August 3, 2012

Offsetting Gains and Attributing Losses

What evidence is necessary to establish loss causation and economic damages? Two recent circuit court decisions address this issue, albeit at different stages of a securities fraud case.

(1) In Aciticon AG v. China North East Petroleum Holdings, Ltd., 2012 WL 3104589 (2d Cir. Aug. 1, 2012), the lower court dismissed the case based on the plaintiffs' failure to adequately plead economic damages. Within a couple of months after the "final allegedly corrective disclosure" was made, the company's stock price rose above the lead plaintiff's average purchase price. The lower court held that a "plaintiff who foregoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure."

On appeal, the Second Circuit rejected this economic-loss rule as "inconsistent with the traditional out-of-pocket measure of damages, which calculates economic loss based on the value of the time of the security at the time that the fraud became known." The court noted that "a share of stock that has regained its value after a period of decline is not functionally equivalent to an inflated share that has never lost value." To hold otherwise, would allow defendants to improperly "offset gains that that plaintiff recovers after the fraud becomes known against losses caused by the revelation of the fraud if the stock recovers value for completely unrelated reasons." Accordingly, the court held, "the [stock price] recovery does not negate the inference that [the lead plaintiff] has suffered an economic loss."

Holding: Dismissal reversed and case remanded.

(2) In Hubbard v. BankAtlantic Bancorp, Inc., 2012 WL 2985112 (11th Cir. July 23, 2012), the plaintiffs alleged that BankAtlantic fraudulently concealed the poor credit quality of its commercial real estate portfolio. The plaintiff’s only evidence of loss causation was the testimony of its expert. After a trial, the court granted judgment as a matter of law to the defendants based on the plaintiffs' failure to establish loss causation.

On appeal, the Eleventh Circuit agreed with the lower court (albeit on a slightly different basis). The court found that a plaintiff must "offer evidence sufficient to allow the jury to separate portions of the price decline attributable to causes unrelated to the fraud, leaving only the part of the price decline attributed to the dissipation of the fraud-induced inflation." The study conducted by the plaintiffs’ expert was supposed to isolate which part of the stock price drop was caused by the materialization of the risk concealed by BankAtlantic. But it failed to adequately take into account that BankAtlantic’s assets were concentrated in loans tied to Florida real estate. The court noted that there was a general downturn in the Florida real estate market at the relevant time, which may have been a substantial cause of the stock price drop. Because the plaintiffs' evidence failed to exclude this possibility, the court affirmed the lower court's decision.

Holding: Judgment affirmed.

Posted by Lyle Roberts at August 3, 2012 6:14 PM | TrackBack
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