This week, the Eleventh Circuit Court of Appeals rejected an expert witness’ event study as insufficient to demonstrate loss causation at trial in a securities fraud class action. In Hubbard v. BankAtlantic Bancorp, Inc., No. 11-12410 (11th Cir. July 23, 2012), the court affirmed the trial court’s decision in favor of the defendants because the plaintiffs’ expert testimony did not sufficiently isolate the effects of the alleged fraud on the company’s stock price. The BankAtlantic case adds to a growing line of precedent establishing the rigors of the loss causation standard, which requires shareholder plaintiffs in a securities fraud class action to prove that the alleged fraud caused the stock price declines identified by plaintiffs as their losses. The case also shows that conducting an event study does not necessarily fulfill plaintiffs’ burden of differentiating between those losses allegedly caused by fraud and those caused by unrelated market and industry factors.
Background Facts and Procedural History
The BankAtlantic case involved allegations that a bank holding company and its management (“Bancorp”) misrepresented the level of risk associated with commercial real estate loans held by its subsidiary, BankAtlantic. BankAtlantic maintained an internal list monitoring the credit risk on all of its land loans. At the same time, however, Bancorp’s public disclosures revealed the amount of loans that Bancorp had designated as “nonaccrual,” meaning unlikely to be repaid. The plaintiffs alleged that the discrepancies between the documents indicated that BankAtlantic’s concern about the loans was not revealed to the public. The plaintiffs also argued that Bancorp’s public statements downplayed any concern about the risks of BankAtlantic’s commercial real estate portfolio as these concerns began to intensify.
In October 2007, Bancorp issued an 8-K that revised BankAtlantic’s loan losses from $4.9 million to $48.9 million. Likewise, the 8-K reported an increase in nonaccrual loans from $21.8 million to $156.3 million. Bancorp’s stock price, which had already declined over the class period, fell an additional 38 percent upon the release of this news.
The plaintiffs brought a securities fraud class action against Bancorp in which they alleged that the company’s misrepresentations had artificially inflated its stock price. The district court certified a class of plaintiffs who had purchased or acquired Bancorp’s stock between November 9, 2005 and October 25, 2007. At trial, the plaintiffs offered a financial analyst as an expert witness on the issues of loss causation and damages.
On the issue of loss causation, the expert performed an event study intended to determine how much of the stock price decline was attributable to Bancorp, as opposed to general market or industry-specific factors. To isolate the market-wide factors, the expert used the S&P 500 Index as the reference data. For the industry-specific factors, she relied on the NASDAQ Bank Index, which includes hundreds of banks and bank holding companies. The expert compared Bancorp’s stock price declines against the indexes’ performance to establish the portion of the stock price movements specific to Bancorp-related news and events. She then looked at analyst reports to determine what portion of the Bancorp-specific stock price movement was related to the alleged fraud.
The jury returned a verdict partially in the plaintiffs’ favor. After the verdict, Bancorp argued that the jury’s interrogatory answers were inconsistent and moved for judgment as a matter of law. The trial court granted Bancorp’s motion, prompting an appeal by the plaintiffs.
Loss Causation and the Insufficient Event Study
The Court of Appeals agreed with the plaintiffs that the trial court erred in granting Bancorp’s motion based on the jury’s findings. The Eleventh Circuit affirmed, however, on the issue of loss causation. The Court held that Bancorp was entitled to judgment as a matter of law because the plaintiffs had not established that the class members’ losses resulted from the alleged violation.
The Eleventh Circuit noted that the plaintiffs utilized the “materialization of the concealed risk” theory to establish loss causation. Under this approach, plaintiffs do not need to prove that the change in stock price was a result of the market’s reaction to a corrective disclosure. Rather, plaintiffs advancing this theory argue that a fraudulently concealed risk caused the company’s stock price to inflate. Once that risk materializes, loss causation is established by the resultant decline in stock price. Assuming without deciding that “materialization of the concealed risk” is a viable theory for proving loss causation, the Eleventh Circuit held that the plaintiffs failed to offer evidence sufficient to support a jury finding of loss causation.
The Eleventh Circuit noted that the plaintiffs’ expert had attempted to isolate the company-specific factors from industry trends by contrasting the change in Bancorp’s stock to the NASDAQ Bank Index, which had performed markedly better in comparison to Bancorp’s stock price. However, the Court noted that the expert failed to account for the effects of the collapse of the Florida real estate market in her analysis. Further, because Florida financial institutions comprise only a small fraction of the NASDAQ Bank Index, the Court found that the index would be inappropriate for filtering out the effects of external factors that may have affected the stock price of a bank like BankAtlantic, whose assets were concentrated in loans tied to Florida real estate. Because plaintiffs offered no evidence of how much of the decline in stock price resulted from the downturn in the Florida real estate market – a risk that was not concealed – there was insufficient evidence to support a jury finding that Bancorp’s misstatements were a substantial factor in causing the plaintiffs’ losses. In other words, the plaintiffs’ evidence did not exclude the possibility that the class members’ losses were caused by market forces rather than any misleading information about BankAtlantic’s portfolio. The Eleventh Circuit accordingly found that Bancorp was entitled to judgment as a matter of law.
From a broad perspective, the BankAtlantic case shows that loss causation remains a formidable obstacle to plaintiffs in securities fraud class actions – even on a post-trial appeal. More specifically, BankAtlantic reflects that conducting an event study, while necessary to prove loss causation, is not necessarily sufficient. As seen in the BankAtlantic decision, there may be additional external factors that affect the company’s stock price that are not sufficiently captured in the market-wide or industry index chosen by a plaintiffs’ expert for an event study. Once identified, such deficiencies in a plaintiffs’ expert’s event study can support exclusion of the expert and/or a judgment in the defendants’ favor.