Patel v. Patel: Loss Causation and Supervening Market Forces

In Patel v. Patel, 2011 WL 198418, No. 1:09-CV-3684-CAP (N.D. Ga. Jan. 14, 2011), plaintiffs brought suit against defendants based on eight counts, including violations of the Georgia Securities Act, Rule 10b-5, control person liability, and negligent misrepresentation.  Defendants filed a motion to dismiss the plaintiffs’ amended complaint and the court granted defendants’ motion. 

Defendants Mukesh Patel and R.C. Patel founded Horizon BanCorp (later changed to Haven Trust Bancorp, Inc.), a holding company for Haven Trust Bank (“Bank”).  Haven Trust Bancorp (“Haven Trust”) sold shares through private placements and, in the process, distributed placement memoranda (“PPM’s”).  In 2008, the Bank’s collapse left Haven Trust’s stock worthless.  Plaintiffs alleged that the 2006 and 2008 PPM’s concealed the true financial condition of Haven Trust and failed to disclose the Bank’s overly risky lending habits. 

The court dismissed claims under the Count I and II of plaintiffs’ amended complaint, alleging violations of the Georgia Securities Act for failing to plead scienter and the claim for negligent misrepresentation.

Count IV involved alleged violations of Rule 10b-5.  Such a claim required a showing of: (1) a material misrepresentation or omission; (2) made with scienter; (3) in connection with the purchase or sale of a security; (4) reliance of the misstatement or omission; (5) economic loss; and (6) a causal connection between the material misrepresentation or omission and the loss, known as “loss causation.” 

The court concluded that allegations of position (the defendants were directors), attendance at meetings, and access to internal documents was not enough to establish scienter.  Likewise, a motive to ensure a dividend stream was insufficient.  The court viewed the motivation as "closely analogous to the desire to sustain a company's stock price" something that had been held to be insufficient to support an inference of scienter. 

Additionally, the court held that plaintiffs failed to allege loss causation.  The court noted that if plaintiffs’ loss was caused by supervening general market forces unrelated to defendants’ misconduct, plaintiff was precluded from recovery under Rule 10b-5.  Plaintiffs had alleged that the FDIC’s 2008 announcement that it was taking over the Bank caused the loss in value of plaintiffs’ stock; however, the court stated that this only established that the loss was caused by the FDIC’s decision to close the Bank due to the effect of the subprime mortgage and financial crises on the Bank’s loan portfolio and the value of its real estate collateral.  Because plaintiffs could not distinguish between defendants’ alleged misrepresentations and the intervening event, the court held that plaintiffs had not sufficiently alleged loss causation.  Based on this and the fact that plaintiffs did not allege a strong inference of scienter, their Rule 10b-5 claim failed as a matter of law. 

Based on all of the above, the court granted defendants’ motion to dismiss.

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