Securities Litigation


Santa Fe Industries, Inc. v. Green (US 1977)

Facts: “Going-Private” merger under Delaware state law. Santa Fe followed requirements under DE law by having appraisals and share price valuation performed. Santa Fe then gave minority shareholders $25 more than valuation price. Still, minority shareholders sued under 10b-5, not DE law, on the grounds that this valuation was less than fair. Importantly, under DE law, the plaintiffs’ (minority shareholders’) only remedy would have been to sue after the merger for a new appraisal.

Issue: Whether the Court of Appeals erred in holding that Rule 10b-5 extends to “breaches of fiduciary duty by a majority against a minority shareholder” even where the complaint does not allege misrepresentation or lack of disclosure?

Rule: Breach of fiduciary duty only gives rise to a cause of action under Rule 10b-5 if that breach can be fairly viewed as manipulative or deceptive.

Holding: SCOTUS reversed the 2nd Circuit, holding that the complaint did not allege any conduct that was manipulative or deceptive.

Reasoning: The language of Section 10(b) gives no indication that Congress meant to prohibit any conduct not involving manipulation or deception. The availability of a private cause of action is not necessary to “ensure the fulfillment of Congress’s purpose” in adopting the Act.

Notes:

  • The purpose of the Exchange Act is to implement a philosophy of disclosure.
  • The cause of action in this case—undervaluation of shares—is traditionally relegated to state law.
  • Extending Rule 10b-5 to cover this breach of fiduciary duty would create a slippery slope and a flood of vexatious litigation.
  • Contra: very few breaches of fiduciary duty do not involve some conduct constituting fraud or manipulation.
  • Footnote 14 (remember this – professors love testing this FN): Scutus discusses plaintiffs’ claim that failure to provide minority shareholders advance notice of the merger was a material nondisclosure. But Scotus ultimately rejects this on the grounds that the omission wasn’t “material” because there was nothing the shareholders could have done with this information even if they had it in advance of the merger.

Distinction between Santa Fe and Goldberg:

  • Santa Fe: SCOTUS said that there was no misinformation connected with the merger. And the state law only provided a post-merger remedy—not for injunctive relief.
  • Goldberg v. Meridor (2d. Cir. 1977): The complaint alleged that the defendant disclosed misleading information and the state law provided for possible injunctive relief.

Healey v. Catalyst Recovery of Pennsylvania, Inc. (3rd Cir. 1980)

Facts: Lawsuit concerning merger under state law. Unlike Santa Fe where the state law only provided for an appraisal remedy after the merger and no way to enjoin the merger, the plaintiffs allege that (1) there was deceptive disclosure/omissions, and (2) state law provided for possible injunctive relief.

Issue: Whether Rule 10b-5 provides plaintiffs with a right of action where plaintiffs allege manipulative/deceptive conduct and the relevant state law allows for a pre-merger remedy?

Rule: Where a misrepresentation or omission of material information deprives a proper plaintiff minority shareholder of an opportunity under state law to enjoin a merger, there is a cause of action under Rule 10b-5. In the case of omitted information, the question is whether, if the plaintiff had received the information, it would have been significant to the determination of the reasonable probability of ultimate success.

Holding: The 3rd Circuit permits suit under Rule 10b-5.

Dissent (as if you’re not reading enough already): The Losers address the inconsistency/conflict between the implications of footnote 14 and part IV of Santa Fe. They argue that we should give emphasis to Part IV and not to footnote 14. The Losers also say this holding risks interference with state law–i.e., why should we provide federal relief to plaintiffs who already have a state remedy when, in Santa Fe, the court refused to provide federal relief to plaintiffs who didn’t have a state remedy? (The Losers say this is “perverse.”) Moreover, the dissent points out that federal courts can grant no greater relief under 10b-5 than these plaintiffs could have received under state law.


Gallagher v. Abbott Laboratories (7th Cir. 2001)

Facts: Abbott laboratories had long been under investigation by the FDA—these repeated issues with the FDA were public knowledge. On March 7th, Abbott labs issued their periodic report. Then, on March 17th, the FDA investigation took a turn that had a material affect on the stock. Abbott remained silent on this development. Shareholders sued.

Issue: Whether Abbott had a duty to disclose the development with the FDA investigation.

Rule: Firms are entitled to keep silent about good news as well as bad news unless positive law creates a duty to disclose. Section 13 only requires periodic reporting (10-k and 10-Q). It does not require continuous reporting. Nor is there an obligation that firms update their reports—they are only obligated to correct errors in previous reports. And a statement that is correct when it is made cannot be corrected.

In other words: Section 10(b) is aptly described as a catchall provision, but what it catches must be fraud. When an allegation of fraud is based on a nondisclosure, there can be no fraud absent a duty to speak.

Holding: Because Abbott had no affirmative duty to disclose the FDA investigation developments, the company’s silence was not fraud under 10b-5.


Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund (US 2015)

Facts: Omnicare is the nation’s largest provider of pharmacy services for residents of nursing homes. In Omnicare’s registration statement, the company made two statements that the plaintiffs allege are material misrepresentations.

Statements at issue: (1) “We believe our contract arrangements with other healthcare providers, our pharmaceutical suppliers and our pharmacy practices are in compliance with applicable federal and state laws.” (2) “We believe that our contracts with pharmaceutical manufacturers are legally and economically valid arrangements that bring value to the healthcare system and the patients that we serve.”

The federal government subsequently filed lawsuits/enforcement actions against Omnicare for violating anti-kickback laws. Accordingly, plaintiffs asserted that (1) Omnicare made “materially false” representations about legal compliance and (2) the company “omitted to state [material] facts necessary” to make its representations not misleading.

Issue: Whether Omnicare’s two sentences in their registration statements amounted to “materially false” representations about legal compliance, and whether Omnicare omitted to state material facts necessary to make its representations not misleading.

Rule: The Court identified two circumstances under which even a sincerely held opinion can be actionable, assuming materiality: (1) Sincerely held opinion omits information about how the opinion was formed (where omission of that fact makes statement misleading because that omitted information is at odds with the statement); (2) Opinion that contains an embedded fact

Holding: The U.S. Supreme Court held that a pure statement of opinion in a securities registration statement is not an “untrue statement of a material fact” under Section 11 of the Securities Act of 1933 just because the opinion is later proven incorrect, but the opinion can create liability if the opinion was not sincerely held at the time, or if the registration statement omitted material facts about the issuer’s inquiry into, or knowledge concerning, the opinion, and those facts conflict with what a reasonable investor would understand from the statement itself.


Basic Inc. v. Levinson (US 1988)

Facts: Company denied three times alleged merger negotiations. Merger negotiations however were going on. Company then merged. Shareholders who sold between the time of the first denial and the suspension of trading sued.

Issue: What is the standard of materiality applicable to preliminary merger discussions?

  • Materiality: There must have been a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.
  • Materiality of Information Regarding Mergers: Materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity

Holding: Reversed and remanded for decision in accordance with new rule of materiality applicable to merger negotiations.


In re Donald J. Trump Casino SEC Litigation (3rd Cit. 1993)

Facts: The Don was trying to raise capital to finish his hotel/casino, the Taj Mahal (Atlantic City . . . v classy buffets). He offered bonds and put out a prospectus saying that the hotel would be successful enough to pay off the debt. Relying on those statements, a bunch of investors bought bonds to finance the completion of the hotel/casino. Plot twist: the hotel/casino failed and the Don didn’t pay.

The investors brought suit alleging the prospectus accompanying the bonds included “affirmatively misleading statements and materially misleading omissions.” Specifically, the Investors said the following section of the prospectus was BS: “The Partnership believes that funds generated from the operation of the Taj Mahal will be sufficient to cover all of its debt service.”

According to the investors (who def voted for Hillz), that statement was misleading because the Donald never believed it to be true. The Donald argues the prospectus had many disclaimers and cautionary statements stressing the riskiness of the investment.

Issue: Whether it was a material misrepresentation to state that “the Partnership believes that funds generated from the operation of the Taj Mahal will be sufficient to cover all of its debt service.”

Holding: Sigh. The Don won. The Court said that given the context in which the statement was made, it was, at worst, harmless. The Court went on to say the statements were tailored precisely to address the uncertainty of the venture.

Rule: When an offering document’s forecasts, opinions, or projections are accompanied by meaningful cautionary statements, the forward-looking statements will not form the basis for a securities fraud claim if those statements did not affect the “total mix” of information in the document provided to investors.

Key Point: The cautionary statements were tailored precisely to address the uncertainty concerning the Partnership’s prospective ability to repay the bondholders.


Asher v. Baxter International, Inc. (7th Cir. 2004)

Facts: District Court dismissed case under the Bespeaks Caution Doctrine. On appeal, the plaintiff argued that the cautionary statements remained the same even as new events affecting the company unfolded. Thus, the plaintiffs argue that the statements were not meaningful because of their unchanged nature.

Issue: How do we define “meaningful cautionary statements” with regard to the statutory safe harbor for forward-looking statements

  • First, do different standards for cautionary statements apply to oral forward-looking statements vs. written forward-looking statements?
  • Second, are Baxter’s cautionary statements sufficiently meaningful such that Baxter’s liability is precluded under the safe harbor provision?

First Rule: Courts apply the same standard for oral and written forward-looking statements

Second Rule: Regarding the sufficiency of the cautionary statements, the safe harbor does not require the most helpful caution, but merely the principal contingencies that could cause actual results to depart from the projections.

Holding on First Issue: Fraud-on-the-market only exists in an efficient capital market; in which case, the company’s written cautionary language must be treated as if attached to every one of its oral and written statements. So the only question is whether the written cautionary statements are sufficiently meaningful to render the safe harbor provision applicable.

Holding on Second Issue: Court held that it’s possible that Baxter’s language may be sufficient or may fall short, but that it’s too uncertain to dismiss at the pleading stage. The court explained that “there is no reason to think that the items mentioned in Baxter’s cautionary language were those that at the time were the or any of the “important” sources of variance.

Discussion: Easterbrook says that in an efficient market, all public information is known, so it doesn’t matter that oral statements didn’t contain meaningful cautionary statements if the written statements did. To hold otherwise would suggest partial transmission of information, which is antithetical to the efficient capital markets theory. And if the market is inefficient, plaintiffs’ claims regarding misleading oral forward-looking statements still fail because fraud-on-the-market can only occur in efficient markets.


SEC v. Zandford (2002)

Facts: Stockbroker is alleged to have violated Section 10(b) and Rule 10b-5 by selling his customer’s securities and using the proceeds for his own benefit without the customer’s knowledge or consent. Following Zandford’s conviction on criminal charges for his conduct, the Securities and Exchange Commission (SEC) (Plaintiff) filed a civil complaint claiming that § 10 of the Securities and Exchange Act of 1934, and Rule 10b-5 thereunder, had been violated by Zandford by his participating in a scheme to deceive the Woods and misusing their securities without their awareness or approval.

Issue: Whether the alleged fraudulent conduct was “in connection with the purchase or sale of any security” within the meaning of the statute and the rule.

Rule: Where a stockbroker participates in a deceitful scheme in which he yields sales of his customer’s securities for his own benefit, such deceitful behavior is “in connection with the purchase or sale of any security” as defined by § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.

Holding: The allegations of the complaint, if true, entitle the SEC to relief; therefore, the Court of Appeals should not have directed that the complaint be dismissed.

Discussion:

  • The SEC constantly employed a vast interpretation of “in connection with the purchase or sale of any security,” upholding that a broker who receives money for securities that he does not intend to distribute, or who sells securities with an objective to misuse the profits, is in violation of § 10(b) and Rule 10b-5. This understanding of the statutes vague text in the framework of formal adjudication is permitted respect.
  • The need for an inaccuracy regarding a specific security’s worth for a violation of the Act to occur has been never held by the Court or the SEC.
  • Zandford’s claim that although misuse of the profits was deceitful it fails to make the connection with the totally legal sales, is denied because the securities sales and Zandford’s routines were not sovereign actions.
  • Accepting the accusations as accurate, his scheme was furthered by each sale, and was deceitful because none of the sales were approved by, or revealed to, the Woods. Combined, the sales are property regarded as a course of business that functioned as a deception or dishonesty on a stockbroker’s client.

SEC v. Pirate Investor LLC (4th Cir. 2009)

Facts: Stansberry, on behalf of Pirate, published a special report (the “Report”) on USEC’s upcoming contract. The Report analyzed USEC’s financials and role in the pact, and included a statement that a senior USEC executive told Stansberry about a May 22nd approval date for the contract. (The court, however, found that Wingfield never told Stansberry the agreement would be approved on May 22nd; in fact, it was approved June 19.) Stansberry also created and distributed an email solicitation containing the same claim of information about the contract approval date, but not disclosing which company it was.  In order to discover the company’s identity, people had to pay Pirate $1,000 for a copy of the Report. The Solicitation went out in various waves, with later emails also including representations about USEC’s rising share prices.  Ultimately, Pirate sold 1,217 copies of the Report, earning $1,005,000 in net proceeds and $626,500 in profits for Pirate alone. 

Issue: Whether the misstatements in the email and corresponding report satisfied the “in connections with” prong of Section 10(b) and Rule 10b-5.

Rule: Factors for determining whether the “in connection with” requirement has been satisfied:

  1. Whether a securities sale was necessary to the completion of the fraudulent scheme;
  2. Whether the parties’ relationship was such that it would necessarily involve trading in securities;
  3. Whether the defendant intended to induce a securities transaction;
  4. Whether material misrepresentations were “disseminated to the public in a medium upon which a reasonable investor would rely.”
    • Whether the misrepresentations in question were disseminated to the public in a medium upon which a reasonable investor would rely; and
    • They were material when disseminated.

Holding: With regard to element 4 (would a reasonable investor rely on the disseminated information), the Court held that fraud in the sale of investment advice may qualify as “in connection with” the sale of securities when it is expected that the advisees will act on the advice. (Note footnote 19’s reference to the common law’s treatment of materiality of representations: “if the maker of the representation knows or has reason to know that its recipient regards or is likely to regard the matter as important in determining his choice of action.”)

Discussion: Elements of a Section 10(b) / Rule 10b-5 Violation

  1. Made a false statement or omission
  2. Of material fact
  3. With Scienter
  4. In connection with the purchase or sale of securities

SEC must establish each element by a preponderance of the evidence.


Ernst & Ernst v. Hochfelder (1976)

Facts: President of First Securities commits fraud that causes damage to plaintiffs. Plaintiffs contend that this fraud would have been discovered if Ernst & Ernst had conducted audits of First Securities in accordance with accepted auditing standards. The plaintiffs allege that E&E should be liable under 10b-5 for this negligence.

Issue: Whether an action under Section 10(b) / Rule 10b-5 can lie where the plaintiffs fail to allege an intent to deceive, manipulate, or defraud on the part of the United States; is an allegation of negligence alone sufficient?

Rule: Rule 10b-5 requires Scienter—i.e. intent to deceive, manipulate, or defraud. (Negligence is insufficient to maintain a 10b-5 claim.)

Holding: The SCOTUS reversed and dismissed on the grounds that the plaintiffs had failed to allege Scienter—intent to deceive, manipulate, or defraud—and that this is a necessary element of a 10b-5 claim.

Interpretation of the plain language:

  • “Manipulative”: This term connotes intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities.
  • Recklessness & Scienter: Note that the SCOTUS has declined to address whether reckless conduct constitutes Scienter under Rule 10b-5. However, every circuit court to that has addressed the issue has held that recklessness meets 10b-5’s Scienter requirement.
  • What is Recklessness: Highly unreasonable conduct involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.
  • Corporate Scienter: A plaintiff can establish Scienter of a company by showing the individual Scienter of the corporation’s directors or high-ranking officers.

Tellabs, Inc. v. Makor Issues & Rights, LTD. (U.S. 2007)

Facts: Shareholders argue that Tellabs and Tellabs executives (specifically Notebaert) engaged in a scheme to deceive the investing public about the true value of Tellabs’ stock by making four types of misrepresentations.

Issue: What test should courts’ apply when determining whether the PSLRA’s “strong inference” pleading requirement has been satisfied? Could securities fraud plaintiffs allege the requisite mental state “simply by stating that Scienter existed,” or were they required to allege with particularity facts giving rise to an inference of Scienter?

Rule: A complaint will survive only if a reasonable person would deem the inference of Scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.

Holding: Vacate decision and remand case for application of heightened pleading standard adopted by the SCOTUS.

Discussion:

  • Concurrences – Scalia: Argues that the “at least as compelling as any opposing inference” is inapposite to Congress’s intent and that the better standard is “whether the inference of Scienter (if any) is more plausible than the inference of innocence.”
  • Remand: Plaintiffs prevailed even under the heightened standard adopted by the SCOTUS. And the Seventh Circuit explained that the plaintiffs would prevail even under Scalia’s reading of the test. Facts alleged give rise to a “Cogent and Compelling” inference that defendants acted with the requisite Scienter.

Blue Chip Stamps v. Manor Drug Stores (US 1975)

Facts: Blue Chip’s reorganization agreement required it to offer common stock to former retailers who had done business with the company. Plaintiffs, members of this class of offerees, alleged that Blue Chip’s prospectus was intentionally misleading in that it was overly pessimistic and designed to discourage offerees from purchasing the common stock so that blue chip could subsequently offer the stock for higher prices on the open market.

Issue: Whether an offeree who has neither purchased nor sold any of the offered shares may maintain a private cause of action for violations of Rule 10b-5.

Rule: The plaintiff class for purposes or a private damage action under § 10(b) and Rule 10b-5 is limited to actual purchasers and sellers of securities. Birnbaum v. Newport Steel Corp. (2d. Cir. 1952).

Holding: Plaintiffs are not sellers or purchasers of securities, so they cannot maintain their action.

Discussion: Noteworthy case because it upheld the purchaser-seller agreement and articulated the necessity of curbing vexatious private actions.

Three Types of Non-Seller/Purchaser Plaintiffs:

  • First: Potential purchasers of shares who allege that they decided not to purchase because of an unduly gloomy representation or the omission of favorable material which made the issuer appear to be a less favorable investment vehicle than it actually was. (Alternative Remedy Available: NONE)
  • Second: Actual shareholders in the issuer who allege that they decided not to sell their shares because of an unduly rosy representation or a failure to disclose unfavorable material. (Alternative Remedy Available: Derivative Suit)
  • Third: Shareholders, creditors, and perhaps others related to an issuer who suffered loss in the value of their investment due to corporate or insider activities in connection with the purchase or sale of securities which violate Rule 10b-5. (Alternative Remedy Available: Derivative Suit)

Cowin v. Bresler (D.C. Cir. 1984)

Facts: Plaintiff is a minority shareholder of a publicly-owned company. The defendants own more than 70% of the company’s outstanding shares. Plaintiff sued defendants, alleging that their actions and dissemination of misleading reports make his stock less valuable. Plaintiff sought an injunction, not damages, requiring an end to the alleged misrepresentations and disclosure of past misrepresentations.

Issue: Whether the purchaser-seller limitation bars a shareholder’s suit for an injunction against actions that allegedly violate Rule 10b-5.

Rule: The purchaser-seller requirement applies to plaintiffs seeking an injunction under Rule 10b-5.

Holding: Plaintiff was not a purchaser-seller, so he may not maintain an action for an injunction under Rule 10b-5.

Discussion:

  • Injunction vs. Damages: Court notes that plaintiff could not maintain an action for damages because of Blue Chip Stamps holding.
  • Section 29(b) Alternative: Section 29(b) confers a right to rescind a contract that is void under the criteria of the Exchange Act. (Any contract made in violation of any provision of the Exchange Act or Rule 10b-5 is void.)
  • Plaintiff must show: (1) The contract involved a prohibited transaction; (2) Plaintiff is in contractual privity with the defendant; and (3) Plaintiff is in the class of persons the Act was designed to protect.

Binder v. Gillespie (9th Cir. 1999)

Facts: Plaintiff sues beverage company alleging that omissions materially harmed he and other plaintiffs and that these omissions violated Section 10(b). District court held that the Affiliated Ute presumption was not available because the allegations included omissions and misstatements. Without the presumption, reliance would have to be proved by each individual plaintiff, so the court decertified the class.

Issue: Whether the Affiliated Ute presumption of reliance can be applied in cases where plaintiffs allege both misstatements and omissions in violation of Section 10(b).

Rule: The Affiliated Ute presumption should not be applied to cases that allege both misstatements and omissions unless the case can be characterized as one that primarily alleges omissions.

Holding: Court affirmed the district court’s ruling because plaintiffs alleged both omissions and misstatements—not primarily omissions.

Dissent:

  • Explains that the Affiliated Ute presumption was established in Blackie v. Barrack because proving reliance on an omission would require “proof of a speculative negative”—i.e. “I would not have bought had I known.”
  • Dissent says that this logic applies equally to misstatements and misrepresentations as it does to omissions: “I would not have bought/sold had I known what you failed to tell me” is the same as “I would not have bought/sold had I known what you failed to tell me…namely, the truth.”
  • Footnote 3: Dissent states that he would apply Affiliated Ute presumption to pure misstatement cases.

Basic Inc. v. Levinson (U.S. 1988)

Key: This is the most important securities law decision of our time.

Facts: Basic Inc.’s executives made three public statements denying that it was involved in merger negotiations. The court held that these were material misstatements. Then the court turned to the reliance and fraud-on-the-market theory.

Issue: Whether plaintiffs can satisfy Section 10(b)’s (and common-law fraud’s) reliance requirement through a fraud-on-the-market presumption?

Rule: Because most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentation, therefore, may be presumed. Plaintiffs must show:

  1. The defendant made public misrepresentations;
  2. The misrepresentations were material in that they would induce a reasonable, relying investor to misjudge the value of the shares;
  3. The shares were traded on an efficient market;
  4. The plaintiff traded the shares between the time the misrepresentations were made and the time the truth was revealed.

Holding: Court holds that plaintiffs have met the reliance element through the fraud-on-the-market presumption.

Discussion: Defendants argued that the fraud-on-the-market theory effectively eliminates the need to prove reliance. Court explains that reliance is a mechanism for establishing a causal connection between defendant’s misrepresentations and a plaintiff’s injury. Then explains that there is more than one way to prove this causal connection—fraud-on-the-market is one of them.

Fraud-on-the-Market – Presumption’s Prerequisites: (1) plaintiffs must demonstrate that the alleged misrepresentations were publicly known; (2) that the stock traded in an efficient market, and (3) that the relevant transaction took place between the time the misrepresentations were made and the time the truth was revealed.

Identifying an Efficient Market: Five Factor Test from DVI Inc. Sec. Lit. (3d Cir. 2011) (citing Cammer v. Bloom): (1) the average weekly trading volume; (2) the number of security analysts following and reporting on the security; (3) the extent to which market makers traded the security; (what’s a market maker?); (4) the issuer’s eligibility to file an SEC registration Form S-3; and (5) the cause-and-effect relationship between material disclosures and changes in the security’s price.

Another perspective: A market should be deemed “efficient” if an investor would be justified in relying on the integrity of the market price—i.e., if the market bears enough hallmarks of efficiency that the investor would be justified in treating the market price as if it reflected the true value.

Truth-on-the-Market Defense [historically, this defense failed—that’s changing]: Two ways to prove: (1) Market makers knew the truth and thus the market price would not have been affected by the misrepresentations. (2) Truthful information on the matter in question credibly entered the market and dissipated the effects of the misstatements. Courts are granting motions to dismiss based on truth-on-the-market on the theory that if the market knew the truth, the omissions or misstatements were not material.


Shores v. Sklar (5th Cir. 1981) (en banc)

Facts: Plaintiff alleged that the defendants fabricated a materially misleading Offering Circular (which plaintiff never read) in order to induce the government agency to issue, and the public to buy, fraudulently marketed bonds. Plaintiff claims that he satisfies the “causation” element so long as he proves that the scheme was intended to and did bring the Bonds onto the market fraudulently and proved he relied on the integrity of the offerings of the securities market.

Issue: Whether a plaintiff who didn’t read the material containing material omissions or misstatements can nonetheless maintain a Rule 10b-5 action on the grounds that the securities were not entitled to be marketed in the first place.

Rule: To prevail on a fraud-created-the-market claim, a plaintiff must show:

  1. The defendants knowingly conspired to bring securities onto the market which were not entitled to be marketed, intending to defraud purcahsers;
  2. Bishop reasonably relied on the Bonds’ availability on the market as an indication of their apparent genuineness; and
  3. as a result of the scheme to defraud, he suffered a loss.

Holding: Court reverses and remands.

Limiting Principle: If a plaintiff who never read or relied on the misstatements or omissions can only prove that the securities should have been marketed at a lower/higher price, but cannot prove that the securities should not have been marketed at all, then he cannot recover.

The Meaning of “Unmarketable”: Economic Unmarketability – could not be offered at any pricePatently Worthless Enterprise – Sham or Hoax SellerLegal Unmarketability – Legal bar to the marketing of the securities


Brown v. Earthboard Sports USA, Inc. (6th Cir. 2007)

Facts: Brown acts on an investment tip from Vaughn—a friend who wants to be his investment advisor. Vaughn misrepresented the opportunity, but Brown did not do any investigation into the company before investing.

Issue: Whether Brown has submitted sufficient evidence to indicate that he was reasonable in relying on Vaughn’s tip.

Rule: Courts apply a recklessness standard to determine whether the reliance was unjustified.

Holding: Court holds that Brown has submitted sufficient evidence that his reliance was reasonable. Court therefore overturns district court’s grant of summary judgment in favor of Vaughn.

Factors to determine whether reliance is justified and reasonable:

  1. The sophistication of expertise of the plaintiff in financial and securities matters;
  2. The existence of long standing business or personal relationships;
  3. Access to the relevant information;
  4. The existence of a fiduciary relationship;
  5. Concealment of the fraud;
  6. The opportunity to detect the fraud;
  7. Whether the plaintiff initiated the stock transaction or sought to expedite the transaction; and
  8. The generality or specificity of the misrepresentations.

Merger Clauses and Justifiable Reliance – Three views:

  1. Merger clause bears on whether reliance was justified
  2. Merger clause by itself precludes any claim of deceit by prior representations
  3. Merger clause has no relevance for the justifiable reliance question as a result of Exchange Act 29(a)

Dura Pharmaceuticals, Inc. v. Broudo (U.S. 2005)

Facts: Dura Pharmaceuticals, Inc. (Dura) (Defendant) stated that investors (Plaintiff) who had brought a securities fraud class action had not claimed or demonstrated “loss causation” in their complaint, which only alleged that the cost of Dura stock on the date of purchase was exaggerated due to misstatements.

Issue: Whether an inflated purchase cost alone establish or proximately cause the pertinent economic damage needed to claim and demonstrate “loss causation”?

Rule: An inflated purchase cost alone will not establish or proximately cause the pertinent economic damage needed to claim and demonstrate “loss causation.”

Holding: No. An inflated purchase cost alone does not establish or proximately cause the pertinent economic damage needed to claim and demonstrate “loss causation”.  Usually, an inflated purchase cost alone does not establish or proximately cause the pertinent economic damage in fraud-on-the-market cases, like this one.


In Re Omnicom Group, Inc. SEC Litigation (2d. Cir. 2010)

Facts: Accounting fraud. When Omnicom’s subsidiary made bad investments in internet marketing companies, Omnicom tried to reduce losses with some clever accounting that involved transferring the subsidiary a newly created private holding company called Seneca. Omnicom reported that it would not incur any gain or loss from the transaction. Financial reporters covered this transaction closely, and there was a good deal of articles published, but Plaintiffs alleged that the corrective disclosure came in the form of a NYTimes that shined light on the fraud and caused the stock to fall.

Issue: Whether plaintiffs had provided sufficient evidence that the alleged fraud—the Seneca transaction—caused the drop in stock price that damaged the class (to withstand MSJ). In other words, whether the drop in the stock price resulted from the fraud or was caused by other market factors.

Corrective Disclosure Rule: A fraud regarding a company’s financial condition, if concealed, may cause investors’ losses at a later date when disclosure of the fraud is made and the available public information regarding the company’s financial condition is corrected. However, a negative characterization of previously known information cannot constitute a corrective disclosure.

Materialization of the Risk Rule: Plaintiffs can prove loss causation by showing that the loss was foreseeable and caused by the materialization of the risk concealed by the fraudulent statement. A misrepresentation is the proximate cause of an investment loss if the risk that caused the loss was within the zone of risk concealed by the misrepresentation. A misrepresentation is the proximate cause of an investment loss

Corrective Disclosure Holding: No Corrective Disclosure Application. Court dismissed this theory on the ground that the June 12 article did not bring to light any new information regarding the alleged fraud that was not already known publicly.

Materialization of the Risk Holding: No Materialization of the Risk Application. The facts leading to the “risk” events—director’s resignation and negative stories in the media—were all known to the public a year before the resignation. And it is too tenuous to recover on a claim that director’s resignation concerned the Seneca transaction and the director’s resignation precipitated negative stories which possibly precipitated the drop in stock.

Note 1: Plaintiffs sought to prove loss causation under two theories: (1) cause in fact: corrective disclosure—i.e., the market reacted negatively to the corrective disclosure of the fraud; and (2) Proximate Cause: materialization of the risk—i.e., foreseeable materialization of the risk concealed by the fraudulent statement.

Note 2: Materiality of the Risk—Defining the “Zone of Risk”: Determined by the purposes of the securities laws—i.e. to make sure that buyers of securities get what they think they are getting. Recovery is limited to only the foreseeable losses for which the intent of the laws is served by recovery.