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On February 10, 2016, the Eighth Circuit revived a securities fraud action alleging that The Dolan Company (“Dolan”) had made material misrepresentations and omissions concerning the financial stability of its subsidiary, DiscoverReady. Rand-Heart of New York v. Dolan, 2016 WL 521075 (8th Cir. 2016) (Rand-Heart II) (Benton, J.). The Eighth Circuit held that the warnings accompanying the alleged misstatements were not “meaningfully cautionary” because defendants did not provide “a realistic description of the risks applicable to the particular circumstances.” However, the court also found that plaintiffs had not adequately alleged loss causation as to a certain segment of the class period because one of the alleged “corrective disclosures” did not actually correct any prior misrepresentations.

Background

DiscoverReady was a litigation support business. The company’s biggest customer was Bank of America, which accounted for 20% to 30% of DiscoverReady’s revenues.

In late June or early July 2013, Bank of America expressed concern regarding Dolan’s financial stability, and informed Dolan that it “would need to solve its financial problems” “in order for Bank of America to continue to send work to DiscoverReady.” Rand-Heart of New York v. Dolan, 2015 WL 1396984 (D. Minn. Mar. 25, 2015) (Magnuson, J.). In July 2013, Dolan’s board of directors “authorized [the company’s COO] to begin to seek buyers for the DiscoverReady business.”

On August 1, 2013, Dolan’s CEO stated during an analyst call that the company “expect[ed]” DiscoverReady “to grow at double-digit rates over the prior year.” However, he acknowledged that DiscoverReady’s third quarter revenues would likely be below the prior year’s. Dolan’s CEO stated that he did not want “to dampen enthusiasm about . . . growth prospects for DiscoverReady” but explained that the company wanted “to set proper expectations for a business that may experience lumpiness on a quarter-to-quarter basis.” Plaintiffs contended that the August 1, 2013 statements were “materially false and misleadingly incomplete, because none of the statements informed the public about ‘the deterioration of the [c]ompany’s relationship with Bank of America.’”

On November 12, 2013, Dolan’s CEO stated in a press release that “DiscoverReady’s third quarter revenues were affected not only by the quarterly lumpiness that is inherent to the e-discovery business, but also decreased primarily as the result of a period of reduced work from DiscoverReady’s largest customer.” Dolan’s share price fell by nearly 50% following this announcement. Plaintiffs nonetheless contended that “the company’s stock price ‘remained artificially inflated to a material degree’ until” January 2, 2014, when Dolan “announced that it had appointed a ‘Chief Restructuring Officer’ to attempt to restructure the company’s indebtedness.” Dolan’s share price fell by almost 21% after the January 2 announcement.

On March 26, 2015, the District of Minnesota dismissed plaintiffs’ claims. While the court found that plaintiffs had adequately alleged that the August 1, 2013 statements were materially misleading, the court determined that plaintiffs had failed to allege scienter. The court further held that plaintiffs had failed to establish loss causation for the period between November 12, 2013 (the date Dolan disclosed DiscoverReady’s “reduced work” from its “largest customer”) and January 2, 2014 (the end of the class period).

Eighth Circuit Finds Dolan Must Have Known That the Decline in Bank of America’s Business Significantly Impacted DiscoverReady’s Financial Stability

On appeal, the Eighth Circuit explained that “[s]cienter can be established by a deceitful or manipulative state of mind, severe recklessness, or motive and opportunity.” Rand-Heart II, 2016 WL 521075. The Eighth Circuit noted that the district court had “found no motive” for defendants to misrepresent DiscoverReady’s financial stability. The district court also deemed it significant that Dolan’s CEO had “never sold his shares of the company stock.” However, the Eighth Circuit underscored that the absence of motive “does not end the [scienter] inquiry.”

Here, plaintiffs alleged that Dolan had been “severely reckless” “in failing to disclose that Bank of America had stopped sending new work to DiscoverReady” during the August 1, 2013 conference call. Plaintiffs claimed that the loss of Bank of America’s business was so significant that it “prompted [Dolan’s] [b]oard in June 2013 to ‘authorize the marketing of DiscoverReady for sale.’” Based on these allegations, the Eighth Circuit found that “DiscoverReady’s financial instability caused by the decline in Bank of America[‘s business] was, at the least, ‘so obvious that [defendants] must have been aware of it.’” The court therefore held that plaintiffs had adequately pled scienter as to the August 1, 2013 statements.

Eighth Circuit Finds Dolan’s Statements Regarding DiscoverReady’s Financial Prospects Were Not Protected Forward-Looking Statements

The Eighth Circuit rejected defendants’ contention that the August 1, 2013 statements regarding DiscoverReady’s “double-digit” growth and the possible “lumpiness” in DiscoverReady’s quarter-to-quarter revenues were protected forward-looking statements under the Private Securities Litigation Reform Act’s (“PSLRA”) safe-harbor provision. 

Defendants stated that the August 1, 2013 statements were inactionable because they were accompanied by cautionary language from the company’s SEC filings. Specifically, the company warned that “DiscoverReady’s business revenues have traditionally been concentrated among a few customers and if these large repeat customers choose to manage their discovery with their own staff or with another provider and if we are unable to develop new customer relationships, our operating results and the ability to execute our growth strategy at DiscoverReady may be adversely affected.”

The Eighth Circuit found that these warnings, “[e]ven if cautionary,” were “not meaningfully cautionary.” The court explained that the warnings were not “based on a realistic description of the risks applicable to the particular circumstances” affecting DiscoverReady but were instead “a boilerplate litany of generally applicable risk factors.”

Eighth Circuit Finds Plaintiffs Failed to Allege Loss Causation Between November 12, 2013 and January 2, 2014

With respect to loss causation, the Eighth Circuit found that defendants had “fully disclosed on November 12, 2013” that Bank of America was no longer sending DiscoverReady any new litigation support work. The court found meritless plaintiffs’ claim that the alleged fraud was “not fully revealed” until the company’s January 2, 2014 announcement of a new restructuring officer.

The Eighth Circuit determined that the January 2 press release was not a corrective disclosure for loss causation purposes because “[n]othing in the January 2 press release correct[ed] previous misrepresentations.” Rather, the announcement merely “elaborate[d] on [Dolan’]s previously disclosed plan to restructure.”

The Eighth Circuit underscored that “[i]n the financial markets, not every bit of bad news that has a negative effect on the price of a security necessarily has a corrective effect for purposes of loss causation.” The court explained that “[a] drop in stock price is not necessarily caused by an earlier misrepresentation.” Rather, a lower stock price “may reflect . . . changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events, which taken separately or together account for some or all of that lower price” (quoting Dura Pharmaceuticals v. Brodo, 544 U.S. 336 (2005)).

In order to allege loss causation based on the drop in Dolan’s stock price following the January 2 press release, the Eighth Circuit found that plaintiffs had to allege “that Dolan’s fraud—and not other events—caused the price to fall.” Because plaintiffs failed to do so, the Eighth Circuit held that the district court “did not err in finding no loss-causation for the period between November 12 and January 2.”