In Loos v. Immersion Corporation, et al, Docket No. 12-15100 2014 WL 4454992 (9th Cir. Aug 7, 2014), the United States Court of Appeals for the Ninth Circuit granted Immersion Corporation’s (“Immersion”) motion to dismiss for failure to state a claim and dismissed John Loos’ (“Plaintiff”) amended complaint with prejudice for failing to sufficiently allege loss causation.

The complaint alleged Immersion engaged in securities fraud under Sections 10(b), 20(a), and 20A of the Exchange Act and Rule 10b-5. According to the allegations, Immersion disclosed in July 2009 “potential problems” with revenues from earlier periods and announced the commencement of an investigation. A month later, the company revealed to investors that previous financial statements were not reliable. The company disclosed the results of the investigation in February 2010 in an annual report on Form 10-K. The investigation uncovered errors in revenue recognition resulting in premature recognition causing earnings to be restated from 2006 through 1Q09. The investigation  did not find any fraudulent conduct. 

The district court granted Immersion’s motion to dismiss for failure to state a claim, finding insufficient allegations of scienter or loss causation.  An amended complaint likewise lacked the same elements. Consequently, the district court granted Immersion’s motion to dismiss and dismissed the amended complaint with prejudice. Plaintiff then appealed to the Ninth Circuit.

To show financial injury resulting from a company’s violation of Section 10(b) and Rule 10b-5, a complainant must establish six elements: (1) a material misrepresentation or omission; (2) scienter; (3) a connection between the misrepresentation and the purchase or sale of a security; (4) reliance upon the misrepresentation; (5) economic loss; and (6) loss causation. To prove loss causation, a plaintiff must allege the economic loss suffered by a decline in market price was a result of the market learning and reacting to fraud specifically, rather than to reports of the company’s poor financial health generally.

The element of loss causation requires plaintiffs to show that the defendant’s conduct was a “substantial cause” of their economic loss. Id. (“Broadly speaking, loss causation refers to the causal relationship between a material misrepresentation and the economic loss suffered by an investor.”).  During the pleading stage, this requires the plaintiff to allege that his or her  stock losses were proximately caused by fraudulent activity rather than changing market conditions, investor expectations or other unrelated factors.

Plaintiff alleged that Immersion systematically posted incorrect revenues.  The market learned of truth through “a series of ‘partial disclosures’ consisting of (1) disappointing earnings results for 1Q08, 2Q08, 4Q08 and 1Q09; and (2) the subsequent announcement of an internal investigation into prior revenue transactions.”  With respect to the earnings disclosure, the court found that the statements were not accompanied by “any information from which revenue accounting fraud might reasonably be inferred.” Nor did the disclosure of the investigation meet the standards for causation.  

The announcement of an investigation does not "reveal" fraudulent practices to the market. Indeed, at the moment an investigation is announced, the market cannot possibly know what the investigation will ultimately reveal. While the disclosure of an investigation is certainly an ominous event, it simply puts investors on notice of a potential future disclosure of fraudulent conduct. Consequently, any decline in a corporation's share price following the announcement of an investigation can only be attributed to market speculation about whether fraud has occurred. This type of speculation cannot form the basis of a viable loss causation theory.

Because Plaintiff’s amended complaint failed to establish loss causation, the Ninth Circuit Court of Appeals affirmed the district court’s decision, granting Immersion’s 12(b)(6) motion to dismiss.

The primary materials for this case may be found on the DU Corporate Governance website.