Pleading By Euphemism

Two recent decisions from the U.S. Court of Appeals for the Ninth Circuit demonstrate that a fair amount of judicial discretion goes into determining whether the inference of loss causation created by a complaint’s factual allegations is either “unreasonable” or “facially plausible.”

(1) In Metzler Investment GMBH v. Corinthian Colleges, Inc., 2008 WL 2853402 (9th Cir. July 25, 2008), the court examined whether a news story and a press release that lead to stock price declines could “be reasonably read to reveal widespread financial aid manipulation by Corinthian.” The court found that the news story only discussed a Department of Education investigation into improper financial aid practices at one of Corinthian’s schools and, therefore, could not have revealed the supposed fraud. As for the later press release, the plaintiffs alleged that the announcement of higher than anticipated student attrition was understood by the market as the company’s “euphemism for an admission that they had enrolled students who should not have been signed up at all, resulting in a 45% stock price drop.” The court was unwilling to credit this inference, holding that although the corrective disclosure does not have to be an admission of fraud, “that does not allow a plaintiff to plead loss causation through ‘euphemism.'”

Holding: Dismissal affirmed.

Quote of note: “So long as there is a drop in a stock’s price, a plaintiff will always be able to contend that the market ‘understood’ a defendant’s statement precipitating a loss as a coded message revealing the fraud. Enabling a plaintiff to proceed on such a theory would effectively resurrect what Dura discredited – that loss causation is established through an allegation that a stock was purchased at an inflated price. Loss causation requires more.”

(2)In In re Gilead Sciences Sec. Litig., 2008 WL 3271039 (9th Cir. Aug. 11, 2008), the court examined whether loss causation was adequately plead where the market was alerted to the company’s off-label marketing efforts by an FDA warning letter in August 2003 (no decline in stock price), but the alleged financial impact to the company of the FDA warning letter was not announced until October 2003 (12% decline in stock price). The lower court found that it was unreasonable to infer that the August 2003 revelation caused a stock price decline nearly three months later and that the October 2003 announcement of a slowing increase in demand for the relevant product was too speculative a basis for finding loss causation. On appeal, the court held that “a limited temporal gap between the time a misrepresentation is publicly revealed and the subsequent decline in stock value does not render a plaintiff’s theory of loss causation per se implausible.” Moreover, the warning letter’s effect on product demand may not have been understood by the market until the October 2003 announcement.

Holding: Dismissal reversed.

Quote of note: “It is true that the court need not accept as true conclusory allegations, nor make unwarranted deductions or unreasonable inferences. But so long as the plaintiff alleges facts to support a theory that is not facially implausible, the court’s skepticism is best reserved for later stages of the proceedings when the plaintiff’s case can be rejected on evidentiary grounds.”

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