Bass, Berry & Sims attorney Chris Lazarini discussed the Sixth Circuit’s adoption of the materialization of risk standard as a viable means of proving loss causation in a securities fraud case. Chris provided the analysis for Securities Litigation Commentator (SLC). The full text of the analysis is below and used with permission from the publication. If you would like to receive additional content from the SLC, please visit the SLC website to sign up for the newsletter.
Ohio Public Employees Retirement System vs. Federal Home Loan Mortgage Corp., No. 14-4189 (6th Cir., 7/20/16)
The Sixth Circuit joins the majority of circuits and adopts the “materialization of the risk” standard as a viable means of proving loss causation in a securities fraud case.
On November 20, 2007, Freddie Mac disclosed the true extent of its involvement in subprime and other nontraditional mortgage markets and reported a loss of more than $2 billion. That same day, Freddie Mac’s stock price fell by 29%. This class action alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 followed. Lead Plaintiff OPERS alleged that Freddie Mac concealed its overextension in the nontraditional mortgage market and the deficiencies in its underwriting, risk management, and fraud detection practices through misstatements and omissions to investors and that the fund suffered “foreseeable losses” when the concealed risk materialized. After several rounds of dismissal motions and amended complaints, the district court granted Freddie Mac’s motion to dismiss, stating that OPERS’ materialization of the risk argument was not recognized by the Sixth Circuit and concluding that OPERS failed to adequately plead loss causation.
Conducting a de novo review, the Sixth Circuit reverses and joins most other circuits in recognizing materialization of the risk as a viable, alternative loss causation theory. Loss causation, the Court explains, is not meant to impose a great burden on the plaintiff; rather, it is meant to provide the defendant with some indication of the causal link between the alleged misconduct and the economic harm suffered by the plaintiff. Materialization of the risk, whereby a plaintiff alleges that negative investor response to the revelation of a hidden fact is a “foreseeable materialization” of the risk concealed by the hidden fact, meets that standard, the Court concludes.
Then, accepting the allegations of the complaint as true, the Court finds OPERS’ materialization of the risk argument sufficient to withstand Freddie Mac’s dismissal motion. The Court summarizes OPERS’ theory thus: OPERS purchased Freddie Mac stock before November 20, 2007, under the misimpression (allegedly fostered by Freddie Mac’s public statements) that Freddie Mac adequately protected its higher-risk purchases, had virtually no subprime exposure, and enjoyed more success than its competitors. The revelation of $2 billion in losses on November 20 is well within the “zone of risk” that Freddie Mac allegedly concealed.
The Court rejects Freddie Mac’s argument that OPERS failed to plead facts sufficient to exclude more likely explanations for its alleged losses, such as the impact of the Financial Crisis. At this stage, the Court states, OPERS need only allege facts to support a plausible claim, not the most likely one, and given the relationship between the risks allegedly concealed and the risks that subsequently materialized, and the close correlation between the alleged foreseeable materialization of the risk and the fall in Freddie Mac’s stock price, it has done so.