Second Circuit Relaxes Burden for Proving Price Impact, Loss Causation
Reprinted with permission from the December 9, 2016 issue of The Legal Intelligencer. © 2016 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.
On Sept. 27, the U.S. Court of Appeals for the Second Circuit affirmed the Southern District of New York's post-trial rulings in the long-pending securities class action, In re Vivendi Universal, S.A. Securities Litigation, 838 F.3d 223, 2016 U.S. App. LEXIS 17566 (2d Cir. 2016). After a three-month trial, a jury entered a verdict against Vivendi, finding that, during the Oct. 30, 2000-Aug. 14, 2002, class period, the company made 57 material misstatements that artificially inflated its stock price in violation of Section 10(b) of the Securities Exchange Act of 1934 and the U.S. Securities and Exchange Commission Rule 10b-5. The district court denied Vivendi's motions for judgment as a matter of law and for a new trial with respect to all but one of the alleged misrepresentations.
On appeal, Vivendi challenged the district court's rulings on several grounds, all of which the Second Circuit rejected. In its opinion, the court answered in the affirmative two important questions that the Supreme Court has not yet addressed: whether a plaintiff can prove a Section 10(b) claim under a "price maintenance theory" of price impact, and whether a plaintiff can prove loss causation with respect to an alleged misrepresentation where the concealed risk never materialized and the defendant never made a corrective disclosure.
Factual Background
Between 1998 and 2001, Vivendi transformed itself from a French utilities conglomerate into a global entertainment and media conglomerate through a series of multi-billion-dollar, heavily leveraged mergers and acquisitions. By 2002, the company was "running critically low" on funds and "in danger of not being able to meet all of its various payment obligations." Nonetheless, "up until approximately July 2002, Vivendi made numerous representations to the market suggesting that the course ahead for the company was smooth sailing." Beginning in June 2002, the company's stock price "came tumbling down ... after a series of credit downgrades and revelations that Vivendi was strapped for cash." The plaintiffs filed their securities class action soon thereafter.
Price Impact
The Supreme Court's decision in Halliburton v. Erica P. John Fund ( Halliburton II ), 134 S. Ct. 2398 (2014), allows a defendant in a securities class action to rebut the fraud-on-the-market presumption of reliance permitted under Basic v. Levinson, 485 U.S. 224 (1988), by showing that its alleged misrepresentations had no impact on its stock price. Under Halliburton II, a defendant may show a lack of price impact with appropriate evidence that either "the asserted misrepresentation (or its correction) did not affect the market price of the defendant's stock"; see Vivendi, 2016 U.S. App. LEXIS 17566, at *73-74 (explaining that if alleged misrepresentations "do not affect the stock price, then there is 'no grounding for any contention that investors indirectly relied on those misrepresentations through their reliance on the integrity of the market price'") (quoting Amgen v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184, 1199 (2013)).
In its appeal to the Second Circuit, Vivendi argued that the district court should have precluded the artificial inflation analysis presented by the plaintiffs' damages expert, Dr. Blaine Nye. According to Vivendi, Dr. Nye's analysis was unreliable because it failed to directly correlate most of the company's misstatements with an increase in stock price inflation. As summarized in the court's opinion, Vivendi argued that "statements that introduce new inflation actually affect a company's stock price, while statements that merely maintain inflation have no impact. And the reason they have no 'price impact' is because the 'preexisting inflation would have persisted' had the defendant who made those inflation-maintaining statements 'simply remained silent' as was the defendant's right in the absence of a duty to disclose."
The Second Circuit rejected Vivendi's argument, stating that it "agreed with the Seventh and Eleventh circuits that securities-fraud defendants cannot avoid liability for an alleged misstatement merely because the misstatement is not associated with an uptick in inflation," (citing Glickenhaus & Co. v. Household International, 787 F.3d 408, 418 (7th Cir. 2015), and FindWhat Investor Group v. FindWhat.com, 658 F.3d 1282, 1316 (11th Cir. 2011)). According to the court's reasoning, "it is far more coherent to conclude that such a misstatement does not simply maintain the inflation, but indeed 'prevents [the] preexisting inflation in a stock price from dissipating.'"
As we explained in our June 7, article, the Eighth Circuit rejected the price maintenance theory in IBEW Local 98 Pension Fund v. Best Buy, 818 F.3d 775 (8th Cir. 2016). Thus, there is a split among the circuit courts on this issue.
Loss Causation
To prove the essential element of loss causation, a plaintiff must show a causal connection between the alleged material misrepresentation or omission and the plaintiff's economic loss, as in Dura Pharmaceuticals v. Broudo, 544 U.S. 336, 341-44 (2005). In the Second Circuit, "a plaintiff must show that the loss was a foreseeable result of the defendant's conduct (i.e., the fraud), and that the loss was caused by the materialization of the ... risk concealed by the defendant's alleged fraud."
In its appeal, Vivendi argued that the plaintiffs failed to establish loss causation, since the company's liquidity risk "never materialized into an objective event such as bankruptcy, default, or insolvency." But the Second Circuit rejected this contention, explaining that "to show loss causation, it is enough that the loss caused by the alleged fraud results from the 'relevant truth ... leaking out.'"
In other words, "whether the truth comes out by way of a corrective disclosure describing the precise fraud inherent in the alleged misstatements, or through events constructively disclosing the fraud, does not alter the basic loss-causation calculus."
In applying these principles to the evidence plaintiffs presented at trial, the court noted that, "although no specific corrective disclosure ever exposed the precise extent of Vivendi's alleged fraud, Plaintiffs' theory of loss causation nevertheless rested on the revelation of the truth." Thus, the plaintiffs' evidence was "sufficient for the jury to conclude that the nine events identified by Dr. Nye revealed the truth about Vivendi's liquidity risk, and that concealment of the subject of Vivendi's alleged misstatements—its liquidity risk—was therefore the cause of the actual loss suffered by [the plaintiffs]."
The Second Circuit's opinion in Vivendi relaxes plaintiffs' burden for proving loss causation. In similar cases, where "events constructively disclose the fraud," plaintiffs will not need to point to a corrective disclosure or the materialization of a concealed risk to prove this essential element of their Section 10(b) claim.
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