Ninth Circuit Takes Tough Stance on Loss Causation

A company's announcement of an internal investigation may trigger a bad stock market reaction but, by itself, it's not enough to establish loss causation in a securities class action, the U.S. Court of Appeals for the Ninth Circuit held on Aug 7, 2014.

A three-judge panel affirmed U.S. District Judge Maxine Chesney's 2011 dismissal of a shareholders' suit targeting Immersion Corp. and five company executives. In Loos v. Immersio , filed in the U.S. District Court for the Northern District of California, plaintiffs argued that the San Jose, CA, tech company effectively revealed it had “cooked the books” in a 2009 press release announcing it was reviewing previous years' revenue calculations. Immersion's stock price dropped 23% on the news.

But the district and appellate courts found that the company's announcement, and subsequent recasting of past years' earnings, reflected poor financial health, not proof corporate executives had acted fraudulently.

“The announcement of an investigation does not 'reveal' fraudulent practices to the market,” U.S. District Judge Thomas Rice of the Eastern District of Washington wrote for the unanimous panel. Rice was sitting by designation.

“While the disclosure of an investigation is certainly an ominous event, it simply puts investors on notice of a potential future disclosure of fraudulent conduct,” Rice continued. “Consequently, any decline in a corporation's share price following the announcement of an investigation can only be attributed to market speculation about whether fraud has occurred.”

That speculation alone cannot form the basis for a viable loss causation claim, Rice concluded.

The decision is a win for Immersion's legal team at Fenwick & West. Plaintiffs were represented by the New York firm of Brower Piven and attorneys from the San Francisco office of Robbins Geller Rudman & Dowd.

Immersion creates and licenses “haptics” technology, which produces vibrations, resistance and other tactile cues in electronics. After experiencing several years of poor financial results, the company reported four profitable quarters in 2007 and touted expected growth of its medical technology sales in China.

Net losses returned in 2008, however, and the news worsened when Immersion announced the internal investigation in July 2009. One month later the company advised investors that its past financial statements “should no longer be relied upon.” In 2010, Immersion reported to the Securities and Exchange Commission that it had recorded sales revenue in its medical line before the money had materialized. As a result, the company restated its earnings for 2006, 2007, 2008 and the first quarter of 2009.

Cheryl Miller is a reporter for The Recorder, an ALM sister publication of this newsletter in which this article also appeared.

A company's announcement of an internal investigation may trigger a bad stock market reaction but, by itself, it's not enough to establish loss causation in a securities class action, the U.S. Court of Appeals for the Ninth Circuit held on Aug 7, 2014.

A three-judge panel affirmed U.S. District Judge Maxine Chesney's 2011 dismissal of a shareholders' suit targeting Immersion Corp. and five company executives. In Loos v. Immersio , filed in the U.S. District Court for the Northern District of California, plaintiffs argued that the San Jose, CA, tech company effectively revealed it had “cooked the books” in a 2009 press release announcing it was reviewing previous years' revenue calculations. Immersion's stock price dropped 23% on the news.

But the district and appellate courts found that the company's announcement, and subsequent recasting of past years' earnings, reflected poor financial health, not proof corporate executives had acted fraudulently.

“The announcement of an investigation does not 'reveal' fraudulent practices to the market,” U.S. District Judge Thomas Rice of the Eastern District of Washington wrote for the unanimous panel. Rice was sitting by designation.

“While the disclosure of an investigation is certainly an ominous event, it simply puts investors on notice of a potential future disclosure of fraudulent conduct,” Rice continued. “Consequently, any decline in a corporation's share price following the announcement of an investigation can only be attributed to market speculation about whether fraud has occurred.”

That speculation alone cannot form the basis for a viable loss causation claim, Rice concluded.

The decision is a win for Immersion's legal team at Fenwick & West. Plaintiffs were represented by the New York firm of Brower Piven and attorneys from the San Francisco office of Robbins Geller Rudman & Dowd.

Immersion creates and licenses “haptics” technology, which produces vibrations, resistance and other tactile cues in electronics. After experiencing several years of poor financial results, the company reported four profitable quarters in 2007 and touted expected growth of its medical technology sales in China.

Net losses returned in 2008, however, and the news worsened when Immersion announced the internal investigation in July 2009. One month later the company advised investors that its past financial statements “should no longer be relied upon.” In 2010, Immersion reported to the Securities and Exchange Commission that it had recorded sales revenue in its medical line before the money had materialized. As a result, the company restated its earnings for 2006, 2007, 2008 and the first quarter of 2009.

Cheryl Miller is a reporter for The Recorder, an ALM sister publication of this newsletter in which this article also appeared.