CHICAGO (CN) - The 7th Circuit overturned a major victory for shareholders in a long-running securities-fraud suit against Household International, a consumer finance firm now owned by HSBC.
Household's share price fell more than 50 percent from mid-2001 to October 2002, when lender agreed to pay $484 million to settle predatory-lending allegations brought by state regulators. HSBC soon bought the company, but had to write off billions in bad loans.
In 2013, U.S. District Judge Ronald Guzman entered a judgment of $2.46 billion against Household and three of its former executives following a jury verdict that they had misled investors about its predatory-lending practices.
The judgment consisted of $1.5 billion in damages plus almost $1 billion in pre-judgment interest, and was the largest award in a securities-fraud action that went to trial in history.
But the 7th Circuit threw it out last week, finding that the "leakage model" adopted by the jury to determine how much Household's misrepresentations inflated its stock price did not account for other factors that could have impacted the stock.
"[Defendants] argue that the leakage model, which the jury adopted, did not account for firm-specific, non-fraud factors that may have affected the decline in Household's stock price. That is true," Circuit Judge Diane Sykes wrote for the three-judge panel. "The model assumes that any changes in Household's stock price - other than those that can be explained by general market and industry trends - are attributable to the fraud-related disclosures."
Plaintiffs' expert Daniel R. Fischel testified that he looked for firm-specific factors during the relevant period, but did not find any of significance. Household claimed that this investigation was not enough - rather, the leakage model needs to eliminate firm-specific non-fraud related factors because it is plaintiff's burden to prove loss causation.
The 7th Circuit panel agreed, finding that in order to prove loss causation that shareholders also had to "isolate the extent to which a decline in stock price is due to fraud-related corrective disclosures and not other factors" - which the leakage model did not do in this case, the panel said.
"As things stand, the record reflects only the expert's general statement that any such information was insignificant," Sykes wrote. "That's not enough. A new trial is warranted on the loss-causation issue consistent with the approach we've sketched in this opinion."
The panel added that adopting Household's narrow position might doom the shareholders' theory of securities fraud entirely, because it might be impossible for any statistical model to eliminate all non-fraud factors. So the judges advocated for adopting "a middle ground."
"If the plaintiffs' expert testifies that no firm-specific, non-fraud related information contributed to the decline in stock price during the relevant time period and explains in non-conclusory terms the basis for this opinion, then it's reasonable to expect the defendants to shoulder the burden of identifying some significant, firm-specific, non-fraud related information that could have affected the stock price," Sykes wrote for the panel. "If they can't, then the leakage model can go to the jury; if they can, then the burden shifts back to the plaintiffs to account for that specific information or provide a loss-causation model that doesn't suffer from the same problem."
The Chicago-based appeals court also overturned the judgment against the individual defendants - Household's executives - because it is not clear that the they "made" the false statements in the company's press releases.
"We're hesitant to hold as a matter of law that a CEO 'makes' all statements contained in a company press release," Sykes wrote. "We haven't been directed to evidence showing that [CEO William] Aldinger's signature or name appeared in the press releases in the sense of an attribution," nor did he read the release at a press conference, the panel found.
And while, as CEO, Aldinger certainly had authority over the press releases, the shareholders have not shown that he "actually exercised control over the content of the press releases," the 47-page opinion stated.
Michael Dowd, a Robbins Geller Rudman & Dowd partner representing the plaintiffs, told Reuters that his clients will present the "very limited" remaining issues to a jury at a new trial ordered by the appeals court.
"We believe that we will prevail and that class members will finally get the justice they deserve," he said.
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