Pomerantz LLP

Investigations As Loss Causations

ATTORNEY: Louis C. Ludwig

The announcement that government agencies have commenced investigations of possible wrongdoing, particularly SEC and FCPA inquiries, has long played an important role in kicking off securities fraud litigation. Recently, however, the universe of these triggering investigations has expanded to include alleged violations of the Lacey Act involving the importation of illegally logged wood from Russia and China; alleged violations of payday lending rules by the U.K.’s Office of Trading; alleged violations of the International Traffic in Arms Regulation; civil investigative demands regarding Medicare fraud; FTC, DOJ, and Senate Finance Committee investigations; and even Chinese governmental investigations of possible corruption. It has been estimated that such cases triggered nearly 10% of securities class action lawsuits filed in 2013. 

This rise in the filing of these “investigation follow-on” actions has drawn increased judicial scrutiny, specifically in regard to loss causation. To state a claim under Section 10(b) of the Exchange Act, a plaintiff must demonstrate, among other things, that the public disclosure of a misrepresentation caused plaintiff’s complained-of financial loss (or “loss causation”). To satisfy this requirement, there usually has to be a “corrective disclosure” of the true facts which, in turn, causes the losses. The question, then, is whether the announcement that an investigation has begun amounts to a “corrective disclosure.” 

In August, the Ninth Circuit issued Loos v. Immersion Corp., which holds that the “announcement of an investigation, standing alone, does not give rise to a viable loss causation allegation[,]” even though the announcement was accompanied by a drop in share price. To reach this outcome, the Ninth Circuit reasoned that the announcement of investigation disclosed only the “risk” or “potential” for widespread fraudulent conduct, and did not “reveal” fraudulent practices to the market. As stated in Meyer v. Greene, a 2013 Eleventh Circuit opinion followed by the Immersion court, “the announcement of an investigation reveals just that-an investigation-and nothing more.” 

In September, the Ninth Circuit amended its opinion in Immersion to clarify that the court did “not mean to suggest that the announcement of an investigation can never form the basis of a viable loss causation theory.” The court added that “[t]o the extent an announcement contains an express disclosure of actual wrongdoing, the announce-ment alone might suffice” to support loss causation by itself. But what happens if the fraud hinted at by an investigation isn’t confirmed for months, or even years? 

The optimistic take is that if an investigation ultimately bears fruit, loss causation may be shown in hindsight. Interestingly, the Immersion plaintiff argued this exact point, claiming vindication by way of post-class period disclosures that Immersion’s financial statements were unreliable and would have to be restated. Unfortunately, the Ninth Circuit deemed that argument waived because plaintiff failed to raise it before the district court or in his complaint, so it’s uncertain how it would play out on the merits. We do know that the amended Immersion opinion states that its holding doesn’t affect investigatory announcements bolstered by a “subsequent disclosure of actual wrongdoing[,]” implying that such fact patterns are actionable. This appears to validate the Immersion plaintiff’s claim that later revelations “‘solidif[ied] the causative link’ between the fraud and his loss.” He simply failed to plead that link in time. 

If this reading is correct, it raises an additional question: with a two-year statute of limitations governing Exchange Act claims, and with investigations notoriously slow to resolve, should a potential 10(b) plaintiff faced with an investigatory announcement, but no definitive “corrective disclosure” or admission of wrongdoing, file anyway? On one hand, the claim would be preserved – a plaintiff could “wait-and-see,” then, provided that the fraud was ultimately confirmed, argue that the investigation heralded a later “materialization of the risk.” On the other hand, the court could run out of patience prior to the needed corrective disclosure and dismiss the complaint. The difficulty here is that statutes of limitations typically do not start to run until the cause of action “accrues,” which means that enough facts are disclosed to allow investors to file a claim. If there is uncertainty as to whether disclosure of an investigation is sufficient to support a claim, a plaintiff who does not file a case right away risks falling afoul of the statute of l imitations, resulting in the claim being time-barred. 

Practically, the best advice for plaintiffs is to take Immersion at its word and avoid pleading an announcement of investigation as a stand-alone basis for loss causation. Multiple disclosures are often simply unavailable, but as Immersion shows, they should be ferreted out in the pre-filing in-vestigation and pleaded whenever possible. This is demonstrated by Public Employees Retirement System of Mississippi et al. v. Amedisys, Inc., issued by the Fifth Circuit in October as the first decision to grapple with Immersion. In contrast to Immersion, the Fifth Circuit upheld the complaint in Amedisys, which alleged, as corrective disclosures, the announcement of investigations by the DOJ, SEC, and Senate Finance Committee, along with the following additional disclosures: a report published by Citron Research raising questions about Amedisys’s billing; executive resignations; and a number-crunching WSJ article con-cluding that Amedisys was “taking advantage of the Medicare reimbursement system.” While opining that some of these allegations, standing alone, would be insufficient to show loss causation, the court held that the multi-ple partial disclosures “collectively constitute and culminate in a corrective disclosure that adequately pleads loss causation...” In sum, Immersion and Amedisys teach that there is strength in numbers. 

As a postscript, a Pomerantz case, In re LifeLock Sec. Litig. (D. Ariz.), will be the first test of Immersion at the district court level nationwide. Plaintiff alleges that LifeLock de-liberately turned off “identity theft prevention” alerts to elderly customers in violation of a 2010 settlement with the FTC that required ongoing compliance (and honesty with consumers). After a whistleblower came forward, the FTC re-opened its inquiry into LifeLock, causing shares to drop. In their pending motion to dismiss, defendants argue for a broad reading of Immersion, in which investigatory announcements are presumptively ill-suited to support an allegation of loss causation. Plaintiff contends that the renewed investigation didn’t merely portend a “risk” of fraud, but was instead a materialization of LifeLock’s noncompliance with the FTC settlement. Most importantly, the complaint also pleads additional disclosures, making the upcoming ruling not only a test of Immersion, but of the countervailing approach on display in Amedisys as well.