Can a plaintiff in a securities class action use information gained through the discovery process to resurrect previously dismissed claims? In In re Constellation Energy Group, Inc. Sec. Litig., 2012 WL 1067651 (D. Md. March 28, 2012), the court dismissed all of the fraud claims (1934 Act), but allowed the non-fraud claims (1933 Act) to proceed. Following discovery, the plaintiff argued that it had found "new evidence of scienter" and moved for lead to amend its complaint to re-plead the fraud claims.
The court held that neither the plain language nor the purpose of the PSLRA would be frustrated by allowing the fraud claims to go forward. The PSLRA's discovery stay provision (which stays all discovery pending the resolution of a motion to dismiss) was designed to "limit the pressure on innocent defendants to settle cases in lieu of proceeding to expensive discovery" not "to shield all defendants from any adverse evidence that may properly be discovered over the course of litigation." Moreover, the case was still ongoing against the same defendants, so they would not be prejudiced by having to defend themselves against the new claims. In this instance, however, the court denied the motion for leave to amend as futile, finding that even with the new evidence the plaintiff had failed to satisfy the "strong inference" pleading standard for scienter.
Holding: Motion for leave to amend denied.
There is rarely a dull moment when Judge Frank Easterbrook writes a securities litigation opinion. In Fulton County Employees Retirement System v. MGIC Investment Corp., 675 F.3d 1047 (7th Cir. April 12, 2012) (Easterbrook, J.) the court addressed a credit crisis case in which a mortgage loan insurer allegedly made misstatements about the liquidity of an affiliated company. The decision includes a few interesting holdings.
(1) MGIC stated in a press release that the affiliated company (in which MGIC held a 46% interest) had "substantial liquidity," but eleven days later announced that its investment in the affiliated company was "materially impaired." The court concluded that the liquidity statement was inactionable both because it was true when made and because the press release contained specific warnings about the liquidity risk at the affiliated company.
(2) Moreover, the court noted that the events that led to the material impairment of the investment were known to the market. To the extent that the "whole world knew that firms that had issued, packaged, or insured subprime loans were in distress," MGIC was in no better position to foresee what would happen to its investment than anyone else.
(3) The plaintiffs also alleged that certain statements made by officers of the affiliated company during MGIC's earnings call were fraudulent. The court held that (a) MGIC's ownership interest in the affiliated company was insufficient to establish that it "controlled" the affiliate (especially given that another company also had a 46% stake) for purposes of control person liability, and (b) pursuant to the recent Janus decision, MGIC could not be held liable as a "maker" of the affiliated company's statements and had no duty to correct them.
Holding: Dismissal affirmed.
Quote of Note: "The press release went on to detail problems that MGIC was encountering, including the liquidity risk at [the affiliated company]. The goal of this paragraph was to let investors know about the trouble without painting too gloomy a picture. A balancing act of that nature cannot sensibly be described as fraud."
The efficient market hypothesis can be a double-edged sword for plaintiffs. While it is necessary to support a presumption of reliance in securities class actions, it also makes courts skeptical of any theory of fraud that is based on the corporate defendant failing to inform the market about the impact of known events.
In City of Omaha, Nebraska Civilian Employees' Retirement System v. CBS Corp., 2012 WL 1624022 (2d Cir. May 10, 2012), the plaintiffs alleged that CBS should have performed an impairment test on its goodwill and disclosed the results several months before it actually did so in October 2008. The Second Circuit affirmed the dismissal of the case on two grounds.
First, the court held, based on on its prior Fait decision, that estimates of goodwill are statements of opinion. The plaintiffs' failure to allege "that defendants did not believe in their statements of opinion regarding CBS's goodwill at the time they made them" was fatal to their securities fraud claims.
Second, the court found that "all of the information alleged to constitute 'red flags' calling for interim impairment testing . . . were matters of public knowledge." Given the efficiency of the market for CBS stock, the price therefore "would at all pertinent times have reflected the need for, if any, or culpable failure to undertake, if any, interim impairment testing." Under these circumstances, the complaint did not allege in a plausible fashion that "the market price of CBS stock was inflated by a fraud" and that the plaintiffs relied upon that fraudulently inflated price.
Holding: Dismissal affirmed.
On a personal note, Lyle Roberts (the author of The 10b-5 Daily) has joined the Washington, DC office of Cooley LLP. The firm's press release can be found here. Posting has been correspondingly light, but will pick up shortly.