Ninth Circuit Resolves Loss Causation Issue Under Section 10(B)
ATTORNEY: AUSTIN P. VAN
POMERANTZ MONITOR MARCH/APRIL 2018
In Mineworkers’ Pension Scheme v. First Solar, Inc., the Ninth Circuit recently resolved an internal conflict in its case law regarding the loss causation requirement of Section 10(b) of the Exchange Act. The court held that a plaintiff may prove loss causation by showing that revelation of the very facts misrepresented or omitted by the defendant caused the plaintiff’s economic loss, even if the fraud itself was not revealed to the market. That is, to satisfy the loss causation requirement, a plaintiff need not point to a revelation that the defendants committed fraud, but rather only to a revelation of the facts concealed by the fraud. This commonsense ruling greatly improves the ability of investors in California and elsewhere in the Ninth Circuit to recover losses that were sustained as a result of fraud before the fraud itself was revealed to the public.
Defendant First Solar, Inc. is a large producer of solar panel modules. Plaintiffs, a putative class of purchasers of First Solar’s stock, alleged that the company discovered manufacturing defects in its solar panel modules that caused them to lose power within the first several months of use, as well as design defects in the modules that caused them to lose power faster in hot climates. Plaintiffs alleged that First Solar hid these defects and their cost and scope from the market and misrepresented key data in their financial statements.
First Solar’s stock price declined steeply after these defects and their cost and scope were revealed to the market. First Solar initially disclosed the manufacturing defect and significant additional costs related to curing the defect and, over the next year, the company disclosed consistently disappointing earnings and financial results, additional expenses related to curing the product defects, and the departure of the company’s CEO. However, at no point did the company or any other party reveal that First Solar had known about, and misrepresented or fraudulently concealed, any of these problems in the past.
On their motion for summary judgment, defendants argued that plaintiffs had not satisfied the loss causation requirement of Section 10(b) because plaintiffs’ losses were not caused by the revelation that First Solar had committed fraud. Plaintiffs replied that revelation of the facts allegedly misrepresented and concealed by defendants, namely, the company’s product defects and related financial burdens, was sufficient to satisfy the loss causation requirement.
The district court identified two irreconcilable lines of Ninth Circuit case law on this issue. The first line of cases began with In re Daou Sys., where the Ninth Circuit reversed a district court’s decision dismissing a Section 10(b) action on the ground that the plaintiffs had not alleged any disclosures that defendants were engaging in improper accounting practices. The Ninth Circuit held that where disclosure of “the company’s true financial condition” caused the stock to drop, loss causation was satisfied, even though the company’s fraudulent accounting practices were not revealed to the market. The Ninth Circuit took a similar approach in Berson v. Applied Signal Technology, Inc., and ultimately fashioned a standard for loss causation in Nuveen v. City of Alameda when it held that a plaintiff can establish loss causation “by showing that the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff’s economic loss.”
However, the district court in First Solar recognized that a second line of Ninth Circuit cases had applied a different standard. In Metzler v. Corinthian Colleges, Inc., the plaintiff alleged that the defendant, an operator of vocational colleges, had manipulated student enrollment data, and that plaintiff suffered losses when the company issued a press release showing lower earnings than the false data had suggested. The Ninth Circuit affirmed dismissal of the complaint on the ground that plaintiff had failed to allege that the market “learned of and reacted to [the] fraud,” as opposed to merely reacting to reports of the defendant’s newly disclosed poor financial health. In In re Oracle Corp., the Ninth Circuit similarly held that plaintiffs cannot prove loss causation “by showing that the market reacted to the purported ‘impact’ of the alleged fraud . . . rather than to the fraudulent acts themselves.” The Ninth Circuit followed the holdings of Metzler and In re Oracle in Loos v. Immersion Corp. and Oregon Public Employees Retirement Fund v. Apollo Group, Inc., both of which held that loss causation requires a showing that the market reacted to the revelation of fraud, rather than the revelation of the facts concealed by the fraud or the impact of the fraud.
The district court in First Solar ultimately applied the standard from the Daou line of cases and held that plaintiffs did not need to show that the market reacted to the fact that First Solar had committed fraud in order to satisfy the loss causation requirement. However, faced with two irreconcilable lines of cases, the district court requested that the Ninth Circuit resolve the conflict on interlocutory appeal.
In a brief yet unequivocal per curiam opinion, the Ninth Circuit affirmed the district court’s holding, and so upheld its prior rulings in Daou, Berson and Nuveen. The Court announced that “[t]o prove loss causation, plaintiffs need only show a causal connection between the fraud and the loss by tracing the loss back to the very facts about which the defendant lied.” Accordingly, plaintiffs may satisfy the loss causation requirement “even where the alleged fraud is not necessarily revealed prior to the economic loss.”
The Ninth Circuit’s holding in First Solar marks its first definitive resolution of the internal conflict in its case law on loss causation. While the Court did not expressly overrule the Metzler line of cases, it limited those cases to their facts. Moreover, the Court made clear that, contrary to Metzler and its progeny, a plaintiff may prove loss causation by showing that defendant’s stock price fell upon revelation of an earnings miss, even if the market was unaware at the time that fraud had concealed the miss.
In recent years, defendants in Section 10(b) actions in the Ninth Circuit have routinely cited to the Metzler line of cases to support an argument that loss causation is absent in any case where losses were sustained prior to the market learning the fact that defendants had committed fraud. This standard from Metzler permitted defendants to escape liability under Section 10(b) if the negative impact of their fraud was revealed to the market prior to revelation of the fraud itself. With First Solar, the Ninth Circuit has closed the door to that argument and, in the process, granted a significant victory for investors seeking to recover for losses due to fraud that occured prior to revelation of the fraud itself.