An announcement that a company is the target of a government investigation is likely to lead to a stock price decline. The mere fact of an investigation, however, does not tell the market anything about the existence of prior corporate misstatements. Accordingly, some appellate courts have concluded that this type of announcement is not a “corrective disclosure” that can be used to establish loss causation. But what if the company later issues a corrective disclosure revealing that there were prior corporate misstatements related to the subject matter of the investigation? Given that factual scenario, those same appellate courts appear inclined to reverse field and find that the government investigation was a “partial corrective disclosure” that was later confirmed by the company.
In Lloyd v. CVB Financial Corp., 2016 WL384773 (9th Cir. Feb. 1, 2016), the court addressed what appears to be a paradigmatic fact pattern. In August 2010, CVB announced that it had received a SEC subpoena concerning its lending practices. Analysts speculated that the subpoena related specifically to loans made to a certain property company. Following the announcement, CVB’s stock price dropped by 22%. A month later, CVB announced that the property company was unable to pay its loans as scheduled and the bank took a large impairment charge related to the loans. The company’s stock price did not move significantly following this announcement, but at least one analyst speculated that this was because “further deterioration in credit quality and uncertainly surrounding the SEC investigation [were] already reflected in the share price.”
The Ninth Circuit concluded that the investigation announcement standing alone was insufficient to establish loss causation. Once CVB disclosed that it was charging off millions of dollars in loans, however, it was reasonable to conclude that the plaintiffs had plead a sufficient causal connection between the earlier stock price decline and the alleged fraud.
The problem with decisions based on paradigmatic fact patterns is that they leave room for interpretation if the facts are less clear. What if the market had not connected the SEC investigation to the particular loans at issue? What if the company’s decision to take a charge had been announced a year, rather than a month, after the disclosure of the SEC investigation? What if the company’s stock price had moved significantly after the company took its charge? All questions for another day.
Holding: Dismissal affirmed in part, reversed in part, and remanded.
Quote of note: “Under the facts of this case, loss causation is sufficiently pleaded. Indeed, any other rule would allow a defendant to escape liability by first announcing a government investigation and then waiting until the market reacted before revealing that prior representations under investigation were false.”