On August 1, 2012, the Second Circuit decided Acticon AG v. China North East Petroleum Holdings, Limited, No. 11-4544-cv, considering the standard for pleading loss causation -- that is, the necessary causal relationship between an alleged fraud and actual economic loss -- in private civil actions under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5. The Supreme Court previously addressed this issue seven years ago, holding that a plaintiff’s allegations that it purchased securities at a price artificially inflated by supposed fraud are not alone sufficient to plead loss causation. See Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 342 (2005). The Acticon panel considered issues that remained unresolved in the Second Circuit following Dura, and its opinion will influence the ability of plaintiffs to proceed with federal securities fraud claims against public companies and their directors, officers and outside professionals.
Plaintiffs in Acticon alleged that China North East Petroleum Holdings, Limited (“NEP”), a company engaged in crude oil exploration and production in northern China, had misled investors about its reported earnings, oil reserves and internal controls. Plaintiffs also asserted that the market price of NEP stock had declined following each of a series of corrective disclosures on those subjects. Based on those allegations, plaintiffs asserted federal securities fraud and control person liability claims on behalf of a purported class of purchasers of NEP stock, against NEP and certain of its officers and directors. On defendants’ motion to dismiss, the district court noted that during the two months after the last of the alleged corrective disclosures concerning NEP, there were twelve trading days on which NEP stock closed above the average price at which the lead plaintiff had purchased its shares. Under Dura, the district court held, those facts compelled the conclusion that the consolidated amended complaint failed sufficiently to plead economic loss because "[a] plaintiff who forgoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure." In re China North East Petroleum Holdings Limited Sec. Litig., 819 F. Supp. 2d 351, 353 (S.D.N.Y. 2011). The district court noted decisions in which certain other courts had applied Dura to reach the same result. See In re Veeco Instruments, Inc. Sec. Litig., No. 05 Civ. 10226 (S.D.N.Y. June 27, 2007); Malin v. XL Capital Limited, No. 03 Civ. 2001 (D. Conn. Sept. 1, 2005); see also Ross v. Walton, 668 F. Supp. 2d 32 (D.D.C. 2009). Accordingly, the district court dismissed plaintiffs' complaint.
On appeal, the Second Circuit disagreed. Initially, the panel noted that an “out-of-pocket” rule traditionally governs economic loss in Section 10(b) cases, and permits “a defrauded buyer of securities . . . to recover only the excess of what he paid over the value of what he got.” Acticon, slip op. at 7 (quoting Levine v. Seilon, 439 F.2d 328, 334 (2d Cir. 1971) (Friendly, J.)). The panel further noted that the “bounce back” rule under the Private Securities Litigation Reform Act of 1995 (“PSLRA”) generally limits damages in Section 10(b) and Rule 10b-5 actions to the difference between the price at which the plaintiff purchased the security at issue and the mean trading price of that security over the 90 days following a corrective disclosure. Id. (citing 15 U.S.C. § 78u-4(e)(1)). The panel found the ruling of the district court, and the decisions on which the district court relied, to be “inconsistent with both the traditional out-of-pocket measure for damages and the ‘bounce back’ cap imposed in the PSLRA.” Id. at 8. The panel also found that the district court’s reasoning incorrectly equated “an inflated share of stock that has never lost value” -- the situation in Dura -- with “a share of stock that has regained its value after a period of decline,” and thus risked inappropriately offsetting against “losses caused by the revelation of the fraud” gains in market value “for completely unrelated reasons.” Id. at 11. Because the panel could not determine “whether the price rebounds [in NEP stock] represent the market’s reactions to the disclosure of the alleged fraud or whether they represent unrelated gains,” it concluded that those rebounds could not alone “negate the inference that [lead plaintiff] has suffered an economic loss,” vacated the district court’s judgment, and remanded for consideration of defendants’ other grounds for dismissal. Id. at 12.
The Acticon decision is a limited one. Nothing there dilutes in any way the burden that Dura imposes on plaintiffs in private actions under Section 10(b) and Rule 10b-5 to offer sufficient evidence of both economic loss and loss causation at the summary judgment stage, and prove those elements at trial. And importantly, the Second Circuit recognized that, under the “out-of-pocket” rule, price rebounds that reflect the market’s reaction to a corrective disclosure will offset damages. While Acticon holds that, at the pleading stage, a stock price rebound following a corrective disclosure will not alone negate an inference of economic loss, it leaves open whether, in combination with other facts that a court may properly consider under Fed. R. Civ. P. 12(b)(6), such a rebound might render allegations of economic loss insufficiently plausible to survive a motion to dismiss. The Acticon decision also left open the question whether plaintiffs in private federal securities fraud actions must plead loss causation and economic loss with the particularity that Fed. R. Civ. P. 9(b) requires, or may rely on the more liberal notice pleading standard of Fed. R. Civ. P. 8(a) with respect to those elements.