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.”