S.D.N.Y. On Materiality

Only one recent case to report on, but it is fairly interesting:

In re Allied Capital Corp. Sec. Litig., 2003 WL 19641843 (S.D.N.Y. April 25, 2003) involved allegations that Allied Capital’s “flawed valuation policy” caused it to overvalue its investments in nine companies and materially misstate those values in its public filings. An outside hedge manager publicly questioned Allied’s valuation practices, resulting in a stock price decline from $25.99 to $23.20. Within a week, however, the stock had regained most of that loss.

The court found that plaintiffs had failed to adequately plead that defendants made fraudulent or misleading statements because: (1) “plaintiffs have not sufficiently pled that Allied’s valuation policies resulted in its overvaluing of some investments;” and (2) “plaintiffs do not allege that Allied followed different valuation policies than those that it described in its public filings, or that Allied concealed any relevant information about the companies in which it invested.”

More interestingly, the court determined that the alleged misstatements were immaterial. (According to 2d Cir. precedent, for a court to determine on a motion to dismiss that the alleged misstatement or omission is immaterial it must be “so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of [its] importance.”) The court gave three reasons for its ruling.

First, the investments in the nine companies represented just over 10% of Allied’s portfolio. Given that Allied’s public disclosures clearly stated that the valuation process was inexact, “no reasonable investor could consider the fact that a small proportion of Allied’s holdings might have values that were debatable (which is all the Complaint alleges) to be material.”

Second, the stock price declined less than 10%, and then quickly rebounded, negating any inference of materiality.

Finally, “any number of factors unrelated to the alleged overstatements could have contributed to the decline in price on May 16,” including the statements from the hedge fund manager, which might be untrue.

Holding: Motion to dismiss granted.

Quote of note: “In addition, the stock price’s recovery, in the face of a general decline in the market, negates any inference of materiality, because it indicates that investors quickly determined that the ‘new’ information was not material to their investment decisions.” Does that mean that a quick recovery in the stock price will always lead to the conclusion that the alleged misstatements are immaterial?

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