Thursday, August 09, 2018

Supreme Court asked to address proximate cause standard in securities cases

By Rodney F. Tonkovic, J.D.

A petition for certiorari has been filed asking the Supreme Court to address the Ninth Circuit's standard for loss causation. At issue is what the petitioner describes as a three-way split in how the appellate courts require a plaintiff to show the market's reaction to information revealing the fraudulent nature of the defendant's conduct. The petition argues that the Ninth Circuit has adopted a "dramatically less demanding" proximate cause standard for proving loss causation that is inconsistent with the Court's precedent (First Solar, Inc. v. Mineworkers' Pension Scheme, August 6, 2018).

Proximate cause. Investors in First Solar, Inc., a producer of solar panels, alleged that the company and its management concealed a manufacturing defect that reduced the performance of its products. First Solar, for its part, countered that the plaintiffs could not meet their burden to establish that the alleged concealment was the actual cause of their losses. The district court was tasked with weighing competing lines of Ninth Circuit case law on loss causation. A line of cases favoring the plaintiffs stems from In re Daou Systems, Inc. (9th Cir. 2005), and takes the position that loss causation is satisfied by drawing a causal connection between the misrepresented facts and the plaintiff's loss. In a more restrictive line urged by First Solar (following Metzler Investment GMBH v. Corinthian Colleges, Inc. (9th Cir. 2008)), an injury is not enough, and a plaintiff must show a market reaction to the fraud itself.

The district court opted to follow Daou and its progeny, but recognizing that the two lines of cases would lead to very different results, court certified a question for interlocutory appeal to the Ninth Circuit asking "What is the correct test for loss causation in the Ninth Circuit?" The Ninth Circuit panel held that the loss causation inquiry "requires no more than the familiar test for proximate cause." Here, the panel pointed to its most recent decision on loss causation, Lloyd v. CVB Fin. Corp. (decided after the district court's order) holding that "the ultimate issue is whether the defendant’s misstatement, as opposed to some other fact, foreseeably caused the plaintiff’s loss." The more restrictive cases in the Metzler line, the panel said, are simply fact-specific variants of the basic proximate cause test.

The panel then concluded that the district court applied the correct test in determining that the evidence could satisfy the proximate cause test with respect to five out of the six alleged price declines. Without reaching any other issue presented in the case, the panel affirmed the district court's judgment.

Showing loss. The petition asks whether a private securities-fraud plaintiff may establish the critical element of loss causation based on a decline in the market price of a security where the event or disclosure that triggered the decline did not reveal the fraud on which the plaintiff’s claim is based. The petitioner notes that the Court has made clear in Halliburton (2011) that loss causation may be established to the extent that a price decline is caused by the revelation of a misrepresentation to the market. At issue here is what is required to make that showing.

According to the petition, there are three approaches, and three different ways that this case could have come out, depending on where it had been filed. The First, Fourth, Seventh, and Eleventh circuits require a showing that the market learned of and reacted to information that revealed the fraudulent nature of the defendant's conduct. The Second, Fifth, Sixth, and Tenth circuits take a more permissive approach and hold that a plaintiff must show that the market learned of and reacted to the facts fraudulently concealed by the defendant, even if the fraud itself was not revealed. Finally, the Third Circuit (plus the Ninth in this decision) holds that a plaintiff can prove loss causation by "tracing" the information revealed to the market back to the facts concealed by the defendant, even if the market was ignorant at the time of both those facts and the fraud.

The petition also asserts that the Ninth Circuit's decision ignores Supreme Court precedent, the basic principles of proximate causation, and the structure of the PSLRA. The decision, the petition explains, effectively removes the established requirement that a plaintiff must prove that a price decline was the result of a revelation of a misrepresentation rather than some other intervening cause. With such a dramatically less demanding standard for proving loss causation, the Ninth Circuit, already host to a majority of securities class actions, will see those numbers grow, the petition says.

The petition is No. 18-164.