Second Circuit Affirms Judgment Rejecting Securities Fraud Claims Because Plaintiffs Would Have Bought Securities Even Knowing Of Alleged Fraud
10/03/2016On September 27, 2016, the U.S. Court of Appeals for the Second Circuit affirmed the judgment of the Southern District of New York, after a bench trial, finding that Vivendi Universal, S.A. (“Vivendi”) rebutted the fraud-on-the-market presumption of reliance, thereby defeating a non-class, individual group of plaintiffs’ claims under Section 10(b) of the Securities Exchange Act of 1934. GAMCO Inv’rs, Inc. v. Vivendi Universal, S.A., —F.3d—, 2016 WL 5389281 (2d Cir. Sept. 27, 2016). The Court affirmed the district court’s determination that plaintiffs—a number of “value funds” controlled by GAMCO Investors, Inc. (“GAMCO”)—did not rely on Vivendi’s market price, and would have purchased the securities even had they known of Vivendi’s alleged misstatements respecting its liquidity risk. While acknowledging that it would seem unlikely that an investor, “aware of fraud,” would purchase a security, the Court repeatedly emphasized that sufficient evidence in the trial record supported the district court’s findings.
Under Basic Inc. v. Levinson, 485 U.S. 224 (1988), an investor’s reliance on a security’s market price (and, thus, any misstatements affecting that price) is presumed but can be rebutted. The record at trial indicated that GAMCO, a value investor, determined whether to purchase a given security based on its own internal calculation of intrinsic value, as distinguished from the market price, which GAMCO employees often referred to as “irrational.” GAMCO would purchase a security if there was a large enough spread between its internal intrinsic value calculation and the market price, or if GAMCO believed that some “catalyst” would improve the stock’s market price over time. Plaintiffs and Vivendi disputed whether the mere fact that plaintiffs were value investors was sufficient to rebut Basic’s “fraud-on-the-market” presumption. The Court, however, found it unnecessary to address that issue, because sufficient evidence at trial supported the district court’s determination that these particular plaintiffs did not rely on the market price of Vivendi shares in acquiring their stock.
For example, the Court noted that record evidence showed that GAMCO’s chief investment officer testified that there was a 10% chance it would have bought securities in a company knowing the securities’ price was inflated by fraud. The Court also emphasized testimony by the GAMCO analyst primarily responsible for calculating the intrinsic value of Vivendi’s shares, that Vivendi’s liquidity problems, once disclosed, did not actually impact his valuation. In addition, the Court stressed that plaintiffs continued to increase their holdings in Vivendi even as additional information about Vivendi’s liquidity problems came to light, and highlighted testimony establishing that GAMCO believed Vivendi’s liquidity issues were short-term problems that did not affect GAMCO’s intrinsic value calculation.
This affirmance reinforces the view that, in the individual plaintiff’s case, an investor’s idiosyncratic investment strategy may preclude a finding of reliance on alleged misstatements, even in circumstances where price-affecting misstatements have been found at trial and the fraud on the market presumption on behalf of a plaintiff class has been sustained. One can only speculate whether other investors who might have had a similar investment thesis to GAMCO may be hidden in the morass of the successful class of plaintiffs who prevailed against Vivendi and will share any recovery (absent further judicial review).