Saturday, August 13, 2022
Hi, so first, if you're reading this, you probably already noticed, but for what it's worth, it appears that email notifications of new posts have entirely stopped. So, if you've been following us via email up until now, please be aware you'll need to switch to another method - I personally use Feedly to keep track of blog updates.
With that out of the way, obviously, my specialty is corporate and securities law, and one of the odder things about this space is that while it has incredibly well-developed standards for evaluating and litigating fraud claims, those standards are very different from the standards for fraud claims in other areas of law.
I was reminded of this when I read the decision denying a motion to dismiss in Fishon v. Peloton Interactive, 2022 U.S. Dist. LEXIS 143930 (S.D.N.Y. Aug. 11, 2022). Fishon is a consumer fraud action brought under New York law against Peloton for misrepresenting the breadth of its song catalog. Defendants argued, among other things, that the plaintiffs could not prove they had heard any misrepresentations, and therefore they had not been injured. The court rejected that argument, holding:
a plaintiff can also plead both injury and causation under GBL §§ 349 and 350, by alleging that the defendant’s misleading or deceptive advertising campaign caused a price premium, that the price premium was charged both to those who saw and relied upon the false representations and those who did not, and that, as a result of the price premium, plaintiff was charged a price she would not otherwise have been charged but for the false campaign….
These cases persuade the Court that, while a reliance- or exposure-based theory of injury is one way to plead that a defendant’s misrepresentation caused harm, it is not the only way. The operative question is whether a plaintiff suffered an injury because of a defendant’s misrepresentation; it is not whether that injury was tied to plaintiff’s reliance on the misrepresentation. Plaintiffs have alleged that Defendant made misrepresentations that would have mislead a reasonable consumer, that those misrepresentations were consumer-facing and had broad impact, and that as a result of those widespread misrepresentations that mislead reasonable consumers, they paid higher costs. By alleging that they paid a higher price—“increased costs”—for their products because of Defendant’s widespread misrepresentations about the value of the product, Plaintiffs have pleaded an injury that was attributable to Defendant’s alleged misrepresentation, regardless whether they ever personally saw the representation.
That’s fraud on the market. It’s fraud on the market in a consumer action. And, in fact, this kind of holding is not unusual; there are cases with similar holdings under other states’ consumer protection laws. See, e.g., Hasemann v. Gerber Prod. Co., 331 F.R.D. 239 (E.D.N.Y. 2019); Nelson v. Mead Johnson Nutrition Co., 270 F.R.D. 689 (S.D. Fla. 2010). What’s striking here is that a securities fraud plaintiff would absolutely not be able to recover under similar facts, because there has been no showing of market efficiency. And, in fact, courts have rejected attempts by securities fraud plaintiffs to use fraud-on-the-market for primary market transactions, which are of course akin to consumer purchases. See, e.g., Freeman v. Laventhol & Horwath, 915 F.2d 193 (6th Cir. 1990).
What’s the difference? It appears to me that, doctrinally, the reason for the difference is that the consumer protection statutes at issue require causation, but they do not require reliance. So plaintiffs are permitted to argue that a lie generally increased prices, but they don’t have to argue that any consumer subjectively believed that price to be indicative of the product’s value.
That’s different than in the securities context. Securities fraud requires a showing of reliance. Fraud-on-the-market therefore permits two separate and independent presumptions that benefit plaintiffs. First, that false statements impact prices, and second, that investors subjectively believe those prices represent something when they purchase. There’s lots of debate over what, exactly, they’re supposed to subjectively believe, and this “subjective” component has been the subject of academic criticism, see, e.g. Donald C. Langevoort, Judgment Day for Fraud-on-the-Market: Reflections on Amgen and the Second Coming of Halliburton, 57 Ariz. L. Rev. 37 (2015); James D. Cox, Understanding Causation in Private Securities Lawsuits: Building on Amgen, 66 Vand. L. Rev. 1719 (2013); John C.P. Goldberg & Benjamin Zipursky, The Fraud on the Market Tort, 66 Vand. L. Rev. 1755 (2013), but it is real. And it means that, for example, when plaintiffs bring 10(b) claims against underwriters and accountants for a fraudulent offering, they are told:
The security's promoter and other entities involved in the issuance, such as the underwriter, the auditor, and legal counsel—the very entities often charged with fraud—cannot be reasonably relied upon to prevent fraud.
Malack v. BDO Seidman, LLP, 617 F.3d 743 (3d Cir. 2010). In other words, no matter the fraud’s effect on security prices, investors are not justified in believing those prices represent something significant in an inefficient market, and therefore they cannot use the fraud-on-the-market doctrine to satisfy the element of reliance.
To some extent, Section 11 claims are akin to consumer actions in this way; Section 11 claims, unlike 10(b) claims, do not require a showing of reliance, but they do require causation (with the burden of proof on defendants rather than plaintiffs). Thus, Section 11 claims are permitted even in inefficient markets, and the theory behind them - as the legislative history makes clear - is that false statements in a registration statement are likely to influence market prices. See 78 Cong. Rec. 10186 (1934) (“When an issue of securities is proposed, a banking house will investigate the financial statement of the corporation. Based upon the statements contained in the registration statement of the corporation, a banking house will offer the securities at a certain price. Therefore, the market value is fixed by the false statement of the corporation. The individual investor relies upon the investigation made by the banker. It is fair to assume that this situation continues until such time as the corporation makes available a statement showing its earnings for 12 months. Then the market value is influenced by the statement of actual earnings and not by the statements contained in the registration statement, which deceived the underwriter or banker and the investor.”); see also William O. Douglas & George E. Bates, The Federal Securities Act of 1933, 43 Yale L. J. 171 (1933) (“the registration statement will be an important conditioner of the market. Plaintiff may be wholly ignorant of anything in the statement. But if he buys in the open market at the time he may be as much affected by the concealed untruths or the omissions as if he had read and understood the registration statement.”)
I don’t think the cases are perfectly consistent with this doctrinal lineup, but it has some explanatory power, which means in some circumstances, consumers have an easier time alleging fraud-by-price-impact than investors do.