August 16, 2012
At the beginning of August, the Second Circuit handed down an interesting ruling on the topic of calculating investor losses due to fraud. The factual background to Acticon AG v. China North East Petroleum Holdings Limited, — F.3d —-, 2012 WL 3104589, involves fairly straightforward allegations by the Plaintiff investors (Acticon AG and an array of named individuals) that the Defendants (China North East Petroleum Holdings Limited, abbreviated NEP, and certain officers) inflated the value of NEP’s assets and deflated its liabilities in financial statements, leading Plaintiffs to overpay for shares.
Acticon’s path to the Second Circuit was similarly simple; after the fraudulent financial statements were brought to light, NEP’s share price, despite a sharp initial fall, recovered and eventually went higher than what Plaintiffs eventually paid for it. The price recovery meant that the Plaintiffs couldn’t properly allege a loss caused by the fraud, leading the District Court to dismiss the case. In re China North East Petroleum Holdings Ltd. Securities Litigation, 819 F.Supp. 2d 351.
The Second Circuit, however, vacated the District Court’s dismissal and reinstated the case. The mere fact that a stock regained lost value does not lead inexorably to the conclusion that the purchase price the Plaintiff paid was equal to the value he received; in plain English, just because you were eventually able to sell something for what you paid for it doesn’t mean that you weren’t charged too much in the first place.
The Acticon case will probably quickly find its way into the toolbox of investor-plaintiffs. As I read it, I was reminded of an older case on corporate fraud and investment loss: Basic Co. v. Levinson, 485 U.S. 224. Basic stood for the proposition that one purchasing a security needn’t directly show reliance on a fraudulent statement, reliance may be presumed, as, in an efficient market, the fraud will be felt by all market participants.
Acticon doesn’t cite to Basic, but does make mention of the “Fraud on the Market” concept that Basic adopted, and two other cases released the same day did explicitly invoke Basic: Rochester Laborers Pension Fund v. Monsanto, 2012 WL 3143914, and In The Matter of Paul Donald, 2012 CarswellOnt 9499. The second is a case from the Ontario Securities Commission, which gives a sense of the sustained reach and influence of Basic. Time will tell if a case like Acticon will be able to match it.
I wasn’t sure if Basic was really the first case in the Supreme Court to use the “Fraud on the market” concept, so I ran a search in SCT for “Fraud on the Market.” 12 cases come up, and two are older than Basic, but one discusses ‘Fraud in the Market, and the other, Santa Fe Industries v. Green, 430 U.S. 462, only invokes the concept in the headnotes, not in the court’s opinion. Santa Fe Industries is actually cited in Basic, on page 230.
To find recent cases citing to Basic v. Levinson, look at the citing references to the case in WestlawNext and sort the cases by date. The most recent two just happened to come out on August 1, the same day as the Acticon case.