Alert June 27, 2012

Recent Securities Decisions

No Presumption of Reliance When Causation Between Disclosure and Stock Price Lacking

The U.S. District Court for the Southern District of New York recently denied a motion seeking certification of a class of purchasers of Freddie Mac’s Series Z preferred stock in a suit against Freddie Mac’s former CEO Richard Syron and former CFO Anthony Piszel. In re Fed. Home Loan Mortg. Corp. Sec. Litig., 2012 WL 1028642 (S.D.N.Y. Mar. 27, 2012). The plaintiff sued Syron and Piszel after Freddie Mac’s stock price fell after it was publicly called “insolvent” by a former St. Louis Federal Reserve president, and again after Freddie Mac was moved into conservatorship. The plaintiff alleged that Syron and Piszel had misrepresented and omitted material information about Freddie Mac’s underwriting and risk management practices and the adequacy of its capitalization.

In denying class certification, the court found that plaintiff could not establish a class-wide presumption of reliance through a “fraud on the market” theory, without which individual questions about investor reliance on misrepresentations would predominate over common questions. The court stated that the most important factor in determining whether an efficient market exists is whether there is a “demonstration of a cause-and-effect relationship between unexpected, material disclosures and changes in stock prices.”  The court found that this factor was not met because neither of the studies conducted by the plaintiff’s expert could prove the necessary cause-and-effect relationship. Because the plaintiff had failed to show through his expert that the market for Series Z was efficient, no fraud-on-the-market presumption of collective reliance applied, and therefore individual issues predominated over common ones. The court thus denied the plaintiff’s motion for class certification.

No Presumption of Reliance When Efficient Market Did Not Exist

The U.S. District Court for the Central District of California recently denied certification of a putative class of stock purchasers seeking damages for alleged securities fraud. In Dean v. China Agritech, 2012 WL 1835708 (C.D. Cal. May 3, 2012), the plaintiffs alleged that the defendant – a holding company publicly traded within the United States after a “reverse merger” in 2005 – materially misstated its revenue and income for fiscal years 2008 and 2009. The plaintiffs sought to certify a class of purchasers of Agritech stock over a 16-month period, asserting that the stock price had been artificially inflated by the alleged misrepresentations in violation of Section 10(b) of the Securities Exchange Act of 1934 and Section 11 of the Securities Act of 1933.

The court denied class certification because common issues did not predominate. Focusing only on the 10(b) claim, the court noted that the plaintiffs would need to show “(1) a material misrepresentation or omission, (2) scienter, (3) a connection with the purchase or sale of a security, (4) reliance, (5) economic loss, and (6) loss causation.”  The court highlighted reliance as a significant obstacle to certification because reliance typically requires individual evidence that predominates over common issues.

Although the court recognized that reliance is sometimes presumed, it cited Ninth Circuit precedent holding that proving a fraud on the market requires showing that “the securities were traded in an efficient market,” which requires the court to consider, among other things, “the number of securities analysts following the security” and “the existence of a cause-effect relationship between unexpected corporate news and a change in the price of the security.”  After conducting an extensive analysis, the court held that these factors counseled against class certification. Although the plaintiffs’ expert had stated that 13 analysts followed the stock, the plaintiff could not show that these individuals were in fact qualified analysts. Further, the plaintiffs’ experts could not show a statistically significant correlation between disclosures and price changes. The court therefore held that because there was no efficient market, the plaintiffs could not rely on the fraud-on-the-market theory, and reliance had to be proved on an individualized basis. As a result, the court denied class certification because non-common issues predominated.