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Recent 5th U.S. Circuit Court of Appeals opinions have implied that hindsight is more than 20-20 when determining whether an alleged material misstatement by a company adversely affected its shareholders’ investments. In everything from press releases regarding planned transactions to analysts’ misstatements to keeping fellow high-level officers honest, the 5th Circuit is imposing heavy burdens on management in the realm of securities law. On April 21, the 5th Circuit, in Plotkin, et al. v. IP Axess Inc. Etc., et al, held that facts which transpired after a company issued a press release may be used by a securities fraud plaintiff to draw a “strong inference” that a defendant knew or was severely reckless in not knowing, at the time of the release, that a contemplated but as-yet unconsummated transaction was likely to collapse. The court stated that companies must use a reasonable level of diligence when discussing a prospective transaction and to verify material facts relevant to the transaction. A plaintiff can use subsequent events to show that a company failed to meet the requisite level of diligence before it issued the press release. The court stated, “[D]iscovery may refute the inferences, but it is not unwarranted to infer that when a company’s big deal collapses so fast, something was amiss at the outset.” Plaintiffs who bring securities litigation in federal court in the 5th Circuit have a powerful weapon to use against a motion to dismiss, now that the fact-finder can draw an inference based on events occurring after a company issues its press release. The plaintiffs must still sufficiently prove facts and allegations to show a defendant’s intent or recklessness under 10b-5 of the Securities Exchange Act of 1934, but apparently a plaintiff may infer a company’s intent to convey a material misstatement or omission at the time the alleged false statement was made on the basis of subsequent events. In Barrie, et al. v. Intervoice-Brite Inc., et al., decided on Jan. 12 and clarified on May 12, the 5th Circuit also addressed the issue of liability as it pertains to alleged misstatements made by independent third parties, not just officers or control persons of a company. The court held that, for a plaintiff to satisfy the pleading requirement under a “conduit” theory against a defendant based on a statement made by a third-party analyst, the complaint must specify “who supplied information to the analyst, how the analyst received the information, and how the defendant was entangled with or manipulated the information and the analyst.” Under this “conduit” theory, an officer of a company is liable for statements made by an independent third-party analyst, where the analyst made false statements based upon information generated or supplied to him by that officer, as long as the complaint sufficiently specifies the officer’s involvement, and the analyst did not independently formulate the false statement himself. The court held that, because the allegation of entanglement between the defendant and analyst is part of the overall allegation of securities fraud under Rule 10b-5, quoting the Southland opinion, a pleading should “(1) identify the specific forecasts and name the insider who adopted them; (2) point to specific interactions between the insider and the analyst which allegedly gave rise to entanglement; and (3) state the dates on which the acts which allegedly gave rise to entanglement occurred.” BROTHER’S KEEPER The 5th Circuit also held in Barrie that a high-ranking officer of a company is not only responsible for his own misstatements and the misstatements of a third-party analyst but may also be liable for misstatements or omissions of material fact made by another officer of the company, if he is present when another officer makes a misstatement or omission, and he fails to correct them. The court further held that the plaintiff need not individually identify the speaker or the observing party, essentially “co-wrong doers” in such cases. If the plaintiff meets the requisite pleading requirements, all officers present when the false statement is made could be held as liable as they would have been had they made the statement themselves. Again, as it did in Plotkin, the 5th Circuit has increased the burden of due diligence and care that rests squarely on the shoulders of a company’s management concerning statements made, conditions present and situations foreseeable. The 5th Circuit may provide plaintiffs attorneys with a more favorable environment in which to litigate securities fraud cases. Despite these rulings on the circuit court level, here is a bright spot for officers and directors. This spring, the U.S. Supreme Court resolved a split in the circuits concerning the correlation between a false statement, inflated stock price and how a subsequent investor loss must be established. In fraud-on-the-market cases, the Court held on April 19 that an inflated stock price alone is not sufficient to establish proximate cause or the relevant economic loss, shooting down a 9th U.S. Circuit Court of Appeals opinion in Dura Pharmaceuticals Inc., et al. v. Broudo, et al. According to the Supreme Court, it is not sufficient for a plaintiff to prove only that the price of the security on the date of purchase was inflated because of a misrepresentation. The Private Securities Litigation Reform Act of 1995 expressly imposes on all plaintiffs the burden of proving the traditional elements of causation and loss to recover for alleged fraud. Plaintiffs cannot sidestep the pleading rules simply by alleging an economic loss based on over-valuation of stock on the date of purchase. Dan R. Waller is a partner in Secore & Waller in Dallas. His practice focuses on state and federal securities regulation, securities investigations and civil enforcement actions by the Securities and Exchange Commission, the National Association of Securities Dealers and state securities agencies, as well as regulatory matters involving investment companies, investment advisers, broker-dealers and publicly held companies.

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