Let’s Play Two

The U.S. Court of Appeals for the Fourth Circuit has issued a decision that addresses two pressing securities litigation issues. In Teachers’ Retirement System of Louisiana v. Hunter, 2007 WL 509787 (4th Cir. Feb. 20, 2007), the court considered: (a) whether the plaintiffs could establish the scienter of the corporate defendant using a collective scienter theory; and (b) what is the proper pleading standard for loss causation.

Collective scienter – The court rejected the idea that a corporate defendant’s scienter can be established based on the collective knowledge of its employees. Specifically, the court held that “if the defendant is a corporation, the plaintiff must allege facts that support a strong inference of scienter with respect to at least one authorized agent of the corporation, since corporate liability derives from the actions of its agents.” Although the court did not expressly determine whether the agent also must be alleged to have made a misstatement, the court’s citation to the Southland decision (5th Cir.) offers some support for that interpretation.

Loss causation – The court noted that in Dura the U.S. Supreme Court expressly did not decide whether the pleading of loss causation is governed by Fed. R. Civ. P. 9(b). In examining the issue, the court found that a “strong case can be made that because loss causation is among the ‘circumstances constituting fraud’ for which Rule 9(b) demands particularity, loss causation should be pleaded with particularity.” Based on this observation and the public policy concerns outlined in Dura, the court concluded that loss causation must be plead “with sufficient specificity to enable the court to evaluate whether the necessary causal link exists.” In the instant case, the court found that the plaintiffs did not adequately plead loss causation. Although the disclosure that caused the stock price decline accused the corporate defendant of fraud, it did not provide any “new facts” that “revealed [the corporate defendant’s] previous representations to have been fraudulent.”

Holding: Dismissal affirmed (based on the failure to adequately plead falsity, scienter, and loss causation).

Disclosure: The author of The 10b-5 Daily represented the defendants in this litigation.

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