The Apollo Group securities class action has turned out to be far more interesting than anyone could have predicted. The case is based on the company's alleged failure to disclose the existence of a government report finding that its wholly-owned subsidiary, the University of Phoenix, had violated Department of Education regulations.
After a jury trial, the plaintiffs won a $277.5 million verdict. The trial court, however, held that the plaintiffs had failed to prove loss causation and overturned the verdict. In its decision, the court found that the two analyst reports relied upon by the plaintiffs as "corrective disclosures" that led to a stock price decline "did not provide any new, fraud-revealing analysis." Instead, the reports merely repeated information about the government report already known to the market or provided information about the University of Phoenix that was factually wrong (and therefore could not have been corrective).
The plaintiffs appealed to the Ninth Circuit and, in a summary, unpublished opinion, the appellate court held that "the jury could have reasonably found that the [analyst] reports following various newspaper articles were ‘corrective disclosures’ providing additional or more authoritative fraud-related information that deflated the stock price."
So it is on to the Supreme Court, where the question will be whether the justices are ready to revisit the issue of loss causation a mere five years after their Dura decision. Commentators are making a strong argument that the court should grant cert. The Ninth Circuit's decision appears to suggest that the efficient market hypothesis, which forms the basis for the presumption of reliance in securities class actions, somehow does not really apply when examining loss causation. In other words, the market rapidly absorbs information for the purpose of allowing investors to argue that they relied on false information incorporated into the stock price, but once that information is disclosed, these same investors can argue that it was only when the media or analysts more widely broadcast the information that their loss occurred.
In a recent New York Law Journal column (Dec. 8 edition - subscrip. req'd), the authors discuss the case and the related circuit splits over the necessary timing and nature of a "corrective disclosure." SCOTUSblog has the cert petition and other pertinent information here. According to the docket, a number of amicus briefs have already been filed (e.g., a brief from the National Association of Manufacturers supporting the granting of the cert petition).
Oral argument in the Janus case took place this morning. The early verdict is that the U.S. Supreme Court may be headed toward a split decision on whether the investment manager of a fund can be subject to primary liability for securities fraud based on alleged misstatements in the fund's prospectuses.
A few highlights (based on the transcript):
(1) Petitioner (Janus) conceded that its in-house counsel had drafted the prospectuses on behalf of the fund, but argued that the fund was governed by its trustees who were responsible for the contents and issuance of the prospectuses. The court spent a considerable amount of time exploring the nature of the relationship between an investment advisor and a fund. In particular, various members of the court (J. Breyer, J. Kennedy, J. Sotomayor) probed as to whether an investment advisor should be viewed as the equivalent of a corporate manager who can be held liable for the corporation's misstatements.
(2) Justice Sotomayor and Justice Ginsburg both suggested that under Petitioner's theory, a corporate entity could avoid liability by duping another corporate entity into making the misstatements. Petitioner responded that a "dupe case" is addressed in Section 20(b) of the Exchange Act ("the ventriloquist dummy statute"), which makes it unlawful for a person to effect a securities fraud through another person.
(3) Respondent (investors) argued that the Court should adopt the SEC's interpretation of what it means to "make" a statement, i.e., "to create or compose or to accept as one's own." Justice Scalia was skeptical, suggesting that if Respondent was "talking about making heaven and earth, yes, that means to create, but if you're talking about making a representation, that means presenting the representation to someone, not drafting it for someone else to make."
(4) As to whether an investment advisor was the equivalent of a corporate manager, despite the fact that it is an independent entity, Respondent asserted that "contractually outsourc[ing] the management function should not alleviate the securities fraud that is alleged here." Moreover, the investment advisor had "substantive control over the content of the message" and, therefore, was not a mere aider and abettor. In response, Justice Kagan questioned the relevance of "control" given that Respondent had not brought its case under Section 20 of the Exchange Act and presumably could not have done so because of the nature of the relationship between a fund and its investment advisor.
Can a plaintiff adequately allege or prove loss causation by pointing to a corrective disclosure that reveals the company's financial results and condition, even if the disclosure does not directly reveal any alleged misrepresentations? Courts have been reluctant to apply this "true financial condition theory," especially at the proof stage of a case. The U.S. Court of Appeals for the Ninth Circuit is the latest court to find that an earnings miss, or similar adverse financial result, is by itself insufficient to establish loss causation.
In In re Oracle Corp. Sec. Litig., 2010 WL 4608794 (9th Cir. Nov. 16, 2010), the Ninth Circuit reviewed a grant of summary judgment for the defendants. The district court held that plaintiffs failed to identify sufficient evidence as to loss causation for their non-forecasting claims. In particular, plaintiffs relied on an earning miss rather than any actual disclosure about defects in a key product.
On appeal, the Ninth Circuit agreed that the "overwhelming evidence produced during discovery indicates the market understood Oracle's earnings miss to be a result of several deals lost in the final weeks of the quarter," not "that customers did not buy [the product] as a result of defects." The fact that two analyst reports questioned this explanation for the earnings miss could not overcome the "market's consensus." Moreover, Oracle continued to sell large amounts of the product during the following quarter, suggesting that there was no public knowledge of the supposedly concealed defects.
Holding: Grant of summary judgment affirmed.
Quote of note: "Plaintiffs take issue with our opinion in Metzler. Specifically, they assert that they should be able to prove loss causation by showing that the market reacted to the purported 'impact' of the alleged fraud—the earnings miss—rather than to the fraudulent acts themselves. We reject that assertion. Loss causation requires more than an earnings miss."