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From Securities Regulation Daily, August 20, 2013

"Negative causation" did not apply to voting agreement entered into before registration statement was filed

By Rodney F. Tonkovic, J.D.

A 9th Circuit panel has reversed the dismissal of a securities fraud action, finding that “negative causation” defense did not bar the plaintiff's claims. Because the plaintiff did not irrevocably commit to exchange his shares prior to the filing of a registration statement, the plaintiff adequately alleged that material misstatements in the registration statement caused his losses, the panel concluded. The panel found that the district court erred in denying the plaintiff leave to amend (Hildes v. Arthur Andersen LLP, August 19, 2013, Lucero, C.).

Background. Plaintiff David Hildes was a director of Harbinger Corporation, a provider of business-to-business e-commerce software. In April 2000, Pergrine Systems, a software company, entered into a merger agreement with Harbinger. As a condition of the merger agreement, Hildes, along with other Harbinger shareholders, entered into an agreement that his Harbinger shares be voted in favor of the merger.

In May 2000, Peregrine filed a registration statement with the SEC in connection with the merger. The registration statement, Hildes claimed, overstated Pergrine's revenue by over $120 million and understated its net losses by over $190 million. The merger was approved in June 2000. In June 2003, the SEC filed a complaint against Peregrine, alleging that it had filed materially incorrect financial statements with the SEC between 1999 and December 2001, and Peregrine later consented to an injunction.

Leave to amend. Hildes brought this action, which was dismissed by the district court. The district court held that Hildes had entered into a binding commitment when he signed the voting agreement and that any alleged loss could not be attributed to misrepresentations or omissions in the later registration statement. On appeal, Hildes contended that the district court erred in denying him leave to amend his complaint to assert claims against all of the individual defendants under Securities Act Section 11.

The panel first noted the general rule that "a plaintiff need not demonstrate reliance on a misleading registration statement in order to prevail on a Section 11 claim." The district court however, invoked the doctrine of "negative causation," which prevents recovery for losses that are not attributable to an alleged misrepresentation or omission in the registration statement. The district court concluded that Hilde's losses were not attributable to the registration statement because he made a binding commitment to exchange his shares before the date the misrepresentations were made in the registration statement.

The panel disagreed with the district court's analysis, stating that while Hildes was irrevocably committed to voting his shares in favor of the merger, he was not irrevocably committed to exchanging his shares. Under the agreement, the panel elaborated, the exchange of shares was contingent on the consummation of the merger. The panel, moreover, found Hildes' argument that the merger would not have occurred if the registration statement was truthful to be plausible.

The panel accordingly concluded that the defendants did not meet the "heavy burden" of proving that the depreciation in the value of Hildes' shares was the result of something other than the alleged false and misleading statements. The panel stressed that Hildes was not irrevocably bound to exchange his shares at the time the registration statement was filed: "Rather, misrepresentations contained in the Registration Statement played a role in the causal chain that resulted in the exchange of stock," the panel said.

Addressing the denial of leave to amend, the panel stated that because the exchange of shares constituted Hildes’ acquisition of Peregrine securities pursuant to a registration statement, he stated a potentially meritorious Section 11 claim. The panel accordingly reversed the district court's judgment and remanded the case for further proceedings.

The case is No. 11-56592

Attorneys: Robert Grahame Barnes (Kaye Scholer, LLP) for David Hildes. Edward Kim (Bingham McCutchen, LLP) for Arthur Andersen, LLP. Anne H. Hartman, Esquire (Goodin MacBride Squeri Ritchie & Day, LLP) for Thomas G. Watrous, Sr. Robert H. Logan, Esquire (Keesal, Young & Logan) for Douglas S. Powanda.

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