A variation on the normal securities fraud case occurs when a short seller alleges that a company's misstatements caused it to cover its short positions at artificially high prices. Although few cases have directly addressed loss causation in the context of short selling, they generally are not favorable for the plaintiffs. That trend continues in the recent decision in Wilamowsky v. Take-Two Interactive Software, Inc., 2011 WL 4542754 (S.D.N.Y. Sept. 30, 2011).
Take-Two previously had settled a securities class action related to options backdating, but the settlement's plan of allocation excluded short sellers from recovery. Wilamowsky opted out of the settlement and brought his own individual action. On the issue of loss causation, however, the court noted that Wilamowsky's transactions in Take-Two stock (both short sales and covering purchases) ended "prior to the relevant curative disclosure." As a result, Wilamowsky could not "plausibly articulate why [his alleged] losses are attributable to Defendants' misstatements and omissions" as opposed to "legitimate market circumstances and intervening events." The court found that was "particularly so here, where the in-and-out stock transactions began after the stock price was already inflated, spanned an extended time period punctuated by constant legitimate market stimuli and repeated misstatements, and terminated more than a year prior to the corrective disclosure."
Holding: Dismissed with prejudice.
Quote of note: "With hindsight, Plaintiff may wish that he either covered immediately at the end of his short-selling period in January 2005, when the stock fell below his average sale price, or waited until after the corrective disclosure, by which point the price declined enough to put him in a position to earn millions of dollars. But allowing him to state a claim under these circumstances would permit a short seller in any standard misrepresentation case to either win big in the marketplace by covering after a corrective disclosure, or win in court by 'transforming a private securities action into a partial downside insurance policy.'"
A few items from around the web.
(1) The first dismissal in the current wave of China-related securities class actions has occured, but it is difficult to read too much into the decision. In In Re China North East Petroleum Holdings Ltd. Sec. Litig., 2011 WL 4801515 (S.D.N.Y. Oct. 6, 2011), the court concluded that the lead plaintiff had not suffered any economic loss. 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 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." The New York Law Journal has an article (subscrip. req'd) on the decision.
(2) The National Law Journal has an interesting interview (free regist. req'd) with the lead defense counsel in a recent civil securities fraud trial. The case was brought by investors against the former CEO of Homestore.com, who had previously plead guilty to related criminal charges. Although the jury found that the former CEO was liable for certain misstatements that caused $46 million in losses, he was not required to pay any damages because other defendants had already paid more than that amount to settle the claims against them.
(3) The D&O Diary has an informative roundup of the U.S. securities class action filing activity through the third quarter of 2011. At the present pace, there will be 205 filings this year, which is just slightly above the post-PSLRA average.
Is it necessary for the alleged false statements to have artificially inflated the company's stock price to establish loss causation? The Eleventh Circuit recently considered this question in a case where the plaintiffs' expert found that the company's stock price was artificially inflated both before and during the class period by the same amount. The district court granted summary judgment for the defendants, concluding that because the stock price inflation predated the class period, the alleged false statements made during the class period could not have caused the inflation or any subsequent losses.
On appeal - FindWhat Investor Group v. FindWhat.com, 2011 WL 4506180 (11th Cir. Sept. 30, 2011) - the Eleventh Circuit disagreed. The court concluded that false statements "that prevent a stock price from falling can cause harm by prolonging the period during which the stock is traded at inflated prices." Accordingly, "defendants can be liable for knowingly and intentionally causing a stock price to remain inflated by preventing preexisting inflation from dissipating from the stock price."
Holding: Vacating dismissal of claims based on failure to establish loss causation (but affirming the dismissal of certain other claims)
Quote of note: "Defendants whose fraud prevents preexisting inflation in a stock price from dissipating are just as liable as defendants whose fraud introduces inflation into the stock price in the first instance. We decline to erect a per se rule that, once a market is already misinformed about a particular truth, corporations are free to knowingly and intentionally reinforce material misconceptions by repeating falsehoods with impunity."