On September 20, 2005, the defendant company issued a press release announcing its agreement to enter into a reverse merger with another company. At the time of the announcement, the company had approximately 177 million shares of common stock issued and outstanding. On September 26, 2005, the company timely filed a Form 8-K with the SEC together with a complete copy of the Share Exchange Agreement. Among other things, the Share Exchange Agreement stated that, at the closing, the company’s authorized and issued common stock would total 500 million shares.
Plaintiff, asserting claims under Section 10(b) of the Securities Exchange Act and Rule 10b-5, alleged that he purchased shares of the company’s common stock from “approximately the end of September 2005 to November 4, 2005” in reliance on defendants’ allegedly fraudulent misrepresentations. Specifically, plaintiff claimed that (i) at the time he purchased the shares, he did not know the company’s issued and outstanding shares would be “significantly diluted” in connection with the reverse merger, (ii) this dilution caused the stock price to drop by 65%, and (iii) the dilution was not reported in any SEC filings and no advance notice of the merger or the dilution was provided to plaintiff or any other shareholder.
In dismissing the complaint, the Court held that plaintiff failed to plead fraud with particularity or to adequately allege loss causation. The Court ruled that “the fundamental problem” with plaintiff’s fraud theory was that the company’s press release stated that the merger would be accomplished through the issuance of additional shares and the Form 8-K disclosed all elements of the merger transaction, including that the company would be increasing its issued and outstanding shares to 500 million. The Court also rejected the plaintiff’s assertion that defendants had a duty to disclose any information about the merger prior to reaching an agreement with the other company (which was the date of its press release).
The Court’s ruling with respect to the failings of plaintiff’s loss causation allegations was equally decisive. After noting that this element requires that the subject of the allegedly fraudulent statement be the cause of the actual loss suffered, the Court stated that it is “entirely unclear” from the complaint when plaintiff suffered his alleged loss and whether it was causally related to the allegedly fraudulent failure to disclose that the company would be issuing additional shares. Moreover, and contrary to plaintiff’s assertion that the issuance of the common stock caused the stock price to drop by 65%, the Court found that the company’s stock price increased after the merger announcement and disclosure of the issuance of additional shares and continued to trade at a higher price following the issuance of the shares. (Chien v. Skystar Bio Pharmaceutical Co., 2008 WL 2790005 (D. Conn. July 17, 2008))