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Disclosure of Resignation of Director in Connection with Company's "Aggressive Accounting Strategy" was not a "Corrective Disclosure" of Fraud Sufficient to Establish "Loss Causation" for Securities Fraud Claim

The US Court of Appeals for the Second Circuit has affirmed the District Court’s decision granting summary judgment to the defendants in the securities litigation against Omnicom Group, Inc. In re Omnicom Group, Inc. Securities Litigation, --- F.3d ---, 2010 WL 774311 (2d Cir.). Plaintiffs brought claims under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. In dismissing the case the Second Circuit found that the plaintiff could not prove causation.

The plaintiffs claimed that revelations regarding Omnicom’s accounting practices led to the drop in Omnicom’s stock price. Omnicom allegedly misrepresented the value of its shares of stock in Seneca, a company Omnicom formed with a private equity firm to take advantage of perceived opportunities in the e-services consulting and professional services markets. Plaintiffs also claimed that the accounting for the Seneca transaction was fraudulent. At the time of the Seneca transaction, several publications discussed how the true purpose of the Seneca transaction was an attempt by Omnicom to move underperforming assets off its books. A year later, the price of Omnicom’s stock dropped when an article critical of Omnicom was published and one of its directors resigned.

A successful Section 10(b) claim requires a plaintiff to prove (1) a material misrepresentation or omission, (2) scienter, (3) a connection with the purchase or sale of a security, (4) reliance, (5) economic loss, and (6) loss causation. Defendants argued, and the Court agreed, that the plaintiffs could not demonstrate loss causation. The “loss causation” requirement can be satisfied by proving (1) that a particular plaintiff relied upon the misrepresentation, (2) that the misrepresentation is a cause-in-fact of the loss suffered, or (3) that the cause-in-fact of the investor’s losses falls within the class of events that Section 10(b) and the securities laws were designed to prevent. All three concepts were at issue in this case.

Plaintiffs asserted a fraud on the market theory in the complaint. The claim failed to satisfy the reliance theory of loss causation because the misrepresentations plaintiffs complained of – improprieties with the Seneca transaction – were widely reported over a year before the stock price declined. Therefore, the Court found that the Seneca issues were already reflected in the market price of Omnicom’s stock as long as a year before the price drop that lead to the suit. Thus, plaintiff could not prove the market had been relying on any misrepresentations about Seneca when the stock price fell over a year after the initial reports.

Next plaintiffs tried to advance under a cause-in-fact theory. Plaintiffs argued that the drop in Omnicom’s stock price was the result of a later corrective disclosure of the Seneca misrepresentations. The alleged later corrective disclosure was the article that was published a year after the initial coverage of true purpose of the Seneca transaction. The cause-in-fact argument failed because the Court found that the alleged corrective disclosure was simply a negative characterization of previously known information. Since the information was previously known, it re-publication cannot constitute a corrective disclosure and it cannot be the cause-in-fact of the drop in price of Omnicom’s stock.

Plaintiffs’ final argument was that Omnicom concealed the improper accounting of the Seneca transactions and this was the proximate cause of plaintiffs’ losses. To succeed on their proximate cause argument, plaintiffs had to prove that the loss was foreseeable and caused by the materialization of the risk concealed by the fraudulent misrepresentations. Plaintiffs’ argument relied heavily on the resignation of a member of Omnicom’s board of directors. This resignation occurred around the time of the alleged corrective disclosure – a year after the key facts were widely reported. Plaintiffs claimed that the resignation was the result of the director’s disproval of the Seneca transaction, which in turn caused the drip in the market price of Omnicom’s stock. The argument failed because the connection between the resignation of a board member and the stock’s drop in price was too tenuous to be a proximate cause. The Court determined that the resignation had caused only concerns that other unreported problems may exist.

Since plaintiff could not succeed under any of the three loss causation theories, summary judgment in favor of Omnicom was proper.

Jason B. Desiderio, Esq.

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This page contains a single entry from the blog posted on March 22, 2010 4:56 PM.

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