According to the plaintiffs, as the truth was leaked to the public over time, the stock price dropped. Ultimately, the five corrective disclosures caused the share price to plummet from $66.07 as of August 11, 2008 to $24.02 in September 28, 2010.
The five corrective disclosures that allegedly revealed the fraud spanned nearly a two-year period. The first disclosure was an online report that raised questions about the company’s accounting and Medicare billing practices. The same day that this report was made, the company’s stock fell $11.80.
The second came on September 3, 2009, when the company reported that its chief executive officer and chief information officer were leaving to “pursue other interests.” The stock fell $9.42 that same day.
The third alleged partial disclosure was an article published by the Wall Street Journal on April 26, 2010. The article included an analysis of Medicare data by a professor, who found a questionable pattern of home visits clustered around reimbursement targets. The next day, the company’s stock fell $3.98 per share.
The fourth alleged partial disclosure was a combination of three government investigations into the company’s billing practices relating to Medicare. The fifth alleged partial disclosure was the company’s July 12, 2010, announcement that it had disappointing second quarter results.
District Court Dismisses Case for Lack of Causation
Investors filed a series of class action lawsuits against the company that were consolidated and subject to the defendants’ motion to dismiss. The U.S. District Court for the Middle Distrct of Louisiana granted the motion, reasoning that the plaintiffs had failed to adequately plead loss causation. “Loss causation is proximate cause for securities cases,” explains, Joshua D. Jones, Birmingham, AL, cochair of the Securities Litigation Committee of the ABA Section of Litigation. The district court examined each of the partial disclosures in isolation and found that none of them taken alone revealed the fraud scheme and so none could constitute a corrective disclosure. Accordingly, the district court dismissed the suit.
On appeal, the Fifth Circuit rejected the district court’s piecemeal approach and instead examined the disclosures collectively. The appellate court reasoned that partial disclosures must be relevant to the fraud, but need not individually reveal the fraud. The court examined each of the five partial disclosures, found that they “collectively constitute and culminate in a corrective disclosure that adequately pleads loss caution,” and reversed the district court’s dismissal.
Securities Fraud Cases May Be Easier to Plead
“This test acknowledges the reality that news about a fraud leaks out into the market over time and through various sources,” says Matthew L. Mustokoff, Radnor, PA, cochair of the Class Actions Subcommittee of the Securities Litigation Committee. “This case makes pleading a securities fraud case easier,” Mustokoff says, “by not requiring each partial disclosure to reveal the fraud scheme individually.” The court held that the partial disclosure must now be “related to” or “relevant to” the company’s alleged fraud and misstatements.
The decision may be more far-reaching than just affecting pleading standards. “If you are dealing with partial disclosures over a couple of years, an experienced plaintiff’s lawyer is going to consider whether to attempt to extend the timeframe at issue by citing an earlier partial disclosure in an effort to increase the potential damages,” says Jones.
The case also provides a roadmap for securities litigators. “Plaintiff’s counsel will want to provide much detail as possible as to the timeline on the purported fraud because any partial disclosure may be the one that ‘culminates’ in a corrective disclosure,” Jones notes. “In addition, doing so may allow plaintiffs to expand the damages range by securing a larger drop in share price.” On the other hand, Jones suggests that defense counsel should focus on whether each partial disclosure is relevant to the underlying fraudulent misrepresentation. “If not,” Jones observes, “it should not contribute to a finding of a cumulative corrective disclosure.”
Andrew J. Kennedy is an associate editor for Litigation News.