Commercial Litigation and Arbitration

Securities — Circuit Split as to Whether PSLRA’s Heightened Pleading Standards Apply to Loss Causation Allegations — Rebound in Stock Price after Disclosure of Fraud Does Not Defeat Inference of Economic Loss

Acticon AG v. China NE Petroleum Holdings Ltd., 2012 WL 3104589 (2d Cir. Aug. 1, 2012):

This case requires us to consider whether the fact that a stock’s share price recovered soon after the fraud became known defeats an inference of economic loss in a securities fraud suit. Plaintiff–Appellant Acticon AG (“Acticon”) is the lead plaintiff in a consolidated putative class action suit against China North East Petroleum Holdings Limited (“NEP”) brought pursuant to §§ 10(b) & 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) & 78t(a), and under SEC Rule 1 0b–5, 17 C.F.R. § 240.10b–5. Acticon alleges that NEP misled investors about its reported earnings, oil reserves, and internal controls. It further alleges that NEP revealed this information through a series of corrective disclosures and that in the trading days after each disclosure was made, NEP’s stock price dropped. NEP argues that these allegations are not sufficient to allege economic loss because its share price rebounded on certain days after the final disclosure to the point that Acticon could have sold its holdings and avoided a loss. We disagree. For the reasons below, we hold this price recovery does not defeat an inference of economic loss. Accordingly, we vacate the judgment of the District Court and remand for further proceedings not inconsistent with this opinion. ***

[T]he District Court granted defendants’ motion to dismiss. It held as a matter of law that Acticon did not suffer an economic loss, grounding its holding in a line of cases applying Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005). In its words, “Since Dura, courts have held as a matter of law that a purchaser suffers no economic loss if he holds stock whose post-disclosure price has risen above purchase price-even if that price had initially fallen after the corrective disclosure was made.” In re China Ne. Petroleum Holdings Ltd. Secs. Litig., 819 F.Supp.2d 351, 352 (S.D.N.Y.2011). It observed that Acticon had purchased 60,000 NEP shares with an average purchase price of $7.25 per share. Id. at 353. NEP stock had closed at a price higher than $7.25 on twelve days during October and November 2010 after NEP was relisted. Id. The District Court held that because Acticon had foregone multiple opportunities to sell its shares at a profit, it had not suffered an economic loss. Id. It therefore dismissed the consolidated complaint. Id. at 354. ***

After Dura, it is unclear whether the plaintiffs must satisfy the “short and plain statement of the claim” standard demanded by Rule 8(a)(2) or the more stringent heightened pleading requirements of Rule 9(b) in pleading economic loss. In Dura, the Supreme Court “assume[d], at least for argument’s sake, that neither the Rules nor the securities statutes impose any special further requirement in respect to the pleading of proximate causation or economic loss.” 544 U.S. at 346.

Although we are aware of no decision by our sister Circuits considering which pleading standard plaintiffs must satisfy to adequately allege economic loss in the wake of Dura, several Circuits have considered which pleading standard applies to loss causation. This analysis is instructive because Dura considered the two elements together and left the pleading standard applicable to loss causation equally ambiguous. The Circuits have split in the wake of Dura as to which rule applies to loss causation. The Fourth Circuit has held that heightened pleading requirements of Rule 9(b) apply to the element of loss causation because it is “among the circumstances constituting fraud.” Katyle v. Penn Nat’l Gaming, Inc., 637 F.3d 462, 471 & n. 5 (4th Cir.2011) (internal quotations omitted). The Fifth Circuit, in contrast, has held that only the requirements of Rule 8(a)(2) apply, relying upon the fact that the Supreme Court in Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007), construed Dura in formulating its plausibility standard. Lormand v. U.S. Unwired, Inc., 565 F.3d 228, 256–58 (5th Cir.2009). And the Ninth Circuit has recognized that ambiguity exists regarding which pleading standard applies, but has found it unnecessary to resolve which standard applies because in each case where it could address the issue, either pleading standard was satisfied. See WPP Lux. Gamma Three Sarl v. Spot Runner, Inc., 655 F.3d 1039, 1053–1054 (9th Cir.2011); In re Gilead Scis. Sec. Litig., 536 F.3d 1049, 1056 (9th Cir.2008). Because we find that the price fluctuations here would not rebut an inference of economic loss under either standard, we, like the Ninth Circuit, find it unnecessary to resolve this issue at this time. ***

The limitation upon damages imposed by the District Court—and by the other district court decisions upon which it relied—is inconsistent with both the traditional out-of-pocket measure for damages and the “bounce back” cap imposed in the PSLRA. This line of cases, beginning with Malin v. XL Capital Ltd., holds that a securities fraud plaintiff suffers no economic loss if the price of the stock rebounds to the plaintiff’s purchase price at some point after the final alleged corrective disclosure. No. 03 Civ.2001, 2005 WL 2146089, at *4 (D.Conn. Sept.1, 2005); see also Ross v. Walton, 668 F.Supp.2d 32, 43 (D.D.C.2009); In re Immucor, Inc. Sec. Litig., No. 09–CV–2351, 2011 WL 3844221, at *2 (N.D.Ga. Aug. 29, 2011); In re Veeco Instruments, Inc. Secs. Litig., 05–MD–1695, 2007 WL 7630569, at *7 (S.D.N.Y. June 28, 2007).***

[A] share of stock that has regained its value after a period of decline is not functionally equivalent to an inflated share that has never lost value. This analysis takes two snapshots of the plaintiff’s economic situation and equates them without taking into account anything that happened in between; it assumes that if there are any intervening losses, they can be offset by intervening gains. But it is improper to offset gains that the plaintiff recovers after the fraud becomes known against losses caused by the revelation of the fraud if the stock recovers value for completely unrelated reasons. Such a holding would place the plaintiff in a worse position than he would have been absent the fraud. Subject to the bounce-back limitation imposed by the PSLRA, a securities fraud action attempts to make a plaintiff whole by allowing him to recover his out-of-pocket damages, that is, the difference between what he paid for a security and the uninflated price. See Levine, 439 F.2d at 334. In the absence of fraud, the plaintiff would have purchased the security at an uninflated price and would have also benefitted from the unrelated gain in stock price. If we credit an unrelated gain against the plaintiff’s recovery for the inflated purchase price, he has not been brought to the same position as a plaintiff who was not defrauded because he does not have the opportunity to profit (or suffer losses) from “a second investment decision unrelated to his initial decision to purchase the stock.” Harris v. Am. Inv. Co., 523 F.2d 220, 228 (8th Cir.1975), cert. denied, 423 U.S. 1054, 96 S.Ct. 784, 46 L.Ed.2d 643 (1976). We are aware of no circuit court or Supreme Court decision imposing the economic-loss rule embraced by Malin, and we find it significant that the PSLRA, while it did impose the 90–day bounce back limit on damages, did not impose the limitation on damages favored by Malin.

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