This is absurd.
I could perhaps get on board for most of the opinion. And I understand that the last part is consistent with -- or at least analogous to -- a decision of the Eleventh Circuit.
But that doesn't make it right.
A publicly-traded company reports certain revenues during various quarters. Everyone trades as if those revenues are real. Then, one day, it announces that it's conducting an "investigation" into those revenues. It says: "[T]he Audit Committee of the Board of Directors of Immersion Corporation
(“Immersion”) is conducting an internal investigation into certain previous revenue transactions in its Medical line of business. The investigation is being conducted with the assistance of outside counsel. The Audit Committee has not yet determined the impact, if any, to Immersion’s historical financial
statements. As a result of this investigation, Immersion may discover information that could raise issues with respect to its previously-reported financial information, which could be material. Immersion will not be able to evaluate the full impact of the aforementioned matters until the Audit Committee completes its review and further analysis is completed."
Everyone and their mother knows exactly what that means. The stock tanks 23% the same day.
The Company thereafter reports the "results" of that investigation. Which reveals exactly what anyone with a brain already knew as a result of the initial disclosure. The Company had indeed improperly reported revenue. Case closed.
Stockholders sue. Assume -- as the Ninth Circuit does (and must) -- that the stockholders can prove that the officers and directors of this company knew that they were cooking the books; i.e., that there's scienter. Can the stockholders sue?
The Ninth Circuit says "No."
Why not? Because according to the Ninth Circuit, there's no "loss causation". Sure, the stock tanked, wiping out millions in company value. But it tanked only due to an "investigation," not the reporting of actual fraud. "An investigation is merely an investigation." So the loss was only caused by the report of the investigation. Not a report of actual fraud. Hence the fraud didn't cause any losses.
There was an investigation because there was fraud. And the entire universe of investors knows that by the time a company publicly reports that they're investigating whether revenue has be improperly booked, the company knows darn well that revenue has indeed been improperly booked. Want proof? That's why the stock price tanks. Because if an investigation was "just an investigation," no one would care, right? But they do. Know why? Because people with money on the line are much, much, much smarter than people in black robes who might say "Oh, it's only an investigation, no actual fraud."
Want more proof? Go ahead and list all those times you remember in the last half-century in which a company reported that it was conducting an investigation into financial misreporting and then later said that the investigation had concluded that everything was okay. Go ahead. I'll wait.
Yeah, good luck with that. How many could you recall?
Thought so. Zero.
When a company stock tanks because it's "investigating" misreporting, everyone knows what that means. A reality amply indicated by the reality of the stock price. To close one's eyes to that is to blind oneself to reality. As well as to allow deliberate misconduct to knowingly go unpunished.
Under this Ninth Circuit rule, going forward, no smart company is ever going to be found liable for misreporting. All they have to do is warn people first. Indeed, warn 'em in the worst possible terms. When you find out -- or realize that others are about to find out -- that you've cooked the books for, say, $50 million, go ahead and report that you're conducting an "investigation" into whether the books have been cooked, and make the warning as dire as possible. Your "investigation" has, of course, not yet concluded. Nothing's "official" yet. But "maybe" there's $50 million in fake revenue. Or even $100 million. Or even $1 billion. You don't know yet. But fear not. You'll find out, and then let everyone know.
Sure, your stock price will plummet. People will lose millions. But fear not. Thanks to the Ninth Circuit, you're not liable. Even if you deliberately engaged in fraud. Because the stock tanked only upon an announcement of the "investigation". Presumably, as long as the stock price doesn't tank even further once you announce the fraud, there's no "loss causation" anymore.
And you're not an idiot. That's not going to happen. Because you made the "non-actionable" announcement so scary that the actual "results" of the investigation will actually seem pretty mild by comparison. Heck, the stock price might even go up. Which the Ninth Circuit will conclude means that the market actually liked the fact that you engaged in fraud. Right? Because the losses were the result only of an "investigation", whereas the actual "fraud" caused the stock price to rise. See? No damages at all from the actual fraud.
Look, there may be extraordinary circumstances in which a stock price drop at the announcement of an investigation isn't properly actionable. Imagine, for example, a stock that dropped 25% upon the announcement, but then when the results were announced, it bounced back 30% (or 24%). Okay. I agree that might establish that the actual "fraud" wasn't material. Because if (after adjusting for market forces) a stock was trading at $25 before anyone knew of any alleged fraud, and $26 (or $24.99) after the fraud was finally and completely revealed, then, yeah, that reflects no loss causation.
But the Ninth Circuit does not say that's what transpired here. It instead simply holds that there's no loss causation from an announcement. Period. Nothing about subsequent market performance. No data about subsequent stock movement. Nothing.
So the way virtually every observer (and court) is going to read this opinion is to have it stand for the proposition that announcement losses aren't recoverable. That's wrong. Flatly wrong. Announcement losses are recoverable. They're the "result" of the fraud. At least presumptively. How do you know? The same way the market knows. Because the market knows that "investigation" means "fraud". Or at least a high probability (indeed, in reality, a near certainty) thereof. Which is why the stock tanks.
Can that presumption be rebutted? Sure it can. Just like lots of other things (e.g., the fraud on the market theory) can be rebutted in this area. So if the stock price rebounds upon the disclosure of the actual results -- adjusting, again, for market conditions and other changes -- then, yes, there may well be no loss causation. Or, alternately, it might reduce damages. So, all other things being equal, if a stock's at $30, it drops to $10 upon the announcement of an "investigation", then rebounds to $20 once the results are revealed, the losses are $10 a share ($30 minus $20), not the full $20 a share the stock dropped on the announcement. That's the right rule.
Any other rule immunizes misconduct. Any rule that says that losses on an announcement don't matter because it's "only an investigation" -- mere "speculation" of misconduct -- is wrong. Clearly wrong. In a way that really, materially matters.
So I'd be fine with an opinion that says that announcement drops don't matter when the stock bounces back completely (after adjusting for all other events) upon the subsequent disclosure of the fraud. I'd also be less vociferous if the Ninth Circuit merely held that it was the plaintiff's burden to prove the absence of a future bounceback and that that burden wasn't met here (if, indeed, it wasn't). (Though, for me, the presumption should be that the market's contemporaneous reaction was accurate, and the defendant should have the burden to prove otherwise.)
But that's not what the current opinion says. Far from it. It instead articulates a powerfully pernicious, and demonstrably erroneous, rule.