April 8, 2011

Picking Sides

The U.S. Court of Appeals for the Third Circuit has weighed in on two controversial issues concerning loss causation and scheme liability. In In re DVI, Inc. Sec. Litig., 2011 WL 1125926 (3rd Cir. March 29, 2011), the court examined the lower court's decision to grant class certification, except as to the claims against the company's outside law firm. The key holdings are:

(1) Loss causation - The court addressed the issue currently before the U.S. Supreme Court in the Halliburton case, i.e., does a plaintiff have to establish loss causation to obtain class certification. In agreement with the Second Circuit and Seventh Circuit (but contrary to the Fifth Circuit), the court held that "a plaintiff need not demonstrate loss causation as a prerequisite to invoking the fraud-on-the-market presumption of reliance." Instead, the burden is on the defendant to introduce evidence "demonstrating an allegedly corrective disclosure did not move the market - that there was no market impact and therefore no loss causation" which "may in some circumstances rebut the presumption of reliance."

(2) Scheme liability - The plaintiffs argued that the Stoneridge decision created a "remoteness test" for assessing whether investors had relied on the fraudulent conduct of secondary actors. The remoteness test allegedly requires courts to assess: (a) the defendant's level of involvement in the fraudulent scheme, (b) whether the misrepresentation was the "necessary or inevitable" result of the defendant's conduct, and (c) whether the defendant's conduct took place in the "investment sphere." Like the Second Circuit, the court rejected this argument, finding that the only issue was whether the deceptive conduct "has been publicly disclosed and attributed to the actor." In the instant case, because the plaintiffs did "not contend that the outside law firm's role in masterminding the fraudulent 10-Q was disclosed to the public, they cannot invoke the [fraud-on-the-market presumption of reliance]."

Holding: Judgment affirmed.

Posted by Lyle Roberts at April 8, 2011 11:27 PM | TrackBack
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