Attorneys: Emma Gilmore and Marc Gorrie
Pomerantz Monitor November/December 2016
In a recent decision in the long-running Vivendi case, the Second Circuit has issued a landmark ruling adopting the so-called “price maintenance” theory of securities fraud. This theory holds that investors can recover for fraudulent statements that did not push up the price of a company’s securities, but maintained that price at an artificially inflated level.
The Vivendi case is 14 years old and counting, one of the longest running securities fraud cases ever. It is also one of the few securities fraud class actions that ever went to trial. That trial lasted three months and, in January of 2010, a jury returned a verdict for plaintiffs, finding that Vivendi had recklessly issued 57 public statements that misstated or obscured its true – and dire –financial condition.
But the jury’s verdict almost seven years ago was far from the end of the story. The Supreme Court subsequently issued its decision in Morrison, holding that the federal securities laws do not apply to foreign securities transactions. As a result, class members who purchased Vivendi stock on foreign exchanges were excluded from the case. Since Vivendi is a French company, that ruling wiped out the claims of many class members, and potentially billions of dollars in judgments went down the drain.
Before awarding damages to other individual class members, the district court allowed defendants to try to prove that some of them, specifically certain sophisticated institutional investors, did not rely on defendants’ misstatements in buying their shares and therefore could not recover damages either. That dispute is what led to the Second Circuit’s decision adopting the “price maintenance” theory.
Background. In 1998, Compagnie Générale des Eaux, the French utilities conglomerate, changed its name to Vivendi and transformed itself seemingly overnight into a global media conglomerate by aggressively acquiring diverse media and communications businesses in the United States and abroad. Vivendi financed these leveraged mergers and acquisitions by issuing stock, but by 2002 the company was “running critically low” of cash and in serious danger of being unable to meet its financial obligations.
Vivendi did not disclose this, but instead made numerous representations to the market suggesting that its business prospects were robust.
Eventually a series of credit downgrades revealing Vivendi’s cash problems sent the company’s shares tumbling, and securities litigation ensued.
By mid-2002, consolidated class actions were filed in the Southern District of New York against Vivendi and its former CEO, Jean Marie Messier, and CFO, Guillaume Hannezo. Plaintiffs alleged that Vivendi violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 in issuing “persistently optimistic representations” denying the company’s near-bankrupt state, and that the CEO and CFO were liable as controlling persons under Section 20(a) of the
Exchange Act. As noted above, in 2010 the jury found for the plaintiff class against Vivendi, but exonerated the two individual defendants.
After trial, the district court ruled that Vivendi should be given the opportunity to show that sophisticated financial institutions had not relied on their misrepresentations in purchasing their shares. Vivendi claimed that plaintiffs failed to prove reliance because its misrepresentations merely maintained its stock price, rather than pushing it up. In its view, unless the price of the company’s stock actually rose as a result of a misrepresentation, there was no price impact and, therefore, no reliance. In this view, maintaining a pre-existing inflated stock price does not constitute a price impact.
The reliance requirement asks whether there is a “proper” connection between a defendant’s misrepresentation and a plaintiff’s injury. To resolve the difficulties of proving direct reliance in the context of modern securities markets, where impersonal trading rather than face-to-face transactions are the norm, the Supreme Court has held that a prospective class of plaintiffs could invoke a rebuttable presumption of reliance by invoking the “fraud on the market theory,” which provides that “[a]n investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price,” where material information about the company (including any fraudulent public statements) are reflected in the market price. Investors are all presumed to rely on the “integrity” of that market price when they purchase shares. Thus, part of what they are relying on, indirectly, are the fraudulent statements.
In Halliburton, however, the Supreme Court held that the fraud on the market theory creates only a presumption of reliance, and defendants are entitled to try to rebut that presumption in particular cases. In Vivendi the company argued that it had rebutted that presumption by showing that its stock price did not increase after most of the alleged misstatements, and therefore those misstatements had no effect on the investors’ decisions to invest.
The district court rejected that argument, accepting the so-called price maintenance theory. This theory, which is being debated in federal courts all over the country, holds that plaintiffs do not have to show that the fraudulent statements pushed the stock price up. Rather, the theory posits that fraud that artificially maintains the inflated market price of a stock does have a price impact and therefore supports investors’ claims that they relied on the integrity of the market price when they purchased their shares.
Second Circuit Decision. Delivering a major victory for investors, the Second Circuit, in its Vivendi decision, embraced the price maintenance theory for the first time. It joined the Eleventh and Seventh Circuits in rejecting the idea that a fraudulent statement, to be actionable, must always introduce “new” inflation into the price of a security. The Second Circuit analyzed Vivendi’s contention as resting on two premises: that the artificial inflation in the company’s share price caused by the market’s misapprehension of the company’s liquidity risk would not have dissipated had Vivendi remained silent and that Vivendi had the option to remain silent, thus permitting the preexisting inflation to persist. In other words, Vivendi argued that their fraudulent statements had no impact because its stock price would have remained inflated anyway had it just said nothing.
The Second Circuit rejected that argument. First, it held that it was not necessarily true that the stock price would have remained unchanged if Vivendi had said nothing:
Perhaps, in the face of silence, inflation could have remained unchanged. But it also could have plummeted rapidly, or gradually, as the truth came out on its own, no longer hidden by a misstatement’s perpetuation of the misconception. . . . It is far more coherent to conclude that such a misstatement does not simply maintain the inflation, but indeed “prevents [the] preexisting inflation in a stock price from dissipating.”
Second, it held that because it chose to issue statements about its financial condition, Vivendi had no option to remain silent about its liquidity problems:
Vivendi misunderstands the nature of the obligations a company takes upon itself at the moment it chooses, even without obligation, to speak. It is well established precedent in this Circuit that “once a company speaks on an issue or topic, there is a duty to tell the whole truth,” “[e]ven when there is no existing independent duty to disclose information” on the issue or topic.
Thus, far from being a “fabricated” and “erroneous” argument, as Vivendi labeled it, the Second Circuit said that the price maintenance theory prevents companies from “eschew[ing] securities-fraud liability whenever they actively perpetuate (i.e., through affirmative misstatements) inflation that is already extant in their stock price, as long as they cannot be found liable for whatever originally introduced the inflation. Indeed, under Vivendi’s approach, companies (like Vivendi) would have every incentive to maintain inflation that already exists in their stock price by making false or misleading statements. After all, the alternatives would only operate to the company’s detriment: remaining silent, as already noted, could allow the inflation to dissipate, and making true statements on the issue would ensure that inflation dissipates immediately.” After discussing the theory with approval and at length, the Second Circuit concluded:
In rejecting Vivendi’s position that an alleged misstatement must be associated with an increase in inflation to have a “price impact,” we join in the Seventh and Eleventh Circuits’ conclusion that “theories of ‘inflation maintenance’ and ‘inflation introduction’ are not separate legal categories . . . Put differently, we agree with the Seventh and Eleventh Circuits that securities fraud defendants cannot avoid liability for an alleged misstatement merely because the misstatement is not associated with an uptick in inflation.