The Fifth Circuit recently upheld the dismissal of a securities fraud class action due to the plaintiffs’ failure to plead the mandatory requirement of loss causation. Catogas v. Cyberonics, Inc., No. 07-20787 (5th Cir. Sept. 8, 2008). The plaintiffs in Cyberonics had alleged that the company defrauded investors through the use of improper stock option practices. For such a claim brought under Section 10(b) of the Securities Exchange Act of 1934, the complaint must allege a causal connection between the alleged misrepresentations and the injury allegedly suffered by investors (i.e., the decline in the company’s stock price), which is known as loss causation. See 15 U.S.C. § 78u-4(b)(4).
To survive a motion to dismiss, Plaintiffs cannot merely allege that the misrepresentation “‘touches upon’ a later economic loss.” Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 343 (2005). Instead, they must show “that the market reacted negatively to a corrective disclosure,” which revealed for the first time the allegedly undisclosed negative facts about the company. Id. at 347. The recent Cyberonics decision turned on whether a particular press release issued by the corporate defendant could qualify as a corrective disclosure for purposes of pleading loss causation.
The Fifth Circuit agreed with the lower court, holding that this press release was not, in fact, a corrective disclosure. Cyberonics, at *6. The court distinguished between a corrective disclosure, which could assist in pleading loss causation, and confirmatory information, which could not. A corrective disclosure is a statement revealing that the prior representations made by the company were false. Id. at *3. A given statement issued by a company may, however, contain only confirmatory information, which would be information already known to the market. Id. at *4. Such confirmatory information cannot constitute a corrective disclosure because previously disseminated public information is presumed under the “fraud-on-the market” theory to be reflected already in the company’s stock price. See id. at *3 (citing Greenberg v. Crossroads Sys., Inc., 364 F.3d 657, 663 (5th Cir. 2004)).
The plaintiffs’ only loss causation allegations concerned statements from one particular press release issued on the last day of the class period. The plaintiffs alleged that this release constituted “the first time that the market learned the full ramifications of the backdating and repricing scheme.” Id. at *4. The press release disclosed that an internal investigation was ongoing and the company’s SEC Form 10-K for the year 2006 would be further delayed. Id. at *2. The release also stated that the defendant corporation had received a letter from NASDAQ regarding possible delisting from the exchange if the corporation’s 10-K was not timely filed. Id. The company’s stock price did drop significantly after the issuance of this press release, but the only new information previously undisclosed to the market -- a discussion of the possible NASDAQ delisting -- did not reveal any previous misstatements regarding the company’s stock option accounting procedures. Id. at *4.
Moreover, months before the press release was issued, an investment analyst had already published a report raising questions about the company’s prior stock option grants. An informal inquiry by the SEC followed, as did announcements by the company that its Audit Committee would conduct an internal investigation and that the company would delay the filing of its Form 10-K due to this investigation. Thus, the press release at issue contained only confirmatory information, which the court held could not have affected the company’s stock price and, thus, could not be used by plaintiffs to establish a connection between their losses and any supposedly undisclosed facts on stock options.