Market idealism

I am perpetually, endlessly amused by how courts navigate the tension between the presumption of market efficiency inherent in the fraud on the market doctrine, and the actual reality that markets may be generally efficient, but there are all kinds of blips and imperfections.  The Supreme Court acknowledged as much in Halliburton Co. v. Erica P. John Fund, Inc., but it still creates difficulties for the doctrine.

Case in point:  Fagen et al. v. Enviva, which was just decided in the District of Maryland.  Plaintiffs accused Enviva of greenwashing by, among other things, falsely claiming that its wood pellets were sourced from “low value” wood, such as tree trimmings and underbrush, rather than whole trees.  When the truth was revealed – partially through a short attack, and then through exposure on a conservation website – Enviva’s stock price dropped.

Enviva defended against the claim by pointing to various public filings where it admitted that its low value wood included some whole trees deemed unsuitable for sawmilling, such as small ones, or ones with defects.  Which of course sounds very reasonable, except there’s the pesky stock price drop that accompanied the disclosure.  So, on a motion to dismiss, the court held:

Plaintiff’s argument that drops in stock prices suggest individual investors’ ignorance of the truth, is irrelevant to the court’s ultimate inquiry about the reasonable investor’s knowledge….even if Mr. Keppler and Mr. Calloway indeed lied that Enviva does not source wood fiber from whole trees, the Category C Statements are immaterial in light of the total mix of information available revealing Enviva’s use of whole trees.

This is hardly the first time a court has held that the beliefs of actual investors are irrelevant when gauging injury to the Platonic form of investor whose interests are actually protected by the securities laws, but it is one of the most blatant.

Further on the subject of courts’ willingness to jettison cases on the assumption that publicly disclosed information must have offset any lies, there’s In re Ocugen Securities Litigation, 2024 WL 1209513 (3d Cir. Mar. 21, 2024), decided a few months ago by the Third Circuit.  Ocugen, a pharmaceutical company, contracted with an Indian company to develop a Covid drug in 2020.  It was then alleged to have made several overly optimistic statements about its ability to obtain an FDA Emergency Use Authorization, and its stock dropped when the truth was revealed.

The Third Circuit held that “information about the quality of the Indian COVAXIN study and the FDA’s guidance concerning study protocols and diversity was readily available to any reasonable investor,” and therefore, any false statements were immaterial. In a footnote, the court noted, “to the extent there were questions about whether the study adhered to proper protocols, the amended complaint observes that the issue was reported in the Indian media before the class period even began.”  Without further discussion, then, the Third Circuit apparently concluded that pre-class period reports in Indian media are sufficient to offset any misrepresentations to US market participants. 

Now, to be fair, the Third Circuit was vague about whether its holding was based on market efficiency, or whether it was doing a simple Basic “total mix of information” analysis.  But if the holding was simply about the “total mix,” was the court really saying, on a motion to dismiss, and with no further discussion or analysis, that reports in Indian media are part of the total mix of information available to US traders?  And if the holding was efficiency-based, the Third Circuit was certainly assuming a high level of it. 

(As a side note, I’ll observe that in 10(b) cases, courts frequently adopt a blanket rule that when the pre-class period statements are false, they are not actionable – without much analysis as to why that should be so.  See In re Refco, 503 F. Supp. 2d 611, 643 n.27 (S.D.N.Y. 2007).  Truthful ones, though, are apparently sufficient to offset any lies.).

By contrast, though, let’s look at the Ninth Circuit’s decision in In re Genius Brands Securities Litigation, 2024 WL 1804408 (9th Cir. Apr. 5, 2024). There, a television production company lied about the number of times one of its shows aired on Nickelodeon Jr, and the truth was disclosed in a short report.  The Ninth Circuit rejected defendants’ argument that the truth was already public on Nickelodeon’s website, because:

The shareholders attached to their complaint several printouts of the webpage on Nickelodeon Jr.’s website that features the broadcast schedule. The printouts covering the week of March 18, 2020, span over twenty-five pages and reflect no fewer than 377 show listings. A shareholder hoping to fact check Genius’s March 17 claim that Nickelodeon Jr. aired Rainbow Rangers twenty-six times per week would have no easy time doing so. She would have to go onto Nickelodeon Jr.’s website, find the schedule webpage, sift through hundreds of listings for shows like  Bubble Guppies and Team Umizoomi, and tally up the handful of Rainbow Rangers listings.

We also note that the shareholder’s task would be considerably more difficult retrospectively because it appears that the Nickelodeon Jr. schedule webpage is updated daily or every other day….

For that reason, the shareholders have plausibly alleged that the truth became known through the Hindenburg Report,

Thus, in Genius Brands, the Ninth Circuit displayed much more comfort with a kind of imperfect efficiency, even in a fraud on the market claim.