The 10b-5 Daily

When a court grants a motion to dismiss a securitites class action based on the failure to meet the heightened pleading standards of the PSLRA, the plaintiffs often seek to file an amended complaint addressing the identified deficiences. At least one court has found, however, that plaintiffs cannot take a wait-and-see-what-happens approach if they are aware of additional facts.

In In re Stone & Webster, Inc. Sec. Litig., 217 F.R.D. 96 (D. Mass. 2003), the court addressed whether to grant a motion for leave to file a second consolidated and amended complaint after dismissing most of the claims in the case because they were not plead with the required specificity. The plaintiffs premised their motion “on the theory that the facts that would allegedly remedy the pleading defects identified in the [court’s] order were ‘newly discovered,’ [but] conceded at the scheduling conference that much of this information was in fact available to them during the pendency of the motions to dismiss.” The court found that the plaintiffs’ failure to provide these additional facts while the court considered the motion to dismiss was “precisely the sort of ‘undue delay’ that should result in a denial of leave to amend.”

Holding: Motion for leave to amend denied.

Quote of note: “The fact that the plaintiffs chose to oppose the motions to dismiss on the grounds that their complaint was, in their view, sufficiently pleaded, rather than providing the additional information known to them during the necessarily lengthy period during which the motions to dismiss were being considered, smacks of gamesmanship bordering on bad faith.”

Securities Litigation Watch notes that the recent decision in the K-Mart case (see this post) addresses loss causation and appears to follow the line of cases holding that merely alleging the stock was purchased at an artificially inflated price does not adequately plead a “causal nexus” between the misstatement and any economic harm. The 10b-5 Daily recently summarized the current split of appellate authority on this issue.

According to Second Circuit precedent, for a court to determine on a motion to dismiss in a securities fraud case that the alleged misstatement or omission is immaterial, it must be “so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of [its] importance.” Judges in the S.D.N.Y. recently have been exploring what “obviously unimportant” means, with favorable results for defendants. (See this post in The 10b-5 Daily for a discussion of the Allied Capital case.)

In re Duke Energy Corp. Sec. Litig., 2003 WL 22170716 (S.D.N.Y. September 17, 2003), involved allegations that Duke Energy had failed adequately to disclose that its revenues were overstated due to “round trip” or “wash transactions,” involving simultaneous sales and purchases of energy at the same prices and in the same amounts. The stock price dropped over the time period that the company made announcements concerning the discovery of these trades. Finally, in August 2002, the company confirmed that it had engaged in $217 million of these transactions.

The court found that the concealment of these transactions could not have been material. An inflation of $217 million in Duke Energy’s revenues over a two-year period amounted to about 0.3% of the company’s total revenues — a total that the court found immaterial as a matter of law. The plaintiffs made two counterarguments that were rejected by the court as insufficient.

First, the plaintiffs argued that the fall in share price after the announcement of the discovery of these transactions demonstrated that they were material to investors. The court found: (a) the plaintiffs’ allegations of a connection between the company’s disclosures and the stock price decline were too vague (really a loss causation argument); and (b) “bare allegations of stock price declines cannot cure the immateriality of an overstatement as small as the one here at issue.”

Second, the plaintiffs argued that the nondisclosure was qualitatively material because it involved illegal activity. The court found that even assuming that the transactions were illegal, the failure to disclose them did “not give rise to a securities claims if their only effect in terms of what was disclosed to the public was a miniscule 0.3% inflation of revenues.”

Holding: Motion to dismiss with prejudice granted.

Quote of note: “Plaintiffs are vague about what constituted this underlying ‘illegality,’ as ‘wash sales’ and ’round-trip trading’ are not necessarily illegal per se. But even assuming they were, illegality of a financial nature (as opposed, say, to rape or murder) must still be assessed, for disclosure purposes, by its economic impact. Otherwise, every time a giant corporation failed to disclose a petty theft in its mailroom, it would be liable under the securities laws.”