9th Circuit decision clarifies securities fraud loss causation rule

In an admirably short and clear per curiam opinion, an ideologically diverse panel of the 9th U.S. Circuit Court of Appeals (Judges Sidney R. Thomas, J. Clifford Wallace and Consuelo M. Callahan) reaffirmed that loss causation in securities fraud cases is not as doctrinally complicated as it sometimes seems. The case, Mineworkers Pension Scheme v. First Solar, Inc., 2018 DJDAR 1063 (9th Cir. Jan. 31, 2018), answered the district court's question, certified for interlocutory review, "as to the correct test for loss causation under the Securities Exchange Act of 1934." The answer? Simply a "general proximate cause test."

Background

Section 10(b) of the Securities Exchange Act of 1934 makes it unlawful "[t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. Section 78j(b). Securities and Exchange Commission Rule 10b-5 implements this provision by making it unlawful to, among other things, "make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading." 17 C.F.R. Section 240.10b-5(b). To state a claim under Section 10(b), a plaintiff must allege: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." In re Quality Sys., Inc. Sec. Litig., 865 F.3d 1130, 1140 (9th Cir. 2017).

Concerning loss causation, the Private Securities Litigation Reform Act of 1995 -- which is applicable to Section 10(b) claims -- provides that "the plaintiff shall have the burden of proving that the act or omission of the defendant alleged ... caused the loss for which the plaintiff seeks to recover damages." 15 U.S.C. Section 78u-4(b)(4). To adequately plead loss causation, a plaintiff need only "provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind." Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 347 (2005). The U.S. Supreme Court in Dura Pharms declared that the pleading requirements for loss causation "are not meant to impose a great burden upon a plaintiff."

First Solar's Loss Causation Ruling

The simplicity of the 9th Circuit's answer regarding loss causation in First Solar is entirely accurate and remarkable only because of the complicated language in the 9th Circuit's decisions that led the district court to ask: "[c]an a plaintiff prove loss causation by showing that the very facts misrepresented or omitted by the defendant were a substantial factor in causing the plaintiff's economic loss, even if the fraud itself was not revealed to the market ... , or must the market actually learn that the defendant engaged in fraud and react to the fraud itself?" The 9th Circuit held that a plaintiff's burden in establishing loss causation under the Exchange Act "requires no more than the familiar test for proximate cause." (Quoting 15 U.S.C. Section 78u-4(b)(4).) Thus, "[d]isclosure of the fraud is not a sine qua non of loss causation, which may be shown even where the alleged fraud is not necessarily revealed prior to the economic loss." (Quoting Nuveen Mun. High Income Opportunity Fund v. City of Alameda, Cal., 730 F.3d 1111, 1120 (9th Cir. 2013).)

Regarding the 9th Circuit cases that occasioned the district court's question concerning whether a more restrictive test applied, the 9th Circuit held that they "should be understood as fact-specific variants of the basic proximate cause test, as clarified by Lloyd [v. CVB Fin. Corp., 811 F.3d 1200 (9th Cir. 2016)]." Indeed, First Solar was an easy case at least in part because Lloyd -- which was published after the district court certified the question to the 9th Circuit -- had already clarified the applicable rule.

Lloyd's Loss Causation Decision

Lloyd explained that "loss causation is a 'context-dependent' inquiry as there are an 'infinite variety' of ways for a tort to cause a loss." (Citation omitted.). And "[b]ecause loss causation is simply a variant of proximate cause, the ultimate issue is whether the defendant's misstatement, as opposed to some other fact, foreseeably caused the plaintiff's loss." (Citation omitted.)

Lloyd involved allegations that CVB Financial Corporation misrepresented in SEC filings that, other than certain specified nonperforming loans, there were no other loan problems that would cause serious doubts regarding the ability of borrowers to comply with payment terms. The complaint alleged that CVB failed to disclose that Garrett Group, a significant borrower, informed CVB that it would not make the required payments and was contemplating bankruptcy. After CVB announced that it had received an SEC subpoena requesting information about CVB's loan underwriting guidelines, CVB's stock price plummeted 22 percent. A month later, CVB wrote down $34 million in Garrett loans, and placed the remaining $48 million in its non-performing category. CVB's stock price, however, only slightly reacted to this subsequent disclosure.

The 9th Circuit in Lloyd held that loss causation was adequately pled through a combination of two partial disclosures: (1) the announcement of the SEC subpoena -- which in and of itself was not a corrective disclosure, but prompted a sharp stock price decline; and (2) the subsequent announcement of loan charge-offs -- which was a corrective disclosure, but was not accompanied by any substantial stock price decline. Indeed, Lloyd relied heavily upon the 5th Circuit's decision in Pub. Employees Ret. Sys. of Mississippi, Puerto Rico Teachers Ret. Sys. v. Amedisys, Inc., 769 F.3d 313, 325 (5th Cir. 2014), which involved multiple partial disclosures -- none of which was independently sufficient to constitute a corrective disclosure. The partial disclosures in Amedisys included: (1) an online report by a short seller that the 5th Circuit acknowledged merely raised "[s]peculation of wrongdoing;" (2) an announcement of the resignation of two officers that the 5th Circuit stated did "nothing" to "reveal[] the truth behind earlier misstatements;" (3) a Wall Street Journal article based on an analysis of publicly available data; (4) announcements of a series of governmental investigations -- none of which led to any actual finding of wrongdoing; and (5) a disappointing quarterly earnings report. The court in Amedisys held that together these disclosures "collectively constitute[d] and culminate[d] in a corrective disclosure" because they gradually revealed the truth to the market and "the whole is greater than the sum of its parts." Thus, the 9th Circuit in Lloyd made clear that courts must view loss causation holistically and that a single, independently-sufficient corrective disclosure is not necessarily required to establish loss causation.

Conclusion

While establishing loss causation in securities fraud actions is not always factually simple, it is helpful to be reminded that it is just a proximate causation inquiry; nothing more.