning certain products to Deloitte, who devised an investment scheme based on them and valued the scheme by assuming the correctness of the misleading forecasts. One Mr Urwin, who was not involved in the misleading conduct, proposed the scheme to the investors. The plaintiffs argued that if Digi-Tech had not produced the misleading and deceptive forecasts, there would have been no sufficiently high valuation of the products to support the investment scheme, which would not have gone ahead, so that the promoter Mr Urwin would not have proposed the scheme to any of the investors, with the consequence that the investors would not have invested in it and suffered loss. Thus it was submitted that Digi-Tech’s misleading conduct thereby caused the promoter to act in a way that led to loss or damage to the appellants. [44]

The Court of Appeal (Sheller, Ipp and McColl JJA) drew a distinction between the Janssen-Cilag and Stockland category of claim, and claims in which plaintiffs suffered loss because they themselves were induced by misleading representations to perform some act or omission by which they were prejudiced: [45]

The distinction drawn between the two classes of claim is that, in the first class, no act of the plaintiff contributes to the loss, and the chain of causation is complete without any act or omission on the part of the plaintiff; whereas in the second, which occurs when plaintiffs are induced by misleading representations to perform some act or omission by which they are prejudiced, the inducement of the plaintiff and his or her act or omission causing loss is an essential part of the chain. The Court held that plaintiffs in the second class, who claim damages under s 82(1) on the ground that they entered into transactions induced by the misrepresentations of other persons, must – to establish that “by” that conduct, they suffered loss or damage – prove that they relied on the misrepresentations. However, that was in the context that while the contravening conduct may have satisfied a “but-for” approach to causation, it did no more than contribute to providing an opportunity for the plaintiff to enter into the relevant transactions. Moreover, a significant factor was the consideration that representees who knew the truth, or were indifferent to the subject matter of the representation, should not be able to succeed.

In Ford Motor Company of Australia Ltd v Arrowcrest Group Pty Ltd, [46] Ford contracted with Arrowcrest for certain supplies, and with Arrowcrest’s subsidiary Tristar for the supply of steering gears for a car model intended to be produced over four years – however, the agreement with Tristar was for a term of only three years. Towards the expiry of that term, Ford unsuccessfully sought another supplier of steering gears. Despite disagreements and litigation between Ford on the one hand and Arrowcrest and Tristar on the other, Ford remained dependent on Tristar as the only supplier of the component it required. Tristar informed Ford that the unit production cost of the steering gears had to rise, and supplied “cost breakdown” calculations which, Ford contended, were – along with further written justifications of the “cost breakdown” – false representations. However, Ford had no option but to obtain steering gears from Tristar on unfavourable terms, in order to complete the four-year production program for the model.

Without determining whether or not the representations complained of were false, the primary judge determined that Ford was not entitled to succeed, on causation-related considerations. That decision was upheld on appeal to the Full Court, which held that the primary judge was correct to find that there was no reliance by Ford on Tristar’s alleged misrepresentations, as Ford did not believe them and thus could not have been induced by them to enter into further transactions with Tristar; it was simply a case of commercial advantage, in which Tristar was able to dictate terms when Ford could find no other supplier. In the absence of reliance, Ford could not establish loss. After referring to Janssen-Cilag v Pfizer, Hampic v Adams, McCarthy v McIntyre [47] and Marks v GIO, Lander J (with whom Hill J and Jacobson J agreed) said: [48]

What that case establishes is not that the applicant must necessarily prove that it relied on the contravening conduct, but that the applicant must establish that somewhere in the chain of causation, someone relied on the contravening conduct – in other words, that someone was misled or deceived, and that such deception brought about prejudice to the applicant. Unless someone in the chain of causation is deceived, it cannot be said that the ultimate loss to the applicant is “by conduct of” the respondent, because the conduct would be immaterial to the ultimate loss unless it impacted somehow on the causative process.

In Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd, [49] which concerned a claim for damages under Corporations Law, s 1005, in respect of a contravention of s 995, for loss sustained by investors who had participated in a converting note issue, the plaintiffs contended that but for the contravening conduct, the note issue would not have taken place, in which event they would not have acquired any of the notes and would not have suffered loss. However, they did not allege or prove that they were misled. Their case failed on other grounds, but Ipp JA advanced, as a further ground, that as the appellants did not allege or prove that they were misled, Digi-Tech meant that they had not suffered loss “by” the conduct of the respondents. [50] Ipp JA explained Digi-Tech as follows: [51]

After referring to Ford v Arrowcrest, his Honour distinguished cases such as Janssen-Cilag “where a person, by misleading conduct, induces another to act to the prejudice of the plaintiff”, in which “the plaintiff is a passive victim of misleading conduct” and “no action or omission by the plaintiff affects the loss it suffers”, from the Digi-Tech category, in which “the plaintiff acts or refrains from acting to his or her prejudice by reason of conduct of a third party brought about by the defendant’s misleading conduct; the plaintiff’s conduct is a necessary link in the chain of causation”. His Honour explained the rationale of Digi-Tech as follows:

Giles JA rejected the submission that the relevant passages in Digi-Tech should be discounted as obiter dicta, saying: [52]

His Honour explained the relevant distinction between the two classes of claim, and that the second class – in which reliance must be established – is not restricted to a case of direct inducement but extends to all cases where conduct on the part of the plaintiff constitutes a link in the causation chain, in the sense that the plaintiff is someone who made a decision to enter into the transaction, and the representation was material to the decision: [53]

His Honour then, with reference to the judgment of McHugh J in Henville v Walker, considered the extent to which conduct might be said to have caused loss where it was a sine-qua-non of the opportunity to enter into the transaction: [54]

Hodgson JA, while agreeing in the outcome, reserved his position in relation to indirect causation and Digi-Tech, making the following observations: [55]

His Honour’s approach is reflective of that taken in ABCOS, though it did not refer to it. The views of Giles JA and Ipp JA, on the other hand, are not easy to reconcile with ABCOS, [56] which does not appear to have been referred to. However, the following features of Ingot are significant: first, it did not involve any question of market-based causation; secondly, it was a case in which the only effect of the contravening conduct was to contribute to the opportunity for the relevant transactions to take place; thirdly, it recognised that the position of a plaintiff who enters into a transaction simply because the opportunity to do so is available, when it would not have been available but for the misleading conduct, may be regarded as analogous to a passive victim of another’s act; [57] and fourthly, the avoidance of the potential for recovery by persons who knew or were indifferent to the true position was again an important consideration. [58]

The defendants also invoked the statement of Handley AJA in Gardiner v Agricultural & Rural Finance Pty Ltd, [59] that a plaintiff relying on a contravention of Corporations Law, s 995 (and analogous provisions), “must establish that he relied on the misleading or deceptive conduct, or the false or misleading statement, or that he would have acted differently if the material omission had been disclosed.” [60] However, that was merely a statement introductory to a discussion of the evidence of actual reliance adduced in that case, and was not directed to any indirect causation.

Digi-Tech and Ingot were considered by a full court of the Federal Court in ABN AMRO Bank NV v Bathurst Regional Council. [61] As the defendants submitted, that court did not suggest that either was wrongly decided. However, the Full Court said that Ingot did not stand for any “bright-line principle” that it was insufficient for a plaintiff to prove that some other person relied on the alleged misleading conduct and that that person’s reliance led to the plaintiff suffering loss, but was authority only for the proposition that where misleading and deceptive conduct provides the opportunity for an investor to enter into a transaction, that investor will not be entitled to recover where the investor knew the truth of the underlying misrepresentation or was indifferent to its truth and proceeded nonetheless; the entitlement to recover loss or damage in a case of misleading and deceptive conduct was not confined to persons who relied on the conduct, and a plaintiff need not establish that the plaintiff directly received and relied upon the misrepresentation made by a defendant. [62]

Bergin CJ in Eq appears to have been prepared to accept indirect causation, obiter, in McBride v Christie's Australia Pty Ltd, [63] relying on what Hodgson JA had said in Ingot, and also on ABCOS and Janssen-Cilag, though without reference to the judgments of Giles JA and Ipp JA in Ingot:

In Grant-Taylor v Babcock and Brown Ltd (in liq), [64] Perram J accepted, obiter, that a party who acquires shares on a stock exchange could recover compensation for price inflation arising from a failure to disclose material required to be disclosed, so long as they were not themselves aware of the non-disclosed material. His Honour’s reasoning included that while on the authority of Digi-Tech and Ingot, a plaintiff may not recover where it knows of the misleading nature of the alleged conduct, those authorities did not mean that C was necessarily precluded from recovering from A where A misled B, and B in consequence misled C (as ABN AMRO established), and a case in which A misled the market (comprised of many Bs) which then bid up the price and thus caused loss to C, was not relevantly different.

Caason Investments Pty Ltd v Cao [65] was an application for leave to appeal from a refusal to grant leave to amend a statement of claim to include pleadings of “market-based”, as distinct from “reliance-based”, causation. Although an interlocutory appeal, the judgments helpfully describe the type of case that the plaintiffs advance here. Gilmour and Foster JJ concluded that none of the authorities relied upon by the respondents (which included Ingot) supported a submission that the applicants’ market causation case was not arguable. [66] Their Honours observed:

Edelman J also concluded that the legal argument of market-based causation had reasonable prospects of success and should be allowed to proceed to trial, although whether market-based causation is established as a matter of fact is a different question which would require expert evidence. [67] His Honour explained market-based causation as follows:

Reiterating that reliance was not a substitute for the essential question of causation, [68] his Honour explained:

In my judgment, Digi-Tech and Ingot do not deny recoverability in a case such as the present on the basis of indirect market causation. While there appears to be no authoritative decision that conclusively holds that market causation is available, there are – as the above analysis demonstrates – the decisions of Bergin CJ in Eq and Perram J which, albeit obiter, appear to regard such a theory as available notwithstanding Digi-Tech and Ingot, and the Full Federal Court’s decision in Caason v Cao which holds that it is plainly arguable. It may be that Digi-Tech and Ingot are expressed in wider terms than the interpretation afforded them in ABN AMRO and Caason v Cao, and it must be acknowledged, with respect, that (contrary to the suggestion in those decisions) there was not in Ingot any suggestion that the investors actually knew or were indifferent to the true position – although avoiding the potential for investors in such a position to recover was an important influence in Ingot as well as in Digi-Tech. However, Digi-Tech and Ingot must be read in their context: neither involved “market-based causation”; both were concerned with a scenario in which the alternatives were transaction or no transaction, in which the sole causative role of the contravening conduct was in the barest ‘but-for’ sense to contribute to the creation of the opportunity for the relevant transaction to take place; neither were concerned with a case in which the alternatives were not transaction or no transaction, but transaction at a lower or higher price, in which the contravening conduct had the necessary consequence that the higher price would obtain.

The policy that informs Digi-Tech and Ingot is to deny recovery where the contravening conduct did not influence anyone (that is to say, where no-one was deceived or misled by the contravening conduct), and to those who knew, or were indifferent to, the true position. The explanation of those decisions is that (a) if the contravening conduct in fact misleads no-one, then it cannot be said to have caused loss; and (b) where contravening conduct sets in motion or allows to continue a process which culminates in an applicant making a decision to enter a transaction which incurs loss, a decision to enter into the transaction by an applicant who knows the true position or is indifferent to it would break the chain of causation as a novus actus interveniens, so that it could not be said that the loss was incurred “by” the conduct.

This is not a case in which, on the relevant hypotheses, no-one was misled: while the contravening conduct did not directly mislead the plaintiffs, 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. Investors who acquire shares on the share market do so at the market price. In that way, they are induced to enter the transaction (in this case, to their prejudice) on the terms on which they do by the state of the market. 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: in HTW Valuers (Central Qld) Pty Ltd v Astonland Pty Ltd, [69] the High Court spoke of a distinction which is “sometimes difficult to draw, but…is old and fundamental” between ‘real’, ‘true’ or ‘intrinsic’ value on the one hand, and ‘market value’ on the other, [70] and said that ‘market values’ that “are ‘delusive or fictitious’ because they are the result of ‘a fraudulent prospectus, manipulation of the market or some other improper practice on the part of the defendant” may be disregarded in ascertaining true value. [71]

The plaintiffs bought their shares on the ASX, to which HIH released information, including the FY1999 results, the FY2000 interim results and the FY2000 final results, which formed part of the matrix of information that influenced the trading price of the shares from day to day. If the contravening conduct deceived the market to produce a market price which reflected a misapprehension of HIH’s financial position (which is a factual question to be resolved in conjunction with the quantification of damages), 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, plaintiffs who decided – entirely oblivious to the contravening conduct – to acquire shares in HIH, were inevitably exposed to loss. Moreover, they were members of the class who would obviously be affected by the contravening conduct. Upon the assumption that the effect of the misleading conduct was, as the plaintiffs allege, that HIH shares traded on the market at a higher price than would otherwise have been the case, it was inevitable that any purchaser of HIH shares would, upon acquiring such shares, incur loss. The case is analogous to the first class described by McHugh J in Henville v Walker, though it is the laws of the market rather than those of nature which dictated that the inevitable consequence of the contravening conduct would be that share purchasers would pay an inflated price – although an investor who was shown to have acquired shares knowing that the results were overstated, or indifferent to it, could not be said to have incurred the loss “by” the contravening conduct – a decision to do so with such knowledge or indifference would break the causal chain. [72] Alternatively put, the plaintiffs would have acted differently if the contravening conduct had not occurred, in that they would have paid a lesser price for their shares than they did.

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.

This can be tested by a counterfactual inquiry: what would have happened if each contravention had not occurred? On relevant assumptions, the answer is that the market price of the HIH shares would have been lower, and the plaintiffs would have paid less for the shares they acquired.

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. I conclude that “indirect causation” is available and direct reliance need not be established.

As Edelman J pointed out in Caason v Cao, that does not mean that indirect causation has been established. The above reasoning proceeds on the assumption that the contravening conduct caused the market to be inflated. The plaintiffs must establish, by evidence and/or inference, that the contravening conduct distorted the market price so as to cause the shares to trade at an inflated price. [73] In this case, whether the contravening conduct had the effect of inflating the market price of HIH shares is intertwined with the quantification of the plaintiffs’ damages, if any.

The loss and damage which the plaintiffs are entitled to recover is that which the contravening conduct caused. [74] Thus, the measure of the plaintiffs’ damages is closely related to their causation case. On the plaintiffs’ theory of causation, which I have held is open, this is not a simple “no transaction” case – that is to say, it is not a case in which the contravening conduct caused the plaintiffs to acquire (or retain) shares which they would otherwise not have acquired; rather, it caused them to pay, for shares which they would have acquired in any event, a price which was inflated above that which would otherwise have obtained. On this approach, the measure of the plaintiffs’ damages is not the difference between the price paid and the “true value” of their shares, but the difference between the price they paid and the price they would have paid had the contravening conduct not occurred but all other factors remained constant. [75] This necessitates determining the quantum of the impact, if any, of the contravening conduct, on the price at which HIH shares traded. In that context, “true value” is not necessarily a proxy for what the market price would have been absent the contravening conduct, because there may have been other factors which also influenced (and distorted) the market price.

The same exercise will also resolve whether the contravening conduct in fact had any impact on the market price: if the price at which the shares actually traded exceeds that at which, absent the contravening conduct, they would have traded, then indirect causation in fact will be established.

In their closing submissions, the plaintiffs advanced for the first time, as an alternative approach to quantification, the “left in hand” approach to valuation – meaning that each plaintiff would be entitled to recover the difference between the price paid for the subject shares and their value in that plaintiff’s hands at the date of trial. [76] As the defendants submitted, such an approach had not previously been foreshadowed or particularised, and arose too late to be addressed by evidence that could have affected it. Moreover, such an approach to assessing loss is inconsistent with the causation theory on which the plaintiffs’ case depends, which is that they suffered damaged by paying a price higher than they would otherwise have paid to acquire the shares, not that they would not have acquired the shares at all. Thus, it is not correct to say, as the plaintiffs submitted, that by reason of the contravening conduct the plaintiffs are “locked into the property”, [77] because (on relevant hypotheses) they would have acquired the shares and continued to hold them in any event. Their loss, if any, attributable to the contravening conduct, is the extra amount that they paid for their shares over that which they would otherwise have paid.

Table 1 summarises the approximate prices at which HIH shares traded at the end of each period. Prices fluctuated daily, and generally speaking had declined progressively over the preceding 6 months, although the decline was not necessarily constant: [78]

To prove the impact that the contravening conduct had on these prices, the plaintiffs called as an expert witness Dr Jeffrey Coulton, who prepared a report dated 15 November 2013 in the Cuong Ly proceedings, in which he concluded that the true value of an HIH share during the period 29 June 2000 to 26 February 2001 was nil; and reports dated 8 August 2014 in the Baldock proceedings and the De Bortoli proceedings, in which he concluded that the true value of an HIH share was $1.76 during the period 26 November 1998 to 24 August 1999, $0.28 during the period 25 August 1999 to 1 March 2000, and nil after 2 March 2000. For the purpose of those reports, in assessing “true value”, Dr Coulton made adjustments to the reported financial results not only for the incorrect accounting treatment of the Hannover Re arrangements, but also for the extensive range of other matters referred to in Chapter 20 of the Report of the HIH Royal Commission in respect of FY1999 and FY2000, which did not form part of the contravening conduct established in the present proceedings.

For the defendants, Mr Cullimore Gower prepared a report dated 5 June 2014 in the Cuong Ly proceedings, and a report dated 7 November 2014 in all four proceedings. The Gower reports set out Mr Gower’s opinion on issues raised in the Coulton reports and the basis of Dr Coulton’s valuation opinions. However, Mr Gower was not instructed to value HIH or the shares in it, and expressed no valuation opinion.

On 13 February 2015, pursuant to directions made by the Court, the two experts participated in a joint meeting and subsequently conferred via the exchange of emails, resulting in the preparation of a joint report dated 17 February 2015 setting out the matters upon which they agreed, and those upon which they disagreed, including the reasons for disagreement. Shortly prior to the commencement of the hearing, Mr Gower produced a supplementary report dated 23 February 2015. Mr Coulton then provided a further report dated 24 February 2015 (“the fourth Coulton report”). In this fourth report, unlike his earlier reports, he made adjustments to the reported results only for the incorrect treatment of the Hannover Re arrangements. Mr Gower responded in a further report of 26 February 2015.

Dr Coulton’s valuation approach involved a conditional relative valuation model, adapted from authoritative work on the valuation of insurance companies in the United States by Professor Nissim. [79] Essentially, Professor Nissim’s thesis, adopted with some modifications by Dr Coulton, commences from the position that whereas for the valuation of businesses generally, earnings multiples are usually preferred to book value (net asset backing) multiples, for the valuation of insurance companies, book value multiples (specifically, the price to book ratio) provide a significantly more reliable basis than earnings multiples. [80] A valuation involves, broadly, ascertaining the ratio that the share market price of shares in comparable insurance companies bears to their net asset backing, and applying that ratio to the net asset backing of the subject company to derive a value for its shares. One important reason why book value is a more reliable basis than earnings is the nature of the insurance business, and the way in which they are accounted for – in particular, that insurance assets must be reported in the “book” at net market value.

However, Professor Nissim concludes that the accuracy of a valuation using price to book value multiples can be enhanced by conditioning the price to book ratio on recurrent return of equity (“ROE”). This means that while price to book ratio is the dominant influence, it is adjusted having regard to recurrent ROE. Adopting this approach, Dr Coulton developed a model (or equation) for deriving share value, defined as the present value of future earnings, allowing for the required rate of return and future growth. Essentially, Dr Coulton analysed the price to book value of other major Australian insurance businesses (conditioned on their ROE), to generate a regression model of the price to book ratio on ROE, which explains the on-average, over time association between the price/book ratio and the ROE of listed Australian insurance companies. He then applied the output from the regression model to HIH’s ROE and book value (net asset backing), to derive a value for HIH shares. In this exercise, as I have mentioned, in his earlier reports, Dr Coulton adjusted HIH’s reported results for each of the relevant periods having regard to all the accounting adjustments proposed in Chapter 20 of the Report of the HIH Royal Commission, which were not limited to the overstatement of profit associated with the accounting treatment of the Hannover Re arrangements; however, in his fourth report, Dr Coulton excluded adjustments other than those necessary to substitute the proper treatment of the Hannover Re arrangements. On that basis, his fourth report attributed to HIH shares the values of $0.76 for the period 25 August 1999 to 2 March 2000, $0.71 for the period 2 March 2000 to 17 October 2000, and $0.59 for the period after 17 October 2000.

Although there were at first a range of additional disputes about various integers of Dr Coulton’s analysis, many of these fell away during the hearing. Thus, with the abandonment of the claim in respect of the prospectus contravention, nothing turned on any period prior to 25 August 1999. The defendants ultimately did not press for an adjustment in respect of interest that would notionally have been derived on the $200 million deposit under the Hannover Re arrangements; and it became common ground that proposed allowances for “outside equity” could be disregarded. The only remaining differences requiring resolution related to Dr Coulton’s calculation of “recurrent ROE” and were: (a) annualisation: whether for the purpose of calculating recurrent ROE for the 12 months ending 31 December 1999, the appropriate adjustment (for overstated profit by reference to the Hannover Re arrangements) was $100,375,000 (as proposed by Dr Coulton) or $84,975,000 (as per Mr Gower); and (b) extraordinary and abnormal items: whether reported income should be adjusted (for the purposes of calculating ROE) for abnormal and extraordinary items, in particular by excluding loss on the sale of the Ocal coal mine and a special GST expense, and the profit derived from the sale of FAI Life.

As to the annualisation issue, this arises because it is necessary, for the purpose of deriving a value as at 31 December 1999, to ascertain recurrent ROE for the preceding 12 months, which overlaps two financial years. There is no dispute that one half of the agreed overstatement of $108,350,000 for the year ended 30 June 2000 – namely $54,175,000 – should be attributed to the six months ended 31 December 1999. The dispute is whether one-third or one-half of the agreed overstatement of $92,400,000 for the period ended 30 June 2000 should be attributed to the six months ended 30 June 1999. The difference of opinion arises because, on the one hand, the financial statements for the period ending 30 June 1999 were for a period of 18 months; whereas the statement of agreed facts refers to the operating profit for the financial year ended 30 June 1999, which the plaintiffs contend means the 12-month period. In my view the defendants’ contention is correct: while it is true that the statement of agreed facts refers to the “financial year”, that is really shorthand for the period covered by the financial statements for the 18-month period concluding on 30 June 1999. That also has the virtue of according with the reality of the position, in that the operating profit report reported in those financial statements is for an 18-month, not a 12-month, period. The parties ought not to be regarded as having agreed in the statement of agreed facts to a manifestly incorrect understanding of the financial statements. Thus, the appropriate adjustment to operating profit for the 12-month period ending 31 December 1999 is, as Mr Gower contends, $84,975,000.

As to the abnormal items issue, Professor Nissim’s work, upon which Dr Coulton’s approach relies, uses a concept of “recurring ROE”, on the basis that by excluding “onetime items” it is more persistent than simple ROE and provides a stronger relationship between equity value and profitability. He describes such “onetime items” as including “extraordinary items, income from discontinued operations, impairment charges, asset write-downs, restructuring charges, realised gains and losses, and other items which are deemed to be relatively transitory”. Dr Coulton explained that there was a distinction between earnings after abnormal and extraordinary items (which were defined accounting terms with specific content), and recurring versus non-recurring items (which involved a more subjective assessment of what was and was not recurring). Thus, calculation of recurrent ROE involves predicting ongoing ROE, and this may require more than only disregarding plainly abnormal items.

Although Dr Coulton in cross-examination resisted it (at least at first – he ultimately accepted that the sale of the coal mine would fall within Professor Nissim’s described adjustments for calculation of recurring ROE), the plaintiffs ultimately conceded adjustments to net income (for the purposes of calculating ROE) identified by Mr Gower for the abnormal loss on sale of the Ocal coal mine, and an abnormal GST expense, which were reported as abnormal. However, the plaintiffs contended that these should be offset by an abnormal profit on the sale of FAI Life, which Mr Gower had not included in his proposed adjustments, because it was not reported in the financial statements as “abnormal”. Mr Gower conceded that it had some features which might warrant treating it as abnormal, but against that argued that it was less than $50 million, and it was an insurance asset, not a non-core asset.

The argument that it was not abnormal because it was less than $50 million is unconvincing; at $36 million, it still represented a very significant component of reported operating profit before abnormals and tax for the year in question (which was $102 million). While the argument that it was an insurance asset is more persuasive, it nonetheless represented the sale of a subsidiary, which through its quantum had a markedly distorting effect on net income for the year. The sale of a controlled entity is hardly a recurrent item. In my view, failing to exclude it, while excluding the GST expense and coal mine losses, would result in a distorted net income for the purpose of calculating ROE, and the profit from the sale of FAI Life should be treated as abnormal and excluded from net income for the purpose of calculating recurrent ROE.

Once the above resolutions of those issues are incorporated into Dr Coulton’s approach, the result is to attribute to an HIH share during the relevant periods the hypothetical prices in the first row of Table 2, which compare to the actual market price in the second row, and represent the percentage of actual market price indicated on the third row: [81]

The plaintiffs submitted that from not later than January 2001 HIH was insolvent, and that its shares should be regarded as valueless after that date. There is some evidence to the effect that HIH was by then insolvent. However, even assuming that it is established that HIH was in fact insolvent from January 2001, and that in truth its shares were valueless, that would not inform the assessment of the impact of the contravening conduct on the price at which HIH shares traded. The damages to which the plaintiffs are entitled correspond with the impact of the contravening conduct on the market price – not on the difference between price and “true value”, nor on how other matters might have affected the market price.

At the commencement of the hearing, and until close to its conclusion, the defendants’ position was that Dr Coulton’s approach was fundamentally flawed and could not be relied upon. Criticisms of his methodology included, in particular, that he had undertaken no assessment of HIH’s business and earnings outlook, nor analysed the comparators to confirm whether they were relevantly comparable with HIH; and that application of the output from the regression model to the comparators resulted in discrepancies between their known values and their theoretical values, so extreme as to demonstrate that the model was unreliable. However, by final submissions, the defendants’ criticisms were muted, and in large part they urged adoption of Dr Coulton’s approach, subject to the adjustments to which I have referred; in effect, they submitted that I should accept that, absent the contravening conduct, the shares would have traded at the prices referred to in the first row of Table 2.

However, as was foreshadowed during the hearing, there are a number of difficulties with the application of Dr Coulton’s approach, and attractions in an alternative approach.

First, Dr Coulton’s methodology produces, for each of the relevant periods, a constant “flat line” price, whereas in fact the market price fluctuated on a daily basis. This fluctuation reflects the impact of other factors – including, presumably, supply and demand – which Dr Coulton’s analysis excludes. Secondly, although the defendants became less inclined to emphasise it, there is force in their earlier submission that application of Dr Coulton’s methodology to some of the comparators resulted in such a discrepancy between known value and theoretical value as to cast serious doubt on the methodology. Thirdly, although ultimately he used HIH’s reported operating profit and net assets adjusted only for the incorrect treatment of the Hannover Re transactions, his methodology sought to infer a hypothetical value for an HIH share, using other insurance companies as comparators, and disregarding the actual performance of HIH shares. While this might well be appropriate in many contexts where the question is “true value” of a share, when the real question is the impact of the contravening conduct on the market price, the actual performance of the shares on the market is not irrelevant; rather, it may be taken as reflecting all inputs and influences known to the market, which would have continued to operate regardless of the contravening conduct, leaving as the critical question the segregation of the impact of the contravening conduct.

Fourthly, and fatally, when the outcome of Dr Coulton’s exercise after the appropriate adjustments (see Table 2 above), is compared with the actual market price of HIH shares, it fails the reality test: at least as at December 1999, Dr Coulton’s methodology produces a hypothetical price higher than (119% of) the actual market price. The notion that the shares would have traded at a price higher than they actually did, had their (inferior to reported) true profitability and net asset position been known, is ludicrous. This demonstrates that the results produced by Dr Coulton’s approach fail the reality test. (Although the defendants resisted the proposition that this failed the reality test, they did not endeavour to sustain the contention that the contravening conduct caused the shares to trade at a lower price than they otherwise would have). [82]

Mere difficulty in assessing damages does not relieve a court from the responsibility of estimating them as best it can. [83] In the assessment of damages, particularly where hypothetical scenarios are involved, precision is rarely attainable, and speculation is sometimes unavoidable. [84] The defendants rightly suggest that there is a distinction between cases in which sufficient evidence of loss can be but is not adduced, from cases in which the nature of the loss is such that precise evidence cannot be adduced. However, they wrongly submit that the present case is in the former and not the latter category. Precisely how the market would have responded had the Hannover Re contracts been properly accounted for cannot realistically be the subject of precise proof, and necessarily involves hypothesis and a degree of speculation.

Generally speaking, the net assets of a company set the floor of its value, and a share is worth its relative proportion of those net assets. Some write-downs and allowances for costs may be necessary in a liquidation scenario, whereas the value may exceed net assets if earnings indicate that the present value of the economic benefits of holding a share exceed its net asset backing. But in the context of an insurance company, book value is the single most important indicator of value.

However, even in the case of insurance companies, shares rarely trade on the market precisely at their book value. This is because the market attributes a premium or discount to book value, based on its assessment of the likely future economic benefits of holding the share. As Mr Gower explained, if shares in an insurance company are trading above book value, that indicates that there is a profitable business that promises an ultimate return in excess of current book value. If shares are trading at a discount to book value, that means that the market has perceived that the stated book value is not going to be realised – or that supply exceeds demand. Similarly, Dr Coulton explained that an insurance company’s value will be higher than book value if its future return on equity is expected to be higher than its cost of capital (the manager’s rating value). In other words, in those circumstances, its price to book ratio would be in excess of one. On the other hand, if the company’s return on equity is lower than cost of capital, one would expect a price to book ratio of less than one.

At all relevant times, HIH’s price to book ratio was less than one, and deteriorating. During the relevant periods, HIH shares were consistently trading at a price to book ratio below 1: 0.91 as at 30 June 1999. 0.75 as at 31 December 1999, and 0.54 as at 30 June 2000. Dr Coulton said that this indicated that the market was lowering its expectation of HIH’s ROE, and that the market’s expectation of future levels of HIH’s ROE was declining; it also bespoke an assumption of a negative ROE. Similarly, Mr Gower interpreted this as indicating that, looking at the future of HIH’s business, the market was anticipating that, for some reason, shareholders would not gain a full return on book value.

With the price to book ratio below 1, earnings are of reduced significance, and asset-backing assumes the dominant role. Dr Coulton accepted that a notional realisation of assets valuation might be appropriate where, inter alia, the outlook was uncertain, or the capitalised value of future earnings was less than the realisable value of the assets. Mr Gower agreed that generally an earnings-based valuation was appropriate where it would produce a higher value than a book or assets-based valuation, but that if the market was in fact capitalising the company at less than its book value, that pointed against an earnings-based valuation and in favour of a book-based valuation. Here, the price to book ratio of less than 1 means that the market capitalised the company at less than its book value – by from almost 10% as at 30 June 1999 to nearly 50% by 30 June 2000.

In those circumstances, the Court hypothesised that the impact of the contravening conduct could be segregated by applying to the adjusted book (adjusted only for the Hannover Re arrangements and consequential adjustments), the same price to book ratio that the market applied to the reported book.

Intuitively, it is a reasonable and logical hypothesis that the ordinary and natural consequence of an overstatement to the market of a listed company’s financial performance would be to inflate its share price. Moreover, the Morningstar evidence deployed in these proceedings illustrates how analysts use the reported financial statements of listed entities to inform the market of their performance. Mr Gower agreed that, if the market knew that the true book value was less than the reported book value by those proportions, one would expect that a rational market would respond to that knowledge. He then gave the following evidence:

However, the “other factors” referred to by Mr Gower in that answer are hypothetical and theoretical, without practical relevance to this case: in circumstances where the market was discounting book value by between 10 and 50%, it was not anticipating any turnaround, change of management, or takeover; to the contrary, it was anticipating that ROE would be negative, the company would continue to make losses, and book value would not be realised.

In answer to a question as to how he would go about predicting the price at which the HIH shares would have traded had the “true” position (that is, the reported financial position adjusted for the Hannover Re arrangements) been known, he at first answered that he would have sought to establish what were the future maintainable earnings. However, when reminded that the market was attributing a price to book ratio of below 1, indicating that it was not much influenced by the prospect of future maintainable earnings, he responded to the effect that earnings were of reduced significance but still had some influence, while net assets underpinned value and was an important factor:

It may well be that there are more factors; but those other factors, so far as they were known to the market, were already reflected in the price the market attributed to the shares. The one factor that was not reflected in that price was that the true profitability and net asset position of HIH was significantly worse than reported.

Dr Coulton agreed that such an approach was open. He was asked:

Dr Coulton suggested that a shortcoming of this approach was that it used the existing price of HIH shares to infer what their price would have been upon certain assumptions, whereas his approach “quarantined” the actual share price of HIH from the analysis by using the basket of supposedly comparable companies. However, that observation, while relevant if one was engaged in ascertaining the “true value” of an HIH share, has much less force when one is engaged in assessing the impact of certain assumptions on the price at which those shares traded. Indeed, it tends to reinforce the shortcoming of Dr Coulton’s approach in focussing more on “true value” of the subject shares than on the impact of the contravening conduct.

Dr Coulton also mentioned that the existing price might already reflect the market’s awareness that there was an overstatement of book value. While there is no reason to suppose that the market was aware of the incorrect treatment of the Hannover Re arrangements, [85] the possibility needs to be considered that the discount already attributed to book value by the market indicates that, although it might have been unaware of the true position in respect of the Hannover Re arrangements, the market did not believe and did not trust HIH’s financial statements. Given that, as Mr Gower pointed out, accounting standards require in relation to insurance companies that insurance assets and liabilities be reported at net market value, the magnitude and growth of the discount suggests that the market was sceptical, and became increasingly so, of the reliability of the HIH book, and for that reason incorporated a substantial discount on book value, which could be regarded as covering perceived risks that the book would not be realised.

However, the more probable hypothesis is that a rational market – albeit that it already doubted that its reported book value would be realised – would not have shed those doubts had HIH reported still lower operating profits, and consequentially a lower level of net assets. Although the defendants submitted that the proposition that the obvious effects of particular types of misrepresentations could readily be inferred should be confined to the obvious, and that this was not an obvious case, it seems to the obvious and calculated effect of a representation that an insurance company was operating more profitably than in truth it was, and had materially greater net assets than in fact it had, would be that the market would overprice its shares. A general provision for risk and doubt, such as the price to book ratio reflected, would not evaporate upon materialisation of this specific matter. Indeed, Dr Coulton thought that if the result for the year ended June 99 were in truth $92 million worse than reported, the market would likely form an even more cynical view of future return on equity than it did, resulting in a further decline in price to book ratio; thus if anything, using the price to book ratio that the market in fact applied at the relevant times would risk overvaluing rather than undervaluing the shares. He concluded:

His qualification about period 4 suffers from the same problem as the “approaching insolvency” argument referred to above, that such an approach would take into account matters and influences additional to the contravening conduct. And again, it illustrates his misdirected focus on the true value of the shares, rather than the impact of the contravening conduct.

Accordingly, I conclude that the contravening conduct did inflate the price for HIH shares, and that indirect causation in fact is established. In my judgment, doing the best one can with the available material, the impact of the contravening conduct is represented by the difference between the price at which HIH shares actually traded on the market, and the hypothetical price achieved by applying the price to book value at which they traded to an adjusted book (adjusting for the Hannover Re arrangements). The difference can be calculated for each period from the ratio of “adjusted” book value (adjusted for the Hannover Re transactions) to reported book value, as shown in Table 3:

These percentages may be compared to the corresponding results of 83%, 119% and 93% obtained from the adjusted Coulton approach, referred to in Table 2. That comparison shows that the approach I favour is more favourable to the plaintiffs in respect of the period to 31 December 1999, but less for the other two periods, than the adjusted Coulton figures; that by reference to 30 June 1999 and 30 June 2000, it is relatively conservative; and by reference to 31 December 1999, that it is less volatile and more internally consistent.

This approach has the additional attraction of excluding the effect of any matter other than the contravening conduct, because all other influences on price are reflected in the actual price movements on the ASX, and seeking to identify only the impact of the contravening conduct. It also means that the hypothetical price will fluctuate proportionately to fluctuations in the actual price, rather than being a fixed “straight line” for each six-month period.

I have independently concluded that this approach is to be preferred. However, as is apparent from what is already set out, it was tested with both experts, and the parties were invited to make submissions in respect of it. Both parties accepted that this approach was open. In their closing written submissions, the plaintiffs accepted that it was open to the Court to proceed on this basis, and did not seek to raise any argument against its availability. [86] Although the defendants resisted the proposition that logic dictated that, had the market known that the assets were worth 10% less than it thought they were, it would have discounted the price by 10%, the defendants accepted the corollary – that it was a valid and accepted methodology to reason that, if the market applied a price to book multiple of 0.91 to the reported book, it would have applied the same multiple to the “true” book had it known the “true” book was 10% less. [87] As it transpired, this acceptance may have initially been based on an incorrect assumption as to timing, reflected in a graph produced by the defendants. Nonetheless, the defendants agreed that it was an acceptable methodology. [88]

Accordingly, in principle, plaintiffs who acquired their shares when the FY1999 results were in circulation are entitled to damages equivalent to 6.25% of the price they paid; those who acquired their shares when the FY2000 interim results were in circulation, to 9.5% of the price paid, and those who acquired their shares when the FY2000 final results were in circulation, to 13% of the price paid.

My conclusions may be summarised as follows.

The consolidated HIH financial statements incorporated, in the results of the consolidated entity, those of its subsidiaries. Thus, the misleading information ultimately contained in the reported financial results was originally generated by FAI and C&G, included in their financial statements, and carried forward into the consolidated HIH financial statements. The misstatement in the subsidiaries’ financial statements was the genesis of the misrepresentations in the reported financial results of HIH. In this way, the treatment of the Hannover Re arrangements by FAI and C&G in their financial statements was a fundamental input to the contravening conduct. “Participation”, in the relevant sense, is established.

Publication of the subsidiaries’ accounts was authorised by Mr Fodera, in both relevant years; accordingly, it is Mr Fodera’s knowledge that is relevant. Given his position and role in both HIH and the subsidiaries, his accountancy background and experience, the manifest purpose of the Hannover Re transactions in strengthening the appearance of HIH’s financial statements but not in fact removing the risk from HIH, and his involvement in executing transaction documents, hypotheses that he had a mistaken understanding of the Hannover Re arrangements or did not understand their proper accounting treatment, or passively acquiesced in them without forming any considered view as to their effect, are highly improbable. In the absence of any contrary evidence, I am comfortably satisfied on the balance of probabilities that Mr Fodera knew that the treatment of the Hannover Re arrangements in the FAI and C&G financial statements would be replicated in the consolidated HIH results, and, so replicated, would create a misleading and deceptive appearance of HIH’s operating profit for the relevant periods.

It follows, pursuant to TPA, s 84, that FAI and C&G had the requisite knowledge of the essential facts constituting HIH’s contraventions, and by publication of their own financial statements were knowingly concerned in and/or party to the contraventions, so as to incur liability in respect of them as persons involved in the contraventions.

Digi-Tech and Ingot do not deny recoverability in a case such as the present on the basis of indirect market causation. “Indirect causation” is available in a case such as the present, and direct reliance need not be established, although the plaintiffs must establish, by evidence or inference, that the contravening conduct did inflate the market.

On the remaining issues in respect of Dr Coulton’s approach:

Once the above resolutions of those issues are incorporated into Dr Coulton’s approach, the result is to attribute to an HIH share during the relevant periods the hypothetical prices $1.50 as at 30 June 1999, $1.67 at 31 December 1999 and $0.93 at 30 June 2000, which represent respectively 83%, 119% and 93% of actual market price at those dates.

However, the better approach to evaluating the impact of the contravening conduct on the share price is to identify the difference between the price at which HIH shares actually traded on the market, and the hypothetical price achieved by applying the price to book value at which they actually traded to an adjusted book (adjusting only for the Hannover Re arrangements). On that basis, the shares would have traded at 93.75% of actual price after the FY1999 results were released, 90.54% after the FY2000 interim results were released, and 86.90% after the FY2000 final results were released.

That also demonstrates that the contravening conduct did inflate the price for HIH shares, so that indirect causation in fact is established.

Accordingly, in principle – subject to issues affecting particular cases which are reserved for further argument – plaintiffs who acquired their shares during the period 25 August 1999 to 2 March 2000 are entitled to damages equivalent to 6.25% of the price they paid; those who acquired their shares during the period 3 March 2000 to 17 October 2000 to 9.5% of the price paid, and those who acquired their shares after 17 October 2000 to 13% of the price paid.

I direct that the parties bring in short minutes to give effect to this judgment (including if necessary directions for the resolution of any remaining issues) on a date to be fixed.