Securities Law - Second Circuit Accepts Rule 10b-5 Pleading of Economic Loss after Share-Price Recovery

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Securities Law--Second Circuit Accepts Rule 10b-5 Pleading of Economic Loss After Share-Price Recovery--Acticon AG v. China North East Petroleum Holdings Ltd., 692 F.3d 34 (2d Cir. 2012)

Securities and Exchange Commission (SEC) Rule 10b-5 (1) provides the principal remedy for private investors ensnared in fraudulent securities transactions. (2) A successful pleading of a fraud-on-the-market claim under Rule 10b-5 requires a showing of actual economic loss caused by a fraudulently inflated price of a security purchased by the plaintiff. (3) In Acticon AG v. China North East Petroleum Holdings Ltd., (4) the Court of Appeals for the Second Circuit considered whether a defrauded investor's unrealized opportunity to sell securities at a profit precludes the ability to prove economic loss under Rule 10b-5's fraud-on-the-market theory. (5) The Second Circuit held that a recovery in share price after the fraud was disclosed to the purchasers does not automatically defeat an inference of economic loss at the pleading stage. (6)

Between January and May of 2010, Acticon AG (Acticon) acquired a total of 60,000 shares in China North East Petroleum Holdings Limited (NEP) at an average price of $7.25 per share. (7) Acticon alleged in its complaint that after each acquisition of stock, NEP disclosed corrections to financial statements that the company had filed with the SEC prior to Acticon's purchases. (8) NEP issued its first allegedly corrective disclosure on February 23, 2010, when the company announced it was withdrawing its 2008 and 2009 financial statements due to purported accounting errors. (9) According to the complaint, NEP made its final corrective disclosure on September 1, 2010, when it filed restated financial reports that eliminated its entire originally reported profit margin. (10) Although Acticon held its NEP stock for several months after NEP's final disclosure, the company ultimately sold a portion of its 60,000 NEP shares by May 2011 at prices ranging from $3.50 to $6.33 per share. (11) However, on twelve separate occasions during the period between NEP's final corrective disclosure and Acticon's sale of NEP stock, NEP stock traded and closed higher than Acticon's purchase price of $7.25 per share. (12)

Acticon filed suit against NEP in the United State District for the Court Southern District of New York, alleging securities fraud under Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5. (13) In the complaint, Acticon claimed NEP misled investors as to its financial viability and anticipated profits, and caused Acticon significant economic losses by repeatedly issuing corrective disclosures that prompted declines in NEP's share price. (14) On March 22, 2011, NEP filed a motion to dismiss for failure to state a claim, asserting that Acticon repeatedly passed on opportunities to realize a profit and therefore suffered no loss. (15) The district court sided with NEP, dismissing the case on the grounds that Acticon's prolonged holding and subsequent sale of NEP stock at a loss, combined with several foregone opportunities to sell the shares at a profit, resulted in a failure to show the requisite economic-loss element of securities fraud. (16)

The Great Depression and the decade that preceded it--a period of unprecedented growth in securities speculation, issuance, underwriting and investment in the United States--provided the impetus for the federal legislation that is the basis of today's securities laws. (17) The Securities Act of 1933 ('33 Act) requires extensive financial disclosures prior to issuing stock for sale to the public, while the Exchange Act mandates continual periodic disclosures by publicly traded securities issuers after their initial public tender offer. (18) In 1942, after a brief deliberation, the SEC promulgated Rule 10b-5, which would unintentionally become the chief remedy for defrauded investors of private securities. (19) Because Rule 10b-5's private right of action arose from judicial construction, the development and refinement of its elements has taken considerable time and generated voluminous litigation. …