In Massachusetts Retirement Systems v. CVS Caremark Corp., 2013 WL 2278599 (1st Cir. May 24, 2013), the plaintiffs asserted that the company had failed to disclose integration problems following a merger. The district court dismissed on loss causation grounds, holding that the complaint did not plausibly allege that the company's statements prior to the stock price decline, which related to lost contracts, revealed the supposed fraud. On appeal, the First Circuit provided guidance on how to evaluate loss causation.
(1) "Mirror-image" disclosure not required - The court found that "a corrective disclosure need not be a 'mirror-image' disclosure - a direct admission that a previous statement is untrue." Although the company did not attribute its lost contracts to integration issues, the company's statements "plausibly revealed to the market that CVS Caremark had problems with service and the integration of its systems." In particular, the court noted that the strongly negative analyst and stock price reaction "likely reflected an understanding that something systemic had gone wrong."
(2) Lost contracts v. reason for lost contracts - The defendants argued that CVS Caremark's loss of certain clients "was public knowledge" well before the disclosures that led to the stock price decline. The court agreed that the market knew about the lost contracts, but concluded that the core allegation in the complaint was that the disclosures revealed "for the first time the real reason for the loss: the failed integration of CVS and Caremark" and "this new information could plausibly have caused [the plaintiffs] losses."
(3) Use of analyst reports - To support their assertions about the "meaning" of the company's disclosures, the plaintiffs relied heavily on analyst reports. The court held that "[w]hen a plaintiff alleges corrective disclosures that are not straightforward admissions of a defendant's previous misrepresentations, it is appropriate to look for indications of the market's contemporaneous response to those statements." In this case, the analyst reports plausibly reflected an understanding that "the merger had failed to produce any value for CVS Caremark" and the reports "should have been considered in deciding the motion to dismiss."
Holding: Dismissal vacated and case remanded for further proceedings.
Section 11 of the '33 Act creates liability for material misrepresentations in a registration statement. According to the Second Circuit (Fait) and Ninth Circuit (Rubke), however, if the alleged misrepresentation is an opinion, the plaintiff must establish that the opinion was both objectively false and disbelieved by the defendant at the time it was made. In effect, these rulings convert a Section 11 claim based on an opinion from a strict liability (the company) or negligence (the individual defendants) standard to a knowing falsity standard.
The Omnicare securities litigation has generated a number of decisions discussing the pleading standards for Section 11 claims. After the district court dismissed the case, the Sixth Circuit reversed as to the Section 11 claim, finding that the district court had erred by requiring the plaintiffs to plead loss causation. The plaintiffs initially pursued a writ of certiorari on the issue of whether Section 11 claims can be subject to the heightened pleading standard of FRCP 9(b), but then, after the U.S. Supreme Court asked for the government's view of the cert request, withdrew their petition and went back to the district court. The district court then dismissed the Section 11 claim again, finding that the alleged misrepresentations were opinions and the plaintiffs had failed to sufficiently plead the defendants' knowledge of falsity.
In Indiana State District Council of Laborers v. Omincare, Inc., 2013 WL 2248970 (6th Cir. May 23, 2013), the court examined the "knowing falsity" rule for opinions. The court found that while it "makes sense that a defendant cannot be liable for a fraudulent misstatement or omission under Section 10(b) and Rule 10b-5 if he did not know the statement was false at the time it was made" that logic does not extend to strict liability claims. Under Section 11, if a defendant "discloses information that includes a material misstatement, that is sufficient and a complaint may survive a motion to dismiss without pleading knowledge of falsity." Nor was the court persuaded by the reasoning of the Second and Ninth Circuits, which had relied on the Supreme Court's decision in the Virginia Bankshares case interpreting a non-strict-liability securities statute. According to the court, "it would be unwise for this Court to add an element to Section 11 claims based on little more than a tea-leaf reading in a Section 14(a) case."
Holding: Dismissal reversed in part and affirmed in part.
In a famous market manipulation that lead to multiple criminal convictions, the A.R. Baron brokerage engaged in a pump-and-dump scheme to induce customers to purchase the securities of small companies at artificially inflated prices. Among many others, investors sued an individual whose acts allegedly facilitated Baron's frauds in violation of Section 10(b). The district court dismissed the Section 10(b) claim.
On appeal, the Second Circuit addressed this dismissal (Fezzani v. Bear Stearns & Co., Inc., 2013 WL 1876534 (2d Cir. May 7, 2013) (Lohier, J. dissenting). The court found that manipulation violates Section 10(b) "when an artificial or phony price of a security is communicated to persons who, in reliance upon a misrepresentation that the price was set by market forces, purchase the securities." The Supreme Court, in its decisions in Stoneridge and Janus, has held that in a Section 10(b) claim involving a misrepresentation there can only be primary liability for entities or individuals who actually communicated the misrepresentation to the injured investors. Applying that principle in the instant case, the court found that because there was no allegation that the individual defendant actually communicated the artificial price information to the investors (as opposed to assisting Baron in its fraud), there could be no Section 10(b) primary liability.
In a vigorous dissent, however, one of the panel members challenged whether Stoneridge and Janus are applicable in a case alleging market manipulation. The dissent noted that a "market manipulation claim permits the plaintiff to plead that it relied on an assumption of an efficient market free of manipulation, whereas a misrepresentation claim requires the plaintiff to allege reliance upon a misrepresentation or omission." As a result, a plaintiff alleging market manipulation is entitled to use a fraud-on-the-market theory to establish reliance (i.e., the defendant engaged in a transaction that sent a fale pricing signal to the market, which was then communicated by the market to the investor). Accordingly, the dissent concluded, the fact that the individual defendant was a key participant in the transactions that sent a false pricing signal was sufficient to establish Section 10(b) primary liability.
Holding: Dismissal affirmed.
Quote of note (dissent): "I fear that every market manipulator . . . will be cheered by the extra shelter for stock manipulation under the federal securities laws that the majority opinion unnecessarily provides them. If I thought that Stoneridge or Janus required that result, I would shrug, concur, and move on. Because I conclude that neither case forecloses the federal claim of market manipulation against Dweck, I respectfully dissent."
Based on the Supreme Court's recent decisions, a plaintiff is not required to prove the existence of loss causation (Halliburton) or materiality (Amgen) to certify an investor class. In the Halliburton case, however, the defendants pursued a related issue on remand. Halliburton argued that it should be allowed to rebut the fraud-on-the-market presumption of reliance by establishing that the alleged misrepresentations did not have a stock price impact. The district court found that price impact evidence did not bear on the critical inquiry of whether common issues predominated under FRCP 23(b)(3) and certified the class. Halliburton appealed.
In Erica P. John Fund, Inc. v. Halliburton Company, 2013 WL 1809760 (5th Cir. April 30, 2013), the Fifth Circuit found that "Halliburton's price impact evidence potentially demonstrates that despite the presence of the necessary conditions for market price incorporation of fraudulent information (fraud-on-the-market reliance), no such incorporation occurred in fact." Although this evidence certainly could be used at trial to refute the presumption of reliance, the court questioned whether it was appropriate to consider it at class certification.
Under Amgen, the court held, price impact evidence should not be considered if it is "common to the class" and if there is no risk "that a later failure of proof on the common question of price impact will result in individual questions predominating." The court found that both criteria were met and the district court did not err in declining to consider Halliburton's price impact evidence. First, "price impact is ordinarily established by expert evaluation of a stock's market price following a specific event and it inherently applies to everyone in the class." Second, although defeating the presumption of reliance would presumably still leave open the possibility of individual claims, "[i]f Halliburton were to successfully show that the price did not drop when the truth was revealed, then no plaintiff could establish loss causation." Accordingly, the claims of all individual plaintiffs would fail.
Holding: Affirming grant of class certification.
Addition: As detailed in a February 2010 post, the Halliburton case has a remarkable procedural history that now includes a Supreme Court decision and two Fifth Circuit decisions on class certification. What next?