The issue of loss causation is proving to be difficult for the S.D.N.Y. as it addresses the numerous research analyst cases. The general theme of the cases is straightforward: the defendants committed fraud by disseminating research reports that they knew to be overly optimistic. A key question, however, has been whether the subsequent decline in the company’s stock price was caused by the research reports.
In the Merrill Lynch decision, the court found that there was no alleged connection between the research reports and the companies’ financial troubles or the collapse of the overall market. In distinguishing that case, other S.D.N.Y. judges have pointed to additional facts linking the research reports to the alleged loss. In the Robertson Stephens decision, for example, the court noted that there was “evidence that disclosure of defendants’ scheme caused a further decline in the price of [the] stock, even after the overall bubble had burst.” While in the WorldCom decision, the plaintiffs had alleged that the analyst was aware of and concealed the accounting irregularities that led to the loss.
This week has seen the issuance of another research analyst decision from the S.D.N.Y., with what appears to be a new take on loss causation. In DeMarco v. Lehman Brothers, Inc., 2004 WL 602668 (S.D.N.Y. March 29, 2004), the plaintiffs allege that a Lehman analyst made buy recommendations for RealNetworks, Inc. stock during the class period (July 11, 2000 to July 18, 2001) while secretly holding negative views of the stock. In October 2000, the stock price declined, allegedly causing plaintiffs’ losses. Investors did not discover that the Lehman analyst had misled them about his opinion on RealNetworks until the release of certain e-mails by the SEC in April 2003.
On the issue of loss causation the court made the following holding:
“[A]ssuming arguendo that plaintiffs must plead that their losses proximately resulted from the marketplace’s reaction to the revelation of the truth that defendant’s actionable statements concealed (as contrasted to independent market forces), the Complaint adequately alleges that in or around October 2000, the market was finally apprised of the negative information concerning RealNetworks that had earlier led [the Lehman analyst] to take a secretly negative view of the stock and that, as a result of these revelations, the stock declined, causing the losses on which plaintiff here sues.”
The decision leaves a number of questions unanswered:
(1) Did the plaintiffs allege any facts demonstrating that the analyst knew about negative information that was not available to the market? (This factual scenario is suggested by the holding, but there is nothing in the decision to support it.)
(2) If the answer to Question 1 is no, what about the Merrill Lynch decision, which would appear to have reached the opposite conclusion on loss causation (but is not discussed by the court)?
(3) If the loss occurred in or around October 2000, how can the class period extend until July 18, 2001?
Things are getting interesting. Here’s a final question: what is the Second Circuit going to say about all of this and when?
Holding: Motion to dismiss denied.
Addition: As to when the Second Circuit is going to deal with the issue of loss causation and the research analyst cases, a good guess is as part of the Merrill Lynch appeal. The scheduling order for the appeal states that briefing will be completed on May 24, with argument to be heard as early as the week of July 12. Thanks to Adam Savett for passing along this information.
The 10b-5 Daily 
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