In a strongly worded decision that will make it easier for private plaintiffs to withstand dismissal of securities fraud claims in certain cases, the Second Circuit vacated and remanded a federal district court’s dismissal of a putative securities fraud class action. In Acticon v. China Ne. Petroleum Holdings Ltd., — F. 3d —, 2012 WL 3104589 (2d Cir. Aug. 1, 2012), (found here), the Second Circuit squarely rejected what it described as the district court’s reliance on a “more expansive view” of the Supreme Court’s decision in Dura Pharmaceuticals v. Broudo, 544 U.S. 336 (2005). Acticon, 2012 WL 3104589, at *6. In Dura, the Supreme Court held that a private plaintiff in a securities fraud action must plead that the plaintiff’s claimed loss was proximately caused by the defendant’s alleged misrepresentation. This is typically accomplished through an allegation that the price of the security dropped following public disclosure of the alleged fraud, an allegation made by the Acticon plaintiffs in their complaint.
According to the Second Circuit, some district courts, including the court below, incorrectly “extrapolated” from Dura, granting dismissal motions based on a showing that the stock price rebounded after its initial drop following corrective disclosure to a level at or above the price at which the plaintiff purchased the security. Acticon, 2012 WL 3104589, at *5. The Second Circuit found this view contrary to both the “out of pocket” measure of damages and the “bounce back” provision contained in the Private Securities Litigation Reform Act that caps the amount of damages available in a securities fraud action. Id. at *6. The Court also reasoned that it would be improper to assume, at the pleading stage, that the stock rebounded from its initial price drop because of the market’s reaction to the disclosure of the alleged fraud, instead of “unrelated gains.” Id. at *6-7. Accordingly, the Second Circuit held that stock price rebound does not negate an inference of economic loss at the pleading stage. Id. at 7.
The Second Circuit’s decision should prove significant in those securities fraud cases in which the share price of the defendant increased after an initial decline following a corrective disclosure. Notably, the decision came in the first case in which a district court granted a motion to dismiss in a securities fraud action against a U.S. listed Chinese company in the so-called “reverse Chinese merger” cases. It remains to be seen whether the ruling will impact the numerous cases pending against other Chinese companies that entered the market through reverse mergers.
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