This post was written by Michael Coffino and Marc Goldich.
The press release is an efficient and effective way to provide new or updated information about the operations, business and financial performance of public companies, especially during periods between formal public filings, such as 10Qs and 10Ks. Where there have been recent, material developments, companies may be required to make public disclosure (through a press release, a Form 8-K, or both) on a more immediate basis rather than wait for their next Form 10 K or Form 10-Q. At other times, companies may wish to make a disclosure that, while not strictly necessary, concerns a significant industry or company development. Because the current regulatory environment commands increased transparency in public companies, doubts about whether issuers are duty-bound to speak often are appropriately resolved in favor of the disclosure. Companies often must make strategic decisions regarding what, when and how to disclose such information. This is especially true when a company is compelled to correct a prior material misstatement by disclosing bad news that, taken in isolation, presents a limited picture of the company’s financial and business condition and prospects.
It is important to keep in mind that press releases tend to pack a punch, and sometimes disproportionately so. Markets tend to absorb the contents of press releases with a fair degree of immediacy, and press releases often will have a discernable impact on stock price. When the news is bad, in addition to a decline in stock price, consequences can include reduced workforce, reduced compensation, damage to corporate credibility and reputation, and increased risk of litigation. It is not unusual for markets to overreact to news that is not placed in the overall context of the larger business or financial picture. Worse, corrective disclosures in a vacuum can precipitate a rush to judgment by potential class action plaintiffs or their lawyers champing at the bit to launch a securities fraud class action.
Hence, when companies must report negative news, they should consider whether the time is ripe to disclose other information that might impact an upward or downward movement of the stock price or place into wider context the negative news they must report. In this way, managers can decide how best to disseminate information that will not unduly erode public confidence in the company and mitigate potential negative stock price repercussions that could result from isolated disclosures. Stated differently, management should not feel compelled to isolate disclosures from other disclosures they otherwise would or might want to make. While management should avoid selective disclosure and act consistently in strict accordance with legal requirements and limitations, recent legal developments show that bundling current good news and even other bad news with corrections of prior financial disclosures can at once mitigate litigation risk, enhance transparency and favor shareholders with a complete informational mix.
The Supreme Court decision in Dura Pharmaceuticals and the role of corrective disclosures.
In a relatively recent decision, the U.S. Supreme Court held that plaintiffs in a securities fraud case must prove a causal connection between the allegedly false public statement on which the case is based and a later decline in the value of the stock that occurs when “the truth emerges.” Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 347 (2005). This imposes the common sense burden on plaintiffs to prove they suffered actual economic injury from a prior misstatement or “loss causation.” In the past, plaintiffs often could prove injury by showing only that the allegedly false public disclosure artificially inflated the stock price. But, as the Court in Dura observed, shareholders who sell their stock position while the price is artificially inflated have not suffered economic loss. They suffer economic loss when a subsequent “corrective disclosure” removes the allegedly inflated portion of the stock price and accordingly reduces market price. Dura stressed that plaintiffs must tie the subsequent, corrected disclosure and stock price drop specifically to the prior (now corrected) misrepresentation. Establishing the direct causal nexus is pivotal because the reduced price could reflect other factors, including “changed economic circumstances, changed investor expectations, new industry specific or firm specific facts, conditions or other events.” Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 343 (2005).
Dura mandates two important pre-requisites for a securities fraud action. First, “the truth” must become known before the decline in the stock price that quantifies the economic loss. Second, the disclosure that causes the price drop must be specifically tied to the corrected prior representation. The requirement that the correction specifically cause the drop in stock price, however, can be daunting if the corrective disclosure is bundled with good or even negative news that is unrelated to the prior, corrected disclosure. Thus, in these instances, courts require plaintiffs to show that the corrective disclosure and not an intervening factor or event caused the reduction in the market price of the stock. E.g, In re Cree, Inc. Sec. Litig., Master File No. 1:03CV00549, 2005 WL 1847004 (M.D.N.C. Aug. 2, 2005); Actema Corp. Sec. Litig., 378 F.Supp. 2d 561 (C.D. Md. 2005); In re Redback Networks, Inc. Sec. Litig., 2007 WL 4259464 (N.D. Cal. Dec. 4, 2007); In re Pfizer, Inc. Sec. Litig., 2008 WL 540120 (S.D.N.Y. Feb. 28, 2008).
The challenge of “bundled news” in press releases.
This development in the law presents corporate management with strategic decisions whenever they must release corrective news to the public. While management must avoid any suggestion of market manipulation or selective disclosure, mixed-news situations provide opportunities to protect shareholder value, increase transparency, and strengthen public confidence in the company, and in the process minimize litigation risk. Corrective disclosures appropriately could appear with other, unrelated good or bad news, including: changing market or industry trends, customer-specific occurrences or issues, regulatory problems or government intervention, extraneous factors such as unforeseeable bad weather that damages crops or that affect shipping, litigation, and political unrest, particularly in foreign nations. Each bit of news could affect stock price. But, in isolation, each may provide a blurry or very limited snapshot of the company, while together they may more fully put the picture of the company into more accurate and complete focus.
Consider, for example, the situation where a newspaper company issues a press release disclosing significantly lower than anticipated revenues while correcting previously disclosed but erroneous data regarding newspaper circulation. The market responds with a significant drop in stock price and class action plaintiffs sue, alleging that fraudulent prior misstatements based on erroneous data caused the stock price decline and resulting losses. The company’s corrective press release, however, also contains disclosures regarding reduced revenue from changes in computation methodology and regarding increased industry-wide declines in circulation attributable to consumers’ usage of the Internet as an alternative news source. In other words, the press release contains several significant kernels of bad business news. This puts plaintiffs to the task of parsing and connecting items of bad news with stock price movement to prove that one of them, the corrective disclosure, caused all or some of the stock price decline. To be sure, this multi-layered loss-causation inquiry is a formidable undertaking fraught with uncertainty. How will a plaintiff persuasively meet this challenge?
Consider also that a company’s quarterly reports for the first three quarters of a fiscal year reflected positive growth but, as it turns out, allegedly misstated the number of new customer subscribers. The announcement for the fourth quarter contained negative earnings news, unwelcome and unanticipated news about non-renewal of subscriptions, and several corrections to earlier reports, including the number of new subscribers. Following the announcement, share price falls. Plaintiffs who sue in reaction to the price decline have their work cut out for them. Did the price drop because of the corrective disclosure or the other negative information in the fourth quarter announcement?
The trend toward requiring greater specificity in loss-causation allegations presents a reporting company with important decisions regarding the timing and content of press releases. The corporate goals are often multiple: complying with legal requirements, achieving appropriate degrees of transparency, fairly depicting current business circumstances and financial performance, and protecting shareholder value. While this approach might complicate the lives of securities plaintiffs, a bundled news approach forces opportunistic litigants to do what the law requires – tie an alleged loss to a specific corrective disclosure – rather than take advantage of general negative market trends that inflate actual loss. Striking the correct balance can only be determined on a case-by-case basis. But the current legal environment provides managers with opportunities to improve information flow and ward off litigation that has no redeeming value.
Michael Coffino is a San Francisco partner in Reed Smith’s Securities Litigation Group and concentrates on a wide range of securities litigation and arbitration matters, including class action defense, shareholder derivative litigation, regulatory enforcement proceedings, broker-dealer arbitrations and corporate governance issues. Marc Goldich, who assisted with this article, is a litigation associate in the Philadelphia office and focuses on a variety of commercial and securities litigation matters.