Not Exactly Meritless

Can a company face securities fraud liability for describing a lawsuit brought against it as “meritless” if the plaintiff goes on to win a big verdict?  In Grobler v. Neovasc, Inc., 2016 WL 6897760 (D. Mass. Nov. 22, 2016), Neovasc was hit with a $70 million verdict in a case alleging that it stole intellectual property, its stock price declined by 75 percent when the verdict was announced, and investors brought a securities class action.  The investors alleged that Neovasc had lied when it repeatedly told them that the intellectual property case was “without merit” and “baseless.”

The district court concluded that the PSLRA’s safe harbor for forward-looking statements applied to Neovasc’s statements.  First, the statements “were predictions about the future outcome of the pending litigation, and could only be invalidated by reference to the ultimate outcome of the case.”  Second, the statements were accompanied by meaningful cautionary language that “included detailed and specific warnings about the possibility and the consequences of losing” the intellectual property case.  Finally, whether Neovasc actually believed that it was likely to lose the intellectual property case was irrelevant because “examining an alleged present belief apart from the forward-looking aspects of the statement requires an inquiry into the state of mind of the defendant—something that the first prong of the safe harbor provision is written to ignore.”  Accordingly, the court found that the alleged false statements were inactionable.

Holding: Motion to dismiss granted with prejudice.

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On This Record

On the same day that it issued its “Model V” decision, the Second Circuit issued another opinion in the Vivendi securities litigation addressing whether “value investors” can invoke the fraud-on-the-market presumption of reliance.

In Gamco Investors, Inc. v. Vivendi Universal, S.A., 2016 WL 5389281 (2d Cir. Sept. 27, 2016), the district court held that Vivendi had successfully rebutted the fraud-on-the-market presumption.  In particular, the court found “that, given the facts in the record, Vivendi proved that GAMCO would have purchased Vivendi securities even if it had known of Vivendi’s alleged fraud.”  The district court entered judgment for the defendant.  (Click here for a summary of an earlier decision in the case on this issue).

On appeal, the Second Circuit rejected GAMCO’s contention that the district court had created a blanket rule barring “value investors” from invoking the fraud-on-the-market presumption because those investors do not necessarily consider the market price to be an efficient reflection of the value of the security.  Instead, the panel focused on the evidence and concluded that it was sufficient to establish that “had GAMCO known of Vivendi’s liquidity problems, GAMCO would still have believed, first, that Vivendi’s securities were substantially undervalued by the market and second, that an event was likely to happen in the next few years that would awake the market to that fact.”  Accordingly, “the district court did not clearly err in concluding, on this record, that in this case, and with regard to this particular fraud” that GAMCO could not establish reliance on the alleged misrepresentations.

Holding: Judgment of district court affirmed.

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Don’t Buy a “Model V”

In a typical securities fraud case, where the plaintiff alleges that a misrepresentation artificially inflated the company’s stock price, the defendant may be able to rebut reliance by providing evidence that there was no stock price increase as a result of the misrepresentation. 

At least two circuit courts (Seventh and Eleventh), however, have recognized an alternative “price maintenance theory” of artificial inflation.  Under the price maintenance theory, a misrepresentation can artificially inflate a stock’s price by improperly maintaining the existing price (e.g., by repeating prior falsehoods and preventing the stock’s price from falling to its true value). The Pfizer case decided by the Second Circuit earlier this year caused some speculation as to whether that court might break with its sister circuits on price maintenance, but this week the Second Circuit firmly endorsed the theory.

In In re Vivendi, S.A. Sec. Lit., 2016 WL 5389288 (2d Cir. Sept. 27, 2016), Vivendi argued that the trial court had improperly admitted expert testimony about a series of alleged misrepresentations that had not caused stock price increases.  The Second Circuit found, however, that “[i]t is hardly illogical or inconsistent with precedent to find that a statement may cause inflation not simply by adding it to a stock, but by maintaining it.”  Any other result would allow companies to “eschew securities-fraud liability whenever they actively perpetuate (i.e., through affirmative misstatements) inflation that is already extant in their stock price, as long as they cannot be found liable for whatever originally introduced the inflation.”  Accordingly, the court held that it did “not accept Vivendi’s position that the ‘price impact’ requirement inherent in the reliance element of a private § 10(b) action means that an alleged misstatement must be associated with an increase in inflation to have any effect on a company’s stock price.”

Holding: Partial judgment of trial court affirmed.

Quote of note: “Suppose an automobile manufacturer widely praised for selling the world’s safest cars plans to release a new model (‘Model V’) in the near future. The market believes that Model V, like all of the company’s previous models, is safe, or has no reason to think otherwise. In fact, the automobile manufacturer knows that Model V has failed crash test after crash test; it is, in short, simply unfit to be on the road. To protect its stock price, however, the automobile manufacturer informs the market, as per routine industry practice, that Model V has passed all safety tests. When the truth eventually reaches the market, the automobile manufacturer’s stock price bottoms out. . . . [T]he question of the automobile manufacturer’s liability for securities fraud does not turn on whether inflation moved incrementally upwards when the company represented to the market that the new model passed all safety tests. Nor does it rest on whether the market originally arrived at a misconception about the model’s safety on its own, or whether the company led the market to that misconception in the first place.” 

 

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The Gold Standard

In securities class actions, plaintiffs sometimes struggle to establish loss causation where the market does not react consistently to the “revelations of the truth.” An interesting recent example can be found in a decision from the District of Nevada involving a gold mining company.

In In re Allied Nevada Gold CorpSec. Litig., 2016 WL 4191017 (D. Nev. August 8, 2016), the plaintiffs alleged that the company had misled investors about its operational difficulties, cash position, and projected financial performance.  According to the plaintiffs, these problems were slowly revealed to the market in a series of partial disclosures ending in August 2013. All of the alleged partial disclosures, however, did not result in stock price declines.

The July 2013 partial disclosure, for example, led to a stock price increase.  The plaintiffs attributed this anomaly to “surging gold prices.”  The problem with that position, however, was that the subsequent August 2013 partial disclosure and stock price decline occurred in the midst of a sharp drop in gold prices.  The court found that “[p]laintiffs have not offered an adequate explanation as to why Allied’s stock price was tied to the price of gold after one disclosure but not the other.”  Accordingly, the court held that “[p]laintiffs have not adequately alleged that the alleged misrepresentations were a substantial cause in the decline in value of their stock.”

Held: Motion to dismiss granted (plaintiffs also failed to adequately allege falsity and scienter).

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A More Sober Approach

The author of The 10b-5 Daily has a guest post on Forbes concerning the use of confidential witnesses in securities class actions.  Please give it a read.

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Scienter Samba

The Sixth Circuit continues to be a source of interesting opinions regarding corporate scienter.  In 2014, the court held in its Omnicare decision that only a limited set of corporate officers (including officers who had either made or approved the alleged misstatements) could have their state of mind imputed to the company.  But what about lower corporate officers who know about undisclosed problems and fail to report them?

In Doshi v. General Cable Corp., 2016 WL 2991006 (6th Cir. 2016), the court addressed a case arising out of General Cable’s financial restatement, which was the result of a “complex theft scheme in Brazil and, to a somewhat lesser extent, accounting errors, primarily in Brazil.”  The plaintiffs alleged that the head of the company’s “Rest of World” (ROW) division, which included Brazil, knew about these issues but failed to report them to the executive management.  Moreover, the plaintiffs argued, his knowledge could be imputed to General Cable because he “furnished information used in General Cable’s false public financial statements.”

The court found that even if the head of the ROW division had acted recklessly,  in the absence of any allegations that he had “drafted, reviewed, or approved” the alleged misstatements, “only his knowledge of the theft and accounting errors – not his state of mind – imputes to General Cable.”  The court then applied its normal “scienter factors” to determine whether the plaintiffs had adequately plead that the company, with that knowledge, had acted with a fraudulent intent.  Ultimately, the court found that the more compelling inference was that “a theft scheme racked General Cable’s operations in Brazil where local managers overrode accounting procedures, which, when coupled with the legitimate freedom afforded ROW to report its financial data, led General Cable to issue materially false public financial statements.”  Accordingly, the plaintiffs’ allegations failed “to create a strong inference that General Cable acted with scienter.”

Holding: Dismissal affirmed.

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Shaky Ground

In Halliburton II, the U.S. Supreme Court held that defendants can rebut the fraud-on-the-market presumption of reliance at the class certification stage with evidence of a lack of stock price impact.  In a typical case, where the plaintiff alleges that a misrepresentation artificially inflated the company’s stock price, the defendant can satisfy this requirement by providing evidence that there was no stock price increase as a result of the misrepresentation. 

At least two circuit courts (Seventh and Eleventh), however, have recognized an alternative “price maintenance theory” of artificial inflation.  Under the price maintenance theory, a misrepresentation can artificially inflate a stock’s price by improperly maintaining the existing price (e.g., by repeating prior falsehoods and preventing the stock’s price from falling to its true value).  But how does a defendant provide evidence to establish a lack of stock price impact under these circumstances?

Perhaps because of the inherent tension between Halliburton II and the price maintenance theory, two recent circuit court decisions appear to question the theory’s use in securities class actions.

In IBEW Local 98 Pension Fund v. Best Buy Co., Inc., 2016 WL 1425807 (8th Cir. April 12, 2016), the court held that the district court had improperly certified a class based on statements made in an earnings call.  According to experts for both sides, the statements were merely confirmatory and did not cause the company’s stock price to increase.  While the plaintiffs argued that a price increase was not necessary under their price maintenance theory, the court found that the “theory provided no evidence that refuted defendants’ overwhelming evidence of no price impact.”

In In re Pfizer Inc. Sec. Litig., 2016 WL 1426211 (2nd Cir. April 12, 2016), the court addressed the issue more indirectly.  The district court granted summary judgment for the defendants after excluding the plaintiffs’ loss causation and damages expert from testifying.  On appeal, the court found that the plaintiffs were relying on a price maintenance theory and that the expert’s testimony would be helpful to the jury in that context.  As to the theory itself, however, the court went out of its way to note that it was not  deciding whether it was “either legally or factually sustainable” and that it “might be that Plaintiffs’ inflation-maintenance theory is deficient under Rule 10b-5.”

As noted by the dissent in the Best Buy case, “[n]either the Supreme Court nor any circuit court has however discussed the type of showing needed to rebut [] a presumption of reliance in a price maintenance case.”  Until that issue is addressed, the price maintenance theory appears to be on shaky ground.

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