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Smilovits v. First Solar Inc.

United States District Court, D. Arizona

August 11, 2015

Mark Smilovits, et al., Plaintiffs,
v.
First Solar Incorporated, et al., Defendants

Decided August 10, 2015

Page 979

[Copyrighted Material Omitted]

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For Mark Smilovits, Individually and on Behalf of All Other Persons Similarly Situated, Plaintiff: Garrett Webster Wotkyns, LEAD ATTORNEY, Schneider Wallace Cottrell Konecky LLP, Scottsdale, AZ; Jennifer Lynn Kroll, Susan Joan Martin, LEAD ATTORNEYS, Martin & Bonnett PLLC, Phoenix, AZ; Jeremy A Lieberman, LEAD ATTORNEY, Pomerantz LLP, New York, NY; Patrick V Dahlstrom, LEAD ATTORNEY, Pomerantz LLP - Chicago, IL, Chicago, IL; Richard W Gonnello, LEAD ATTORNEY, Faruqi & Faruqi LLP - Lexington Ave, New York, NY, New York, NY.

For Johnny Hyldmar, Plaintiff: Richard W Gonnello, LEAD ATTORNEY, Faruqi & Faruqi LLP - Lexington Ave, New York, NY, New York, NY.

For Mineworkers' Pension Scheme, British Coal Staff Superannuation Scheme, Plaintiffs: Andrew S Friedman, Kevin Richard Hanger, LEAD ATTORNEYS, Bonnett Fairbourn Friedman & Balint PC - Phoenix, AZ, Phoenix, AZ; Daniel S Drosman, Danielle S Myers, Jason A Forge, Luke Brooks, Mark Solomon, Michael J Dowd, LEAD ATTORNEYS, Christopher Dennis Stewart, Cody R LeJeune, Darryl J Alvarado, Jennifer N Caringal, Lonnie A Browne, Tor Gronborg, Robbins Geller Rudman & Dowd LLP - San Diego, CA, San Diego, CA; Darren J Robbins, Robbins Geller rudman & Dowd LLP, San Diego, CA.

For First Solar Incorporated, Defendant: Anna Erickson White, Jordan Eth, LEAD ATTORNEYS, Eugene G Illovsky, James P Bennett, Judson E Lobdell, Mark Ryan Scott Foster, Paul Flum, Morrison & Foerster LLP - San Francisco, CA, San Francisco, CA; Joseph Nathaniel Roth, Maureen Beyers, LEAD ATTORNEYS, Osborn Maledon PA, Phoenix, AZ.

For Michael J Ahearn, Robert J Gillette, Mark R Widmar, Jens Meyerhoff, James Zhu, Bruce Sohn, David Eaglesham, Defendants: Anna Erickson White, Jordan Eth, LEAD ATTORNEYS, Morrison & Foerster LLP - San Francisco, CA, San Francisco, CA; Joseph Nathaniel Roth, Maureen Beyers, LEAD ATTORNEYS, Osborn Maledon PA, Phoenix, AZ; Judson E Lobdell, Mark Ryan Scott Foster, Paul Flum, Morrison & Foerster LLP - San Francisco, CA, San Francisco, CA.

For Raymond W O'Brien, George Conway, Vikean Limited, Movants: Jeremy A Lieberman, LEAD ATTORNEY, Pomerantz LLP, New York, NY.

For Oakland County Employees Retirement System, Movant: Stephen Richard Basser, Barrack Rodos & Bacine, San Diego, CA.

For Oakland County Employees Retirement System, Movant: Samuel M Ward, Barrack Rodos & Bacine, San Diego, CA.

For Louisiana Municipal Police Employees Retirement System, Wiltshire Pension Fund, Erste-Sparinvest Kapitalanlagegesellschaft mbH, Movants: Samuel M Ward, Stephen Richard Basser, Barrack Rodos & Bacine, San Diego, CA.

For New York State Teachers' Retirement System, (" NYSTRS" ), Movant: Jeremy James Christian, LEAD ATTORNEY, Tiffany & Bosco PA, Phoenix, AZ; Salvatore Jo Graziano, Bernstein Litowitz Berger & Grossman LLP - New York, NY, New York, NY.

For Wayne County Employees' Retirement System, Movant: Bryan Jens Gottfredson, Jeffrey Dale Gardner, Jeffrey S Leonard, LEAD ATTORNEYS, Sacks Tierney PA, Scottsdale, AZ; Edward M Varga, III, Ira Michael Press, Peter S Linden, LEAD ATTORNEYS, Kirby McInerney LLP - New York, NY, New York, NY.

For Fulton County Employees' Retirement System, Movant: David R Scott, LEAD ATTORNEY, Scott & Scott LLC, Colchester, CT; Garrett Webster Wotkyns, LEAD ATTORNEY, Schneider Wallace Cottrell Konecky LLP, Scottsdale, AZ; Joseph P Guglielmo, LEAD ATTORNEY, Scott & Scott LLP, New York, NY; Michael Craig McKay, LEAD ATTORNEY, Schneider Wallace Cottrell Konecky LLP, Scottsdale, AZ.

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ORDER

David G. Campbell, United States District Judge.

In this complex securities fraud class action, Defendants have filed a motion for summary judgment on all claims (Doc. 311) and Plaintiffs have filed a motion for partial summary judgment on eighteen affirmative defenses (Doc. 309). Defendants have also filed a request for judicial notice (Doc. 341) and two motions to seal (Docs. 342, 387). Each motion has been briefed, and the Court heard oral argument on July 22, 2015. The Court will deny in part and grant in part Defendants' motion for summary judgment, deny Plaintiffs' motion for summary judgment, and grant Defendants' request for judicial notice and motions to seal.

The Court finds two competing lines of cases in the Ninth Circuit on loss causation. Because one line would result in complete summary judgment for Defendants and the other (which the Court chooses to follow) will result largely in denial of summary judgment and a lengthy and expensive trial, the Court will certify this issue for immediate appeal under 28 U.S.C. § 1292(b).

I. Background.

First Solar, Inc. is one of the world's largest producers of photovoltaic solar panel modules. Its stock is publicly traded on the NASDAQ Global Market. By 2008, First Solar's stock had risen to nearly $300 per share. As of the beginning of 2012, the stock price had fallen to less than $50 per share. During this time, which coincided with the recession in 2008, First Solar experienced a change in leadership, a manufacturing defect, and a climate-related technical issue regarding their modules.

Plaintiffs are purchasers of First Solar stock who brought this class action alleging that First Solar and several of its key officers and executives misrepresented the financial state of the company to inflate the price of First Solar stock, committed accounting violations, and concealed material facts relating to the extent of the manufacturing defect and the hot climate issue in violation of § § 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities Exchange Commission Rule 10b-5. Plaintiffs filed their First Amended Complaint on August 17, 2012, and the Court certified Plaintiffs' class on October 8, 2013. Fact discovery has been completed. Expert discovery remains.

A. The Parties.

The class is defined as " [a]ll persons who purchased or otherwise acquired the publicly traded securities of First Solar, Inc. between April 30, 2008 and February 28, 2012" (the " Class Period" ). Doc. 171 at 22.[1]

First Solar, Inc. is headquartered in Tempe, Arizona. During the Class Period, it operated manufacturing facilities in Ohio, Germany, and Malaysia. First Solar is managed by a shareholder-elected Board of Directors. The Board delegates functions to committees within the company, including the Audit Committee, which performs internal accounting audits. First Solar's accounting practices are also audited and reviewed by PricewaterhouseCoopers (" PwC" ), an outside accounting firm.

The Individual Defendants consist of several officers and executives employed by First Solar. Michael Ahearn was the Executive Chairman of the Board throughout

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the entire Class Period. Doc. 312; Doc. 363 at 13. He also served as the Chief Executive Officer (" CEO" ) from April 2008 to October 2009 and from October 2011 to the end of the Class Period. Doc. 363 at 13. Robert Gillette served as CEO and Director of First Solar from October 2009 to October 2011. Id. Bruce Sohn served as President from the beginning of the Class Period until April 2011. Id. at 14. David Eaglesham served as Vice President (" VP" ) of Technology from the beginning of the Class Period until November 2009, when he became Chief Technology Officer. Doc. 312. Jens Meyerhoff served as Chief Financial Officer (" CFO" ) from the beginning of the Class Period until December 2010, and then assumed the role of President of the Utility Systems Business Group. Id. James Zhu served as VP and Corporate Controller, then VP and Chief Accounting Officer, and finally as the Interim CFO. Id. Mark Widmar took over Zhu's role as CFO in April 2011. Id.

Several other individuals employed during the Class Period, but not named as defendants in this action, performed key roles. These include Michael Koralewski, who served separately as Director of Global Quality, then as VP of Global Quality, and later as VP of Site Operations and Plant Manager; TK Kallenbach, who served separately as Executive VP of Marketing and Product Management and later as President of the Components Business Group; Thomas Kuster, who served briefly as VP of Engineering Procurement and Construction and then as VP of System Development; and Bryan Schumaker, who served as Assistant Corporate Controller and later as VP and Corporate Controller. Doc. 312.

B. The LPM Defect.

In March 2009, First Solar received a complaint from one of its German customers that some of its sites were experiencing low power output. Doc. 332 at 19.[2] A few months later, a task force led by Eaglesham discovered that the power loss was the result of a new manufacturing process implemented in June 2008. Doc. 314, ¶ ¶ 10-11. The process " had the effect of producing a small subpopulation of modules that could experience field power loss of 15% or more from nameplate within the first several months of installation." Id., ¶ 12. The modules became known as Low Power Modules (" LPMs" ), and the defective manufacturing process was discontinued in June 2009. Id., ¶ 14.[3]

Shortly after discovering the defect, First Solar agreed to remediate sites affected by LPMs. It contacted customers to notify them of the defect and offered remediation by removing and replacing LPMs at sites that were underperforming. Customers were required to submit remediation claims by November 2010. Doc. 324, ¶ 20.

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In order to account for the added expense of remediation in First Solar's financial statements, Koralewski developed models for estimating the number of LPMs that were produced between June 2008 and June 2009. Id., ¶ ¶ 9-12. At the time, he believed First Solar " could identify LPMs by serial numbers and replace only those modules." Id., ¶ 21. After it became clear that First Solar could not merely replace single LPMs, Koralewski was again charged with estimating the number of modules required to remediate customer sites. Id. These estimates were based on various statistical models and accounted for " hit rate calculations," which " refer to the percentage of returned modules that were LPMs." Id., ¶ 22b. For example, " [f]or small rooftop sites, which usually contained hundreds of modules, [First Solar] determined that it was more efficient to replace all of the modules rather than search for LPMs individually." Id. This required First Solar to replace a greater number of modules than initially anticipated.

In the quarters immediately following discovery of the LPM defect, Koralewski reported his estimates internally to First Solar executives. In the third quarter of 2009 (" 3Q09" ), Koralewski estimated that there were 115,000 LPMs in the field. Id., ¶ 11. In 4Q09, the estimate grew to 154,000. Id. By 1Q10, Koralewski estimated that 450,000 modules were LPMs, which represented less than 4% of the total 11.8 million modules produced during the defect period. Id., ¶ 12.

The estimates regarding the number of LPMs in the field and the number of modules required to remediate the defect directly affected the additional costs First Solar faced as a result of the manufacturing defect. The costs were reflected in the " LPM Remediation Accrual," which was calculated to account for the additional expenses in accordance with Generally Accepted Accounting Principles (" GAAP" ). Doc. 325, ¶ 24. Over the course of several quarters, the LPM Remediation Accrual grew with the estimated number of modules required to complete remediation.

Another factor that contributed to the estimate was the number of customer claims First Solar received, as well as the percentage of those claims that First Solar believed valid. After initially contacting customers, First Solar had completed remediation of " more than two dozen of the approximately 150 sites that had been claimed[.]" Doc. 324, ¶ 25. But in the weeks leading up to the November 2010 deadline, the company " received over 5,000 new claims, most of which were not accompanied by supporting data." Id., ¶ 26.

The LPM manufacturing defect and the resulting remediation costs were not disclosed to the public until July 2010, when the LPM Remediation Accrual appeared as a separate line-item in First Solar's 2Q10 Form 10-Q accompanied by the following explanation:

During the period from June 2008 to June 2009, a manufacturing excursion occurred affecting less than 4% of the total product manufactured within the period. The excursion could result in possible premature power loss in the affected modules. The root cause was identified and subsequently mitigated in June 2009. On-going testing confirms the corrective actions are effective. We have been working directly with impacted customers to replace the affected modules and these efforts are well underway and, in some cases, complete. Some of these efforts go beyond our normal warranty coverage. Accordingly, we have accrued additional expenses of $17.8 million in the second quarter of 2010 and $29.5 million in total to date to

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cover the replacement of the anticipated affected module population in the field.

Doc. 359-1 at 41.[4]

In 3Q10, the figures remained the same. Doc. 325, ¶ 37. In 4Q10, the LPM Remediation Accrual grew by $8.5 million. Doc. 331 at 118. In 1Q11, the figures did not increase, and in 2Q11, the figures increased by $3.6 million. Doc. 325, ¶ ¶ 39, 41. In 3Q11, $22.1 million was added to the LPM Remediation Accrual. By 4Q11, 90% of the outstanding claims had been processed, and the figures were increased by $23.9 million with a $70.1 million product warranty expense. Doc. 340 at 6-7.

Plaintiffs argue that First Solar wrongfully failed to disclose the LPM defect prior to July 29, 2010. Plaintiffs further assert that First Solar misrepresented the true scope of the defect by engaging in improper accounting practices and reporting false information on their financial statements.

C. Hot Climate Degradation.

In April 2010, a team of First Solar scientists discovered data suggesting that First Solar modules installed in hot climates experienced faster power loss than previously understood. Doc. 314, ¶ 32. This data, however, was inconsistent with recent data indicating that " long-term test installations in the Arizona desert" were performing above expectation ratios. Id., ¶ ¶ 33(b), (c). The team continued to monitor sites.

On February 7, 2011, First Solar discovered that the company's Blythe, California plant was producing power at a lower level than its Ontario, Canada plant. Id., ¶ ¶ 35-36. In March, the team of scientists concluded that the modules were experiencing a greater " initial stabilization" in hot climates than previously understood. Id., ¶ 38. Mitigation strategies were implemented, and Koralewski concluded that First Solar's existing warranty accrual was sufficient to cover projected warranty claims from customers. At the end of 4Q11, the hot climate degradation had been resolved, and the Warranty Accrual line item was increased by $37.8 million.[5]

Plaintiffs argue that First Solar wrongfully concealed the hot climate defect for several quarters by manipulating accounting metrics and ignoring the true scope of the defect. They also allege that First Solar buried the extra costs of the hot climate defect in its Warranty Accrual instead of disclosing it in a separate line item.[6]

D. The Trades.

During the Class Period, the Individual Defendants made several trades of First

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Solar stock. Ahearn sold over three million shares in multiple trades, amounting to more than 96% of his shares. Doc. 363 at 55. Eaglesham sold 94% of his stock over several trades, and Meyerhoff sold over 80% of his shares. Id. at 57-58. Sohn sold nearly 75% of his shares, and Zhu sold nearly 50%. Id. at 58. In contrast, both Gillette and Widmar purchased several thousand shares of First Solar stock. Id. at 57-58. Plaintiffs assert that the timing of the sales shows that Defendants knew the LPM defect was going to cost much more than First Solar had reported in its financial statements.

E. Value of First Solar's Stock.

First Solar stock experienced several days of steep declines during the Class Period, which appeared to be market reactions to quarterly financial disclosures and the departure of Gillette as CEO. On July 29, 2010, First Solar announced its 2Q10 earnings, which disclosed the manufacturing defect and additional costs of $23.4 million. Id. at 65-66. The stock price dropped 7.4% the next day. Id. at 66. On February 24, 2011, First Solar announced its 4Q10 earnings, missing its target revenue. Id. at 67. The stock price declined by 5.4% the next day. Id. at 68. On May 3, 2011, the company announced its 1Q11 earnings, which included additional expenses for LPM remediation. Id. at 69. The next day, First Solar stock dropped 6.2%. Id. On October 25, 2011, First Solar announced Gillette's departure as CEO. Id. at 70. The stock price dropped 25% that day, but later rebounded. Id. On December 14, 2011, the company issued a press release and held a conference call relating to its financial state. Id. at 73. First Solar stock dropped an additional 21.4%. Id. On February 28, 2012, First Solar announced disappointing 4Q11 results. Id. at 74-75. The stock price dropped 11.26% that day and 5.8% the next. Id. at 75.

II. Legal Standard.

A party seeking summary judgment " bears the initial responsibility of informing the district court of the basis for its motion, and identifying those portions of [the record] which it believes demonstrate the absence of a genuine issue of material fact." Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986). Summary judgment is appropriate if the evidence, viewed in the light most favorable to the nonmoving party, shows " that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed.R.Civ.P. 56(a). Summary judgment is also appropriate against a party who " fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial." Celotex, 477 U.S. at 322. Only disputes over facts that might affect the outcome of the suit will preclude the entry of summary judgment, and the disputed evidence must be " such that a reasonable jury could return a verdict for the nonmoving party." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986).

Plaintiffs allege that Defendants violated § 10(b) of the Securities Exchange Act of 1934 and Securities Exchange Commission Rule 10b-5. Section 10(b) " makes it unlawful to 'use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe.'" In re Oracle Corp. Sec. Litig., 627 F.3d 376, 387 (9th Cir. 2010) (quoting 15 U.S.C. § 78j(b)). " Commission Rule 10b-5 forbids, among other things, the making of any 'untrue statement of a material fact' or the omission of any material fact 'necessary in order to make the

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statements made . . . not misleading.'" Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341, 125 S.Ct. 1627, 161 L.Ed.2d 577 (2005) (quoting 17 C.F.R. § 240.10b-5 (2004)). " The scope of Rule 10b-5 is coextensive with that of Section 10(b)." Oracle, 627 F.3d at 387. To demonstrate a violation of § 10(b) and Rule 10b-5, " a plaintiff must prove (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 157, 128 S.Ct. 761, 169 L.Ed.2d 627 (2008). Defendants' motion for summary judgment asserts that Plaintiffs cannot prove elements (1), (2), and (6), but focuses first and most extensively on loss causation.

III. Loss Causation, Ninth Circuit Law, and § 1292(b) Certification.

Plaintiffs assert that loss causation is satisfied if the facts misrepresented or omitted by Defendants ultimately cause Plaintiffs' loss. Under their view, " 'a plaintiff can satisfy loss causation by showing that the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff's economic loss.'" Doc. 363 at 62 (quoting Nuveen Mun. High Income Opportunity Fund v. City of Alameda, 730 F.3d 1111, 1120 (9th Cir. 2008) (emphasis in Nuveen ; citation in Nuveen omitted)). Defendants favor a narrower definition. They argue that loss causation can be established only if " 'the market learns of a defendant's fraudulent act or practice, the market reacts to the fraudulent act or practice, and plaintiff suffers a loss as a result of the market's reaction.'" Doc. 379 at 13 (quoting Oracle, 627 F.3d at 392). Each side cites Ninth Circuit cases in support of its position. The Court has read the Ninth Circuit cases cited by the parties -- several times -- and concludes that they reflect two irreconcilable lines of cases. The Court will provide a brief history of loss causation, describe each line of Ninth Circuit cases, and then decide which line to follow.

A. A Brief History of Loss Causation.

As far back as the early 1980s, some federal courts recognized that a securities fraud plaintiff should be permitted to recover under § 10(b) and Rule 10b-5 only if the misrepresentation of omission of the defendant proximately caused the plaintiff's loss. A leading case was Huddleston v. Herman & MacLean, 640 F.2d 534 (5th Cir. 1981), aff'd in part, rev'd in part, 459 U.S. 375, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983), which held that " [t]he plaintiff must prove not only that, had he known the truth, he would not have [purchased the security], but in addition that the untruth was in some reasonably direct, or proximate, way responsible for his loss," id. at 549. " If the investment decision is induced by misstatements or omissions that are material and that were relied on by the claimant, but are not the proximate reason for his pecuniary loss, recovery under [Rule 10b-5] is not permitted." Id. Without this requirement of proximate cause, Huddleston explained, " Rule 10b-5 would become an insurance plan for the cost of every security purchased in reliance upon a material misstatement or omission." Id.

The Huddleston view was not universally accepted. Some courts held that a plaintiff could prevail merely by showing that the misrepresentation or omission caused the plaintiff to purchase the security. See, e.g., Kafton v. Baptist Park Nursing Ctr., Inc., 617 F.Supp. 349, 350 (D. Ariz. 1985). This broader form of causation is sometimes called " transaction causation." It exists when a misrepresentation or omission of the defendant induces the plaintiff to

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purchase the defendant's securities. As the Ninth Circuit has explained, " to prove transaction causation, the plaintiff must show that, but for the fraud, the plaintiff would not have engaged in the transaction at issue." In re Daou Systems, Inc., 411 F.3d 1006, 1025 (9th Cir. 2005). " [T]o prove loss causation, the plaintiff must demonstrate a causal connection between the deceptive acts that form the basis for the claim of securities fraud and the injury suffered by the plaintiff." Id.

A helpful illustration of the difference was provided in Huddleston:

[A]n investor might purchase stock in a shipping venture involving a single vessel in reliance on a misrepresentation that the vessel had a certain capacity when in fact it had less capacity than was represented in the prospectus. However, the prospectus does disclose truthfully that the vessel will not be insured. One week after the investment the vessel sinks as a result of a casualty and the stock becomes worthless.

640 F.2d at 549 n.25. In this example, the investor might be able to prove transaction causation (that the misrepresentation about the vessel's capacity induced him or her to purchase the stock), but could not prove loss causation (that the misrepresentation caused the investor's loss). The loss was caused by the lack of insurance.

Although federal courts disagreed for several years on whether loss causation was required in 10b-5 cases, Congress resolved the disagreement in 1995 when it passed the Private Securities Litigation Reform Act (" PSLRA" ). The PSLRA required proof of transaction causation by requiring proof of reliance -- that the plaintiffs relied on the defendant's misstatement or omission when they purchased the security. See Dura, 544 U.S. at 341 (a 10b-5 plaintiff must prove " reliance, often referred to in cases involving public securities markets (fraud-on-the-market cases) as 'transaction causation'" ). The PSLRA also included a section titled " Loss causation" which provided that " [i]n any private action arising under this chapter, the plaintiff shall have the burden of proving that the act or omission of the defendant alleged to violate this chapter caused the loss for which the plaintiff seeks to recover damages." 15 U.S.C. § 78u-4(b)(4). As the Supreme Court has noted, this provision requires proof of " 'loss causation,' i.e., a causal connection between the material misrepresentation and the loss[.]" Dura, 544 U.S. at 341. Loss causation has thus become a universal requirement of securities fraud cases.

The Supreme Court addressed the requirement of loss causation in Dura. Some courts had held that loss causation could be established merely by showing that the price of the stock on the date of purchase was inflated by the defendant's misrepresentations. The Supreme Court held that loss causation requires more, finding that Congress intended " to permit private securities fraud actions for recovery where, but only where, plaintiffs adequately allege and prove the traditional elements of causation and loss." Id. at 346. Thus, plaintiffs must " prove that the defendant's misrepresentation (or other fraudulent conduct) proximately caused the plaintiff's economic loss." Id. Stated differently, the plaintiff must show a " causal connection" between the " loss and the misrepresentation." Id. at 347.

The parties and the Ninth Circuit agree on this much: that Plaintiffs must prove a causal connection between Defendants' fraudulent actions and their loss. The question is how that connection must be proved. On this question, the parties and the Ninth Circuit cases diverge.

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B. Daou and its Progeny.

Shortly after the Supreme Court decided Dura, the Ninth Circuit issued an amended opinion in Daou, 411 F.3d at 1006. The district court in Daou had dismissed the plaintiff's third amended complaint because it did not " allege that there were any negative public statements, announcements or disclosures at the time the stock price dropped that Defendants were engaging in improper accounting practices." Id. at 1026. In other words, because the defendants' fraud -- the improper accounting practices -- had not been publicly disclosed, the district court concluded that loss causation had not been pled. The Ninth Circuit reversed. It observed that " the price of Daou's stock fell precipitously after defendants began to reveal figures showing the company's true financial condition." Id. (emphasis added). The Ninth Circuit found loss causation to be adequately pled because " Plaintiffs allege that these disclosures of Daou's true financial health, the result of prematurely recognizing revenue before it was earned, led to a 'dramatic, negative effect on the market, causing Daou's stock to decline[.]'" Id. (emphasis added). In other words, it was the disclosure of the company's financial problems -- problems caused by the fraudulent accounting practices -- that led to the stock decline and the plaintiff's loss.

That it was the disclosure of the company's financial condition, rather than disclosure of defendants' fraud, that satisfied loss causation, is made abundantly clear in Daou. The opinion on page 1026 refers to disclosure of " the company's true financial condition" and " Daou's true financial health." Id. The next page refers to the disclosure of " Daou's true financial health," " the true nature of Daou's financial condition," and " Daou's true financial situation." Id. at 1027. Although it is correct that the facts in Daou also included the revelation of additional information from which one market analyst became suspicious that the company was " manufacturing earnings," and although it is also correct that the company disclosed a growing amount of unbilled receivables in one of its accounts, it was not the disclosure of these facts that the Ninth Circuit found sufficient for loss causation. Rather, it was the disclosure of the company's true financial condition, which had been previously misrepresented by the defendants, which led to a drop in the stock price and provided the causal connection between the defendants' wrongful conduct and the plaintiffs' loss. As the Ninth Circuit observed, " the price of Daou's stock fell precipitously after defendants began to reveal figures showing the company's true financial condition." Id. at 1026.

The Ninth Circuit took the same approach three years later in Berson v. Applied Signal Technology, Inc., 527 F.3d 982 (9th Cir. 2008). The plaintiffs in Berson bought stock in Applied Signal during the six months before the company revealed that its revenue had fallen 25%. Immediately following this disclosure, the stock price dropped 16% and plaintiffs sued the company and two of its officers for securities fraud. Id. at 984. The plaintiffs alleged that the company engaged in a misleading process of reflecting the dollar value of government contracts in a " backlog" account, suggesting that the company would perform the contracted-for work in the future and would earn the contracted-for revenues. Defendants did not disclose that some of those contracts were the subjects of " stop-work orders" from the government that meant they might never be performed. Thus, plaintiffs were given the incorrect impression that the company had a substantial backlog of future work, when in fact tens of millions of dollars in the backlog were under stop-work orders and might never be performed.

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The Ninth Circuit provided this description in finding that the plaintiffs adequately pled loss causation: " The complaint describes the stop-work orders in detail, explains that the orders halted a significant amount of work, alleges that the reduced workload caused revenue to fall by 25%, and claims that this revenue reduction caused the stock price to drop by 16%." Id. at 989 (emphasis added). In other words, it was the eventual effect of the misrepresented facts -- the contracts subject to stop-work orders -- that caused revenue to drop, stock prices to fall, and plaintiffs' injuries. The very facts that were wrongly withheld ultimately led to the plaintiffs' loss. As in Daou, it was the revelation of the company's true financial condition, in contrast to the misleading financial condition portrayed by the defendants, that led to the stock price drop and satisfied loss causation.

This approach became even clearer when the Ninth Circuit articulated this test for loss causation in Nuveen : " A plaintiff can satisfy loss causation by showing that 'the defendant misrepresented or omitted the very facts that were a substantial factor in causing the plaintiff's economic loss.'" 730 F.3d at 1120 (emphasis in original) (citing McCabe v. Ernst & Young, LLP, 494 F.3d 418, 425 (3d Cir. 2007)). Thus, drawing a causal connection between the facts misrepresented and the plaintiff's loss will satisfy loss causation. A plaintiff need not show that the fraudulent practices themselves were revealed: " Disclosure of the fraud is not a ...


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