Plaintiffs brought a federal securities class action suit raising allegations of misstatements in connection with stock options backdating and revenue recognition accounting manipulations. The U.S. District Court for the Southern District of New York ruled that, with one exception, plaintiffs failed to adequately allege the loss causation element of their Section 10(b) and Rule 10b-5 claims.

Plaintiffs relied on three separate disclosures, each of which was followed by a substantial decline in share price, to support their loss causation allegations. The first disclosure, which was followed by a 15.2% drop in share price, indicated that the defendant corporation had discovered errors that impacted prior quarters’ financial disclosures but did not materially impact full year results. The second disclosure (followed by a 19.3% drop) reported, without explanation, that the defendant’s CFO was leaving the company. Notably, on the same day that the CFO’s departure was announced, the company also announced that it was not pursuing an expected corporate acquisition. Notwithstanding the sharp stock price declines, the Court ruled that neither of these disclosures sufficed. The first did not reveal to investors that the company’s accounting practices were false and, thus, did not support plaintiff’s claim that the disclosure of the challenged accounting practices, as opposed to disclosure of “bad news” generally, caused the loss. Similarly, the Court ruled that the disclosure of the CFO’s departure, without explanation, did not alert investors to any improprieties that would establish loss causation. The Court also ruled that the plaintiffs failed to show that the price decline following the second disclosure was related to the alleged fraud as opposed to the announcement that the expected acquisition was not proceeding.

The Court did rule that a third disclosure, in which the defendant corporation announced that it had received a subpoena and notice of an investigation relating to the company’s stock option program and certain accounting practices and policies, was partially sufficient to provide the basis for loss causation (this disclosure was followed by a 22.3% decline in share price). The Court ruled that although the disclosure clearly related to the defendant corporation’s stock options program and adequately demonstrated loss causation with respect to the backdating allegations, its references to unspecified accounting procedures were too vague in connection with the accounting practices allegations. In ruling that the stock options investigation disclosure sufficiently alleged loss causation, the Court noted but did not follow a line of California cases suggesting that the mere announcement of an investigation into a practice was not sufficient to support an inference of wrongdoing. (Police and Fire Ret. Sys. of Detroit v. Safenet, Inc., No. 06 Civ. 5797, 2009 WL 2391849 (S.D.N.Y. Aug. 5, 2009))