Everybody’s Talking About Loss Causation

Just when you thought there could not possibly be another appellate loss causation pleading case this summer, along comes the Second Circuit to clarify its position on the issue.

To recap the current scorecard, a clear split in authority has developed between courts that believe plaintiffs must demonstrate a causal connection between the alleged misrepresentations and a subsequent decline in the stock price to establish loss causation (Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir. 2000); Robbins v. Koger Props, Inc., 116 F.3d 1441 (11th Cir. 1997)) and courts that believe plaintiffs merely need to demonstrate that the alleged misrepresentations artificially inflated the stock price (Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824 (8th Cir. 2003); Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003)). (The 10b-5 Daily has discussed the Gebhardt and Broudo cases, both decided in the last few months, in previous posts.)

Breaking the apparent tie is the Second Circuit’s opinion in Emergent Capital Investment Management, LLC v. Stonepath Group, Inc., 2003 WL 22053957 (2d Cir. Sept. 4, 2003), which clarifies some confusion over the Second Circuit’s approach to loss causation. Several courts, including the Ninth Circuit in the Broudo decision, have concluded that the Second Circuit finds allegations of artificial price inflation sufficient to plead loss causation (relying on a 2001 opinion in the Suez Equity case). Not so fast.

In Emergent Capital, the court found that the plaintiff’s “pump-and-dump” allegations were sufficient to establish loss causation. Judge Cardamone, however, took exception to the plaintiff’s attempt to cite his earlier decision in Suez Equity for the position that a “purchase-time value disparity” can satisfy the loss causation pleading requirement. Devoting an entire section of the opinion to the question, Judge Cardamone clarifies:

“We did not mean to suggest in Suez Equity that a purchase-time loss allegation alone could satisfy the loss causation pleading requirement. To the contrary, we emphasized that the plaintiffs had ‘also adequately alleged a second, related, loss–that [the executive’s] concealed lack of managerial ability induced [the company’s] failure.’ Moreover, we expressly distinguished that case from one where the ultimate decline in the market price of a company’s securities would be unrelated to that company’s manager’s concealed negative history.”

The court goes on to conclude that Suez Equity did not undermine the Second Circuit’s “established requirement that securities fraud plaintiffs demonstrate a causal connection between the content of the alleged misrepresentations or omissions and ‘the harm actually suffered.'”

So now we know where the Second Circuit stands. Anybody else? There’s still a week of summer left!

Holding: Judgment of the district court is affirmed, in part, and vacated, in part, and remanded to the district court.

Many thanks to Colin Wrabley for pointing The 10b-5 Daily to this case.

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