The road to recovery for shareholders of failed banks and other companies that lost value in the wake of the Great Recession just got a lot tougher. On January 14, 2011, in Patel v. Patel, No. 1:09-CV-3684-CAP, the Honorable Charles A. Pannell, Jr., U. S. District Judge for the Northern District of Georgia, granted the defendants’ motion to dismiss and dismissed with prejudice a class action brought by shareholders of the holding company for Haven Trust Bank, one of the first in the recent wave of Georgia bank failures.1

 The plaintiffs attempted to bring a class action on behalf of all shareholders of the bank’s holding company (a now bankrupt privately held company) against certain of the holding company’s directors and officers. The complaint included claims for violations of anti-fraud provisions of the federal and Georgia securities laws, as well as Georgia common law fraud and negligent misrepresentation claims. Judge Pannell ruled that the shareholders did not adequately plead the intent to defraud or loss causation elements of any of their claims, and further held that the “direct communication” requirement for pleading and proving a Georgia common law misrepresentation claim in the context of securities transactions could not be met. Judge Pannell therefore dismissed the case in its entirety and entered judgment for the defendants.

Loss Causation

The court’s ruling on the loss causation issue will be significant and likely to have broad application in shareholder fraud actions arising out of the myriad of bank failures and other investment losses caused by the recent economic downturn. Judge Pannell held that the plaintiffs’ allegation that the announcement the FDIC was taking over the bank failed to satisfy the requirement of loss causation.

To state a claim for securities fraud, the plaintiff must properly allege that the defendant’s misstatement or omissions caused his losses. Relying on In re Homebanc Corp. Sec. Litig., 706 F. Supp.2d 1336 (N.D. Ga. 2010), the Patel court concluded the plaintiffs had “not offered any facts distinguishing between losses caused by the defendants’ alleged misrepresentations and the intervening events that wreaked havoc on the banking industry as a whole.”

Notably, the significance of the court’s holding on the loss causation issue is enhanced because the court specifically cited this holding as a reason to dismiss the plaintiffs’ Georgia common law fraud claim.

Intent to Defraud

The Patel court also found legally deficient the plaintiffs’ allegations about the defendants’ intent to defraud (i.e., scienter), even in the face of allegations that the defendants, by virtue of their positions and attendance at meetings, knew about the concealed adverse information and had the motive to maintain a dividend stream. Furthermore, the court held that allegations certain loans were made to the adult children of one of the defendants did not establish scienter. Importantly, the Patel court found these allegations lacking not only under the heightened pleading standard applicable to the plaintiffs’ federal securities claim, but also with respect to the plaintiffs’ Georgia state statutory securities fraud and common law fraud claims.

The “Direct Communication” Requirement for Georgia Common Law Misrepresentation Claims

Finally, the Patel court was one of the first to interpret the “direct communication” requirement for Georgia common law fraud and negligent misrepresentation claims in the context of decisions to purchase, sell or hold securities, a requirement imposed by the recent decision of the Supreme Court of Georgia in Holmes v. Grubman, 691 S.E.2d 196, 286 Ga. 636 (2010).

In Holmes, the Supreme Court of Georgia answered a question of first impression: “Does Georgia common law recognize fraud claims based on forebearance in the sale of publicly traded securities?” Holmes, 691 S.E.2d at 197, 286 Ga. at 636. These are so-called “holder” claims, which refer to those circumstances in which the shareholder desired to sell his stock at a specific time, but was convinced to “hold” rather than sell the stock, in reliance upon specific representations made directly to him. Recognizing the potential for speculative or frivolous claims based upon a holder theory, the Holmes court held that plaintiffs must allege and prove a direct communication by each defendant and loss causation. Further, the Holmes court made clear that these are essential elements for both fraudulent and negligent misrepresentation claims.

In Patel, the court concluded the individual defendants could not be held personally liable on the plaintiffs’ negligent misrepresentation claim because they did not meet the direct communication requirement of Holmes. The court specifically determined that private placement memoranda sent by the holding company were communications from an entity separate and distinct from the individual defendants, and as such, did not qualify as direct communications of any of the individual defendants. In so holding, Judge Pannell observed that “Georgia courts have consistently held that ‘the mere operation of a corporate business does not render a corporate officer personally liable for corporate acts’” (quoting Fussell v. Jones, 401 S.E.2d 593, 594 (Ga. Ct. App. 1991)).


As one of the first decisions to address the loss causation, intent to defraud and “direct communication” elements of shareholder misrepresentation claims arising out of the recent wave of bank failures, the Patel case should have a major impact on a number of other shareholder claims, and provide real comfort to directors and officers. As Patel teaches, merely pointing to a bank’s failure and alleging that the bank’s directors and officers became aware that the bank’s condition was worsening will not be enough to even bring, let alone win, a shareholder’s claim for fraud or negligent misrepresentation.