Saturday, July 23, 2016
It looks like the Fifth Circuit is becoming increasingly isolated.
After the Supreme Court decided Dura Pharmaceuticals, Inc. v. Broudo, 544 US 336 (2005), a circuit split developed as to how plaintiffs can satisfy the element of loss causation in a Section 10(b) action.
All circuits agree that loss causation can be shown via “corrective disclosures” – some kind of explicit communication to the market that prior statements were false, followed by a drop in stock price.
However, as I’ve discussed before, there has been an alternative theory that plaintiffs can use to show loss causation, even without an explicit corrective disclosure. The theory is usually described as “materialization of the risk.” It requires the plaintiff to show that the fraud concealed some condition or problem that, when revealed to the market, caused the stock price to drop, even if the market was not made aware that the losses were due to fraud. For example, a company may report a slowdown in sales, causing its stock price to fall, while concealing the fact that the slowdown was due to an earlier period of channel stuffing. By the time the channel stuffing is revealed, it may communicate no new information about the company’s prospects, so the stock price remains unmoved. Under a materialization of the risk theory, the price drop upon disclosure of the fall in sales would be sufficient to allege loss causation.
The Fifth Circuit has rejected materialization of the risk theory, requiring some kind of communication to the market that the earlier statements were false. The Ninth Circuit generally has done the same, but there’s enough wiggle room in its caselaw that it agreed to hear an interlocutory appeal in Mineworkers’ Pension Scheme, et al v. First Solar Incorporated, et al, No. 15-17282, to resolve the issue.
And this week, in Ohio Public Employees Ret. Sys. v. Federal Home Loan Mortgage Corporation et al. - the long-running crisis-era case alleging that Freddie Mac concealed its exposure to bad mortgage loans - the Sixth Circuit joined the vast majority of circuits in holding that materialization of the risk is sufficient to satisfy the element of loss causation (quietly glossing over earlier caselaw that had seemed to endorse the corrective disclosure standard). Among other things, the Sixth Circuit expressed concern that companies will easily be able to evade liability if liability is functionally predicated on a corporate confession of wrongdoing. That’s a reasonable concern: as Barbara A. Bliss, Frank Partnoy, and Michael Furchtgott have found, in the wake of Dura, corporations have adopted disclosure strategies aimed at masking the cause of stock price reactions, allowing them to reduce litigation risk. (I blogged about an earlier version of the paper here).