A recent petition for certiorari filed in the United States Supreme Court asks the Court to clarify what an aggrieved investor must plead to state a claim for securities fraud under the Securities and Exchange Act of 1934 (the “Exchange Act”). The petition focuses on the “loss causation” element, which requires plaintiffs to prove a direct causal link between the alleged fraud and the loss in value for which they seek to recover. In a typical fraud in-the-market case, plaintiffs allege loss causation by showing that they bought the defendant’s securities at prices artificially inflated by fraud, and then had those securities lose value after a “corrective disclosure” revealed the fraud to the public. If the Supreme Court decides to grant certiorari, it will have the opportunity to lift certain barriers to pleading loss causation in some jurisdictions.
Petitioners, three New England funds (“Funds”) that own stock in Health Management Associates, Inc. (“HMA”), seek to reverse the Eleventh Circuit’s decision that they failed to establish loss causation as a matter of law. The Funds alleged that HMA’s stock price fell precipitously following two disclosures to the market: (1) an announcement that the government had begun an investigation into HMA for fraud, and (2) an analyst report publicizing a whistleblower case filed by a former employee against HMA three months earlier. A panel for the Eleventh Circuit upheld the lower court’s decision that neither event could form the basis of a securities fraud claim. First, the panel held that the announcement of a government investigation could not raise an inference of loss causation at the pleading stage because there had been no finding of “actual wrongdoing.” Second, the panel held that the analyst report was not a “corrective disclosure” because it reported on a publicly-filed case that, although it hadn’t been reported on until then, was already disclosed to the market.
The Funds are petitioning the Supreme Court to overturn both holdings. First, they argue that the Eleventh Circuit’s decision that an ongoing investigation cannot form the basis of a securities fraud claim improperly makes plaintiffs prove, not plead, fraud in the complaint in violation of the Supreme Court’s prior holdings in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005) and Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007). The Funds also take issue with the Eleventh Circuit’s reasoning that once a plaintiff invokes a fraud-on-the-market theory, a court must assume that “any information released to the public is immediately digested and incorporated into the price of a security.” The Funds argue that information about the whistleblower case had not been incorporated into the stock price until the analyst report publicized the case to the market.
Finally, the Funds argue that the Eleventh Circuit’s holding exacerbates circuit splits on both issues. The Eleventh Circuit’s holding puts it in disagreement with the Fifth and Ninth Circuits and some district courts in the Second Circuit, where an investor may plead loss causation based on an ongoing government investigation. As for the second issue, the First, Second and Fourth Circuits agree with the Eleventh Circuit that reports of public information cannot support a claim for loss causation, while the Fifth and Ninth Circuits hold that they can if it is plausible that the market has not yet reacted to the information.
It is not possible to predict whether the Supreme Court will decide to hear this case. However, given the diversity of approaches to pleading loss causation in this country, publically traded companies should be aware that announcements of a government investigation and reports of publically available information represent real risks for securities fraud litigation in some jurisdictions.