Imagine a plaintiff who buys stock in a company that subsequently discloses a misstatement in its financial statements that existed at the time plaintiff invested. The stock price drops upon the initial disclosure, and then rebounds back above the purchase price. Can that plaintiff plead economic loss, as is required under Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005)? According to the Second Circuit, the answer is yes.
Earlier this month, the Second Circuit reversed a decision by Judge Cedarbaum of the Southern District of New York dismissing a putative securities fraud class action brought against China North East Petroleum Holdings Limited (“NEP”) for failing to allege economic loss. The Second Circuit held that a recovery in the price of a stock following the disclosure of a fraud does not defeat an inference of economic loss.
Lead plaintiff Acticon AG alleged that NEP misled investors by inflating its oil reserves and not properly accounting for certain warrants. Beginning in February 2010, when the first claims of fraud became public, NEP announced that it was withdrawing its financial statements for 2008 and 2009 to adjust its prior earnings downward. Several more announcements followed in April and May 2010, including the announcement that the New York Stock Exchange was delisting NEP stock. In September 2010, trading resumed on NEP stock, but the share price dropped by 20%.
The district court dismissed the complaint, agreeing with NEP that Acticon could not show loss causation because it could have sold its holdings for a profit on twelve different days following the final disclosure. The district court relied on Dura for the proposition that a purchaser suffers no economic loss if the post-disclosure price has risen above the purchase price, even if the price had fallen initially after the corrective disclosure was made.
The Second Circuit reversed, explaining that Dura did not reject the traditional out-of-pocket measure for damages, but made it clear that a plaintiff who purchases stock at an inflated price must prove an economic loss proximately caused by a defendant’s misrepresentation. The Second Circuit found that Acticon satisfied Dura’s requirements because it alleged more than just purchase at an inflated price—Acticon alleged a drop in price of NEP stock after the alleged fraud was publicly disclosed.
In particular, the Second Circuit disapproved of the line of cases cited by the district court that evaluate economic loss by comparing two “snapshots” of a plaintiff’s economic situation, without consideration of events occurring between those “snapshots.” The Second Circuit determined that the price recovery did not defeat an inference of economic loss because there was no way to know whether the NEP stock price rebounded due to the market’s indifference to the alleged fraud or something unrelated, and, therefore, whether Acticon’s recovery should be offset against its losses.