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(Article from Securities Law Alert, January 2018) 

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On December 13, 2017, the Sixth Circuit rejected a “categorical” rule that allegations in a third-party complaint cannot constitute corrective disclosures for loss causation purposes. Norfolk Community Ret. Sys. v. Community Health Sys., 877 F.3d 687 (6th Cir. 2017) (Kethledge, J.). Reversing the district court’s decision, the Sixth Circuit held that plaintiffs adequately pled loss causation based on the allegations in a third-party complaint, coupled with the CFO’s admission of one of the central allegations in the complaint. The court found that “these disclosures—and the speed at which [the company’s] share price fell after them—make it at least plausible that the disclosures had something to do with [plaintiffs’] losses.”

The Sixth Circuit explained that the requirement for pleading loss causation is “‘not meant to impose a great burden upon a plaintiff.’” Id. (quoting Dura Pharm. v. Broudo, 544 U.S. 336 (2005)). “Rather it is meant to prevent disappointed shareholders from filing suit merely because their shares have lost value and then using discovery to determine whether the loss was due to fraud.” That “at the pleading stage, a plaintiff need only ‘provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind.’” Id. (quoting Dura, 544 U.S. 336).

The court observed that while “[s]ometimes defendants reveal their own fraud via a ‘corrective disclosure,’ … such admissions can be hard to come by.” And corrective “revelations can come from many sources, including whistleblowers, analysts, and newspaper reports.” Moreover, “such revelations need not come all at once, but can come in a series of partial disclosures.”

In the case before it, defendants contended that the third-party complaint “could not reveal the truth behind their prior alleged misrepresentations because complaints can reveal only allegations rather than truth.” The Sixth Circuit recognized that this “proposition might have merit as a general rule,” but “reject[ed] it as a categorical one.” The court reasoned that “every representation of fact is in a sense an allegation, whether made in a complaint, newspaper report, press release, or under oath in a courtroom.” The court acknowledged that certain types of representations “are more credible than others,” and “[m]ere allegations in a complaint tend to be less credible.” However, “these are differences of degree, not kind, and even within each type of representation some are more credible than others.” The court stated that it must therefore “evaluate each putative disclosure individually (and in the context of any other disclosures) to determine whether the market could have perceived it as true.”

The Sixth Circuit found the third-party complaint at issue was particularly credible because the company’s CEO “promptly admitted the truth of one of the complaint’s core allegations.” The court noted that the allegations of loss causation were similar to those in Lloyd v. CVB Financial Corp., 811 F.3d 1200 (9th Cir. 2016).[1] There, the Ninth Circuit found plaintiffs had adequately pled loss causation based on the announcement of an SEC investigation, together with the company’s subsequent disclosure that it was charging off the loans that were the subject of that investigation. 

The Sixth Circuit also noted that the third-party complaint included expert analyses describing the extent to which the company allegedly inflated its revenues. The court found that the experts’ conclusion concerning the hospital’s inpatient admission practices “was beyond the ken of most investors, and thus revealed new information to them.” 

The court concluded that plaintiffs “plausibly alleged corrective disclosures that revealed the defendants’ antecedent fraud to the market and that thereby caused the plaintiffs’ economic loss.”