The 10b-5 Daily

Under the fraud on the market theory, reliance by investors on an alleged misrepresentation is presumed if the company’s shares were traded on an efficient market. The investors are not entitled to the presumption, however, if they are unable to show that the misrepresentation actually affected the market price of the stock.

The U.S. Court of Appeals for the Fifth Circuit issued an opinion this week, Greenberg v. Crossroads Systems, Inc., No. 03-50311 (5th Cir. April 14, 2004), discussing the fraud on the market theory in a case where the plaintiffs failed to establish that the defendants’ falsely positive statements had increased the company’s stock price. Under these circumstances, the determinations of reliance and loss causation essentially merged, with the court holding that the plaintiffs were only entitled to a presumption of reliance for the falsely positive statements that they could connect to the subsequent decline in the company’s stock price when the “truth” was revealed.

Holding: Affirming in part and vacating in part the district court’s grant of summary judgment.

Quote of note: “We are satisfied that plaintiffs cannot trigger the presumption of reliance by simply offering evidence of any decrease in price following the release of negative information. Such evidence does not raise an inference that the stock’s price was actually affected by an earlier release of positive information. To raise an inference through a decline in stock price that an earlier false, positive statement actually affected a stock’s price, the plaintiffs must show that the false statement causing the increase was related to the statement causing the decrease. Without such a showing there is no basis for presuming reliance by the plaintiffs.”

Here’s a good law school exam question — does a finding of liability under Rule 10b-5 in a private securities case require a reward of damages? The U.S. Court of Appeals for the Fourth Circuit submitted an essay answer today in the form of an opinion in Miller v. Asensio & Co., Inc., No. 03-1225 (4th Cir. April 14, 2004).

Asensio was a short seller that publicized negative statements about Chromatics Color Sciences Int., Inc. (“CCSI”), a company in which it had a significant short sell interest. Stockholders of CCSI sued Asensio alleging that the statements were material misrepresentations, “which Asensio initiated to defraud the market for its benefit, and which caused their CCSI stock to decline in value resulting in substantial losses to them.” After a trial, the jury returned a verdict finding Asensio liable, but awarding $0.00 in damages. On appeal, the stockholders argued that the finding of liability required the award of damages in some amount.

The Fourth Circuit disagreed (after noting that the issue was one of first impression). Courts “often refer to the fact of proximately caused damage and the amount of proximately caused damage as involving separate, although related, inquiries.” To establish Rule 10b-5 liability, a plaintiff only has to prove that the defendant’s misrepresentation was a “substantial cause of the loss” by showing a “direct or proximate relationship between the loss and the mispresentation.” Accordingly, a jury could find that “(1) the plaintiff proved the defendant’s fraud constituted a substantial cause of plaintiff’s loss and so find the defendant liable but (2) the plaintiff failed to provide a method to discern, by just and reasonable inference, the amount of plaintiff’s loss solely caused by defendant’s fraud, and so refuse to award the plaintiff any damages.”

Applying these principles to the case in hand, the Fourth Circuit found that “the evidence at trial provided the jurors with a sound basis on which to reach the result they did.”

Holding: Affirmed.

Quote of note: “In the vast majority of cases, a finding of the fact of proximately caused loss will result in the award of some amount of damages. However, it would seem contrary to Congress’ mandate that a plaintiff prove that the defendant ’caused the loss,’ 15 U.S.C. § 78u4(b)(4), and that no plaintiff ‘shall recover . . . a total amount in excess of his actual damages on account of the act complained of,’ 15 U.S.C. § 78bb(a), to direct a jury that it must award damages, even if faced, as here, with a record from which it cannot do so.”

The “group pleading” doctrine creates the presumption that the senior officers of a company are collectively responsible for misrepresentations or omissions contained in public statements made by the company (e.g., press releases, SEC filings). District courts are divided over whether a plaintiff’s ability to plead in this manner has survived the enactment of the PSLRA with its heightened pleading standards for securities fraud.

Last week, the U.S. Court of Appeals for the Fifth Circuit made a strong statement against the use of group pleading. In Southland Sec. Corp. v. INSpire Ins. Solutions, Inc., 2004 WL 626721 (5th Cir. March 31, 2004), the court held that group pleading “cannot withstand the PSLRA’s specific requirement that the untrue statements be set forth with particularity as to ‘the defendant’ and that scienter be pleaded with regard to ‘each act or omission sufficient to give rise to a strong inference that the defendant acted with the required state of mind.'” As a result of the PSLRA’s repeated references to “the defendant,” the court found that Congress intended plaintiffs to inform each defendant of his or her particular role in the alleged fraud.

Holding: Affirmed in part, reversed in part (the decision also contains an interesting, if relatively uncontroversial, discussion on determining scienter for a corporate defendant).

Quote of note: “[C]orporate officers may not be held responsible for unattributed corporate statements solely on the basis of their titles, even if their general day-to-day involvement in the corporation’s affairs is pleaded. However, corporate documents that have no stated author or statements within documents not attributed to any individual may be charged to one or more corporate officers provided specific factual allegations link the individual to the statement at issue.”