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On the same day that it issued its “Model V” decision, the Second Circuit issued another opinion in the Vivendi securities litigation addressing whether “value investors” can invoke the fraud-on-the-market presumption of reliance.

In Gamco Investors, Inc. v. Vivendi Universal, S.A., 2016 WL 5389281 (2d Cir. Sept. 27, 2016), the district court held that Vivendi had successfully rebutted the fraud-on-the-market presumption.  In particular, the court found “that, given the facts in the record, Vivendi proved that GAMCO would have purchased Vivendi securities even if it had known of Vivendi’s alleged fraud.”  The district court entered judgment for the defendant.  (Click here for a summary of an earlier decision in the case on this issue).

On appeal, the Second Circuit rejected GAMCO’s contention that the district court had created a blanket rule barring “value investors” from invoking the fraud-on-the-market presumption because those investors do not necessarily consider the market price to be an efficient reflection of the value of the security.  Instead, the panel focused on the evidence and concluded that it was sufficient to establish that “had GAMCO known of Vivendi’s liquidity problems, GAMCO would still have believed, first, that Vivendi’s securities were substantially undervalued by the market and second, that an event was likely to happen in the next few years that would awake the market to that fact.”  Accordingly, “the district court did not clearly err in concluding, on this record, that in this case, and with regard to this particular fraud” that GAMCO could not establish reliance on the alleged misrepresentations.

Holding: Judgment of district court affirmed.

In a typical securities fraud case, where the plaintiff alleges that a misrepresentation artificially inflated the company’s stock price, the defendant may be able to rebut reliance by providing evidence that there was no stock price increase as a result of the misrepresentation. 

At least two circuit courts (Seventh and Eleventh), however, have recognized an alternative “price maintenance theory” of artificial inflation.  Under the price maintenance theory, a misrepresentation can artificially inflate a stock’s price by improperly maintaining the existing price (e.g., by repeating prior falsehoods and preventing the stock’s price from falling to its true value). The Pfizer case decided by the Second Circuit earlier this year caused some speculation as to whether that court might break with its sister circuits on price maintenance, but this week the Second Circuit firmly endorsed the theory.

In In re Vivendi, S.A. Sec. Lit., 2016 WL 5389288 (2d Cir. Sept. 27, 2016), Vivendi argued that the trial court had improperly admitted expert testimony about a series of alleged misrepresentations that had not caused stock price increases.  The Second Circuit found, however, that “[i]t is hardly illogical or inconsistent with precedent to find that a statement may cause inflation not simply by adding it to a stock, but by maintaining it.”  Any other result would allow companies to “eschew securities-fraud liability whenever they actively perpetuate (i.e., through affirmative misstatements) inflation that is already extant in their stock price, as long as they cannot be found liable for whatever originally introduced the inflation.”  Accordingly, the court held that it did “not accept Vivendi’s position that the ‘price impact’ requirement inherent in the reliance element of a private § 10(b) action means that an alleged misstatement must be associated with an increase in inflation to have any effect on a company’s stock price.”

Holding: Partial judgment of trial court affirmed.

Quote of note: “Suppose an automobile manufacturer widely praised for selling the world’s safest cars plans to release a new model (‘Model V’) in the near future. The market believes that Model V, like all of the company’s previous models, is safe, or has no reason to think otherwise. In fact, the automobile manufacturer knows that Model V has failed crash test after crash test; it is, in short, simply unfit to be on the road. To protect its stock price, however, the automobile manufacturer informs the market, as per routine industry practice, that Model V has passed all safety tests. When the truth eventually reaches the market, the automobile manufacturer’s stock price bottoms out. . . . [T]he question of the automobile manufacturer’s liability for securities fraud does not turn on whether inflation moved incrementally upwards when the company represented to the market that the new model passed all safety tests. Nor does it rest on whether the market originally arrived at a misconception about the model’s safety on its own, or whether the company led the market to that misconception in the first place.” 

The Sixth Circuit continues to be a source of interesting opinions regarding corporate scienter.  In 2014, the court held in its Omnicare decision that only a limited set of corporate officers (including officers who had either made or approved the alleged misstatements) could have their state of mind imputed to the company.  But what about lower corporate officers who know about undisclosed problems and fail to report them?

In Doshi v. General Cable Corp., 2016 WL 2991006 (6th Cir. 2016), the court addressed a case arising out of General Cable’s financial restatement, which was the result of a “complex theft scheme in Brazil and, to a somewhat lesser extent, accounting errors, primarily in Brazil.”  The plaintiffs alleged that the head of the company’s “Rest of World” (ROW) division, which included Brazil, knew about these issues but failed to report them to the executive management.  Moreover, the plaintiffs argued, his knowledge could be imputed to General Cable because he “furnished information used in General Cable’s false public financial statements.”

The court found that even if the head of the ROW division had acted recklessly,  in the absence of any allegations that he had “drafted, reviewed, or approved” the alleged misstatements, “only his knowledge of the theft and accounting errors – not his state of mind – imputes to General Cable.”  The court then applied its normal “scienter factors” to determine whether the plaintiffs had adequately plead that the company, with that knowledge, had acted with a fraudulent intent.  Ultimately, the court found that the more compelling inference was that “a theft scheme racked General Cable’s operations in Brazil where local managers overrode accounting procedures, which, when coupled with the legitimate freedom afforded ROW to report its financial data, led General Cable to issue materially false public financial statements.”  Accordingly, the plaintiffs’ allegations failed “to create a strong inference that General Cable acted with scienter.”

Holding: Dismissal affirmed.

Plaintiffs often establish the existence of loss causation by pointing to a “corrective disclosure” that allegedly revealed the fraud and led to a stock price decline. What a disclosure must contain to be deemed “corrective,” however, has been the subject of extensive debate.

In Rand-Heart of New York v. Dolan, 2016 WL 521075 (8^th Cir. Feb. 10, 2016), the plaintiffs alleged that Dolan, a professional services company, had failed to adequately disclose that a major customer had stopped sending new work to the company in early 2013.  It was not until November 2013 that Dolan told securities analysts about the problem.  Although the company’s stock price declined based on that announcement, the plaintiffs argued that the fraud was not fully revealed until January 2014, when the company also announced that it had hired a new restructuring officer and the stock price declined again.

While the U.S. Court of Appeals for the Eighth Circuit was willing to allow claims based on the early 2013 to November 2013 time period to proceed, it found that the plaintiffs had inadequately plead loss causation as to any claims based on the November 2013 to January 2014 time period. The court agreed with the Fourth Circuit and Eleventh Circuit that a “corrective disclosure” must contain “new facts” about the alleged fraud to provide a basis for establishing loss causation.  In contrast, “the appointment of a restructuring officer on January 2 does not correct a misrepresentation; it elaborates on the previously disclosed plan to restructure.”

Holding: Dismissal affirmed in part, reversed in part, and case remanded for further proceedings.