In Mass. Ret. Sys. v. CVS Caremark Corp., the First Circuit recently revived a shareholder securities fraud class action stemming from the 2006 merger of retail pharmacy chain, CVS, and prescription benefits manager (PBM), Caremark. The First Circuit joined other circuits in holding that a “corrective” disclosure—a public disclosure by the defendant that reveals a prior misrepresentation to investors—need not be a “mirror-image” disclosure in order to establish loss causation, a key element of a Section 10(b) and Rule 10b-5 securities-fraud claim. Loss causation is the causal connection between the defendant’s material misrepresentation and the drop in the company’s stock price, and it is commonly established by alleging that a corrective disclosure coincided with a drop in the company’s stock price.
The lead plaintiff alleged that CVS Caremark misled investors about the success of the merger and the post-transaction company’s ability to integrate the businesses and systems of CVS and Caremark. Specifically, it alleged that CVS Caremark touted the success of the merger, stating that it had quickly and successfully integrated CVS’s and Caremark’s systems within just one year after the announcement of the merger, and that as a result of the successful merger, CVS Caremark predicted substantial earnings growth. In reality, according to the lead plaintiff, the merger was a disaster and CVS Caremark’s inability to integrate caused serious service issues which, in turn, caused the company’s PBM business to lose billions in customer accounts.
The issue before the court was whether the CEO’s disclosure on a November 2009 earnings call—two years after the company declared that the systems integration was completed successfully—of “big client losses” totaling over $4 billion, in part due to “service issues,” could amount to a corrective disclosure sufficient to establish loss causation. On the same call, the company’s CEO announced that CVS Caremark would not hit its prior forecasts and that the company was actually facing a 12% decline in earnings. The CEO also announced the resignation of Caremark’s president, who was one of the “chief architects of the CVS Caremark integrated model.” After the call, analysts reported that the magnitude of the loss, disclosed on the call and not in the company’s earnings release, raised management “credibility issues” and showed that the merger was a failure.
The district court dismissed the lead plaintiff’s complaint for failure to adequately allege loss causation, reasoning that the November 2009 call did not amount to a disclosure of the truth about CVS Caremark’s failure to integrate the merged entity. The district court focused on the CEO’s denials that there was anything wrong with the CVS Caremark business model and that the “service issues,” which led to client losses, were attributable to the integration of CVS and Caremark. In short, the district court held that the November 2009 call was not a corrective disclosure and that therefore the lead plaintiff’s complaint did not plausibly allege loss causation.
The First Circuit disagreed and held that the lead plaintiff adequately alleged loss causation based on the November 2009 call and associated drop in CVS Caremark’s stock price. Citing 2009 decisions of the Fifth and Tenth Circuits, the First Circuit held that “a corrective disclosure need not be a ‘mirror-image’ disclosure—a direct admission that a previous statement is untrue.” The court reasoned that if a fact-for-fact disclosure were required to establish loss causation, a defendant could defeat liability by refusing to admit the falsity of its prior misstatements.
Instead, the court held, “the appropriate inquiry is whether the November  call, as a whole, plausibly revealed to the market that CVS Caremark had problems with service and the integration of its systems.” When viewed holistically, the November 2009 call—including the disclosure of “service issues,” the magnitude of the losses reported, and the resignation of the “chief architect” of the combined company’s integration model—revealed the truth about the failure of the CVS-Caremark merger. The court also endorsed the use of analyst reports to allege loss causation: “When a plaintiff alleges corrective disclosures that are not straightforward admissions of a defendant’s previous misrepresentations, it is appropriate to look for indications of the market’s contemporaneous response to those statements.”
The First Circuit's decision means that pleading loss causation is not as high a hurdle as some defendants might wish. A plaintiff can meet the loss causation burden by alleging a disclosure (and coinciding stock price drop) that is not directly corrective of a prior statement, so long as the disclosure, as a whole, plausibly reveals the alleged fraud to the market. However, other elements of a securities-fraud claim that are definitively subject to the heightened pleading standards of the Private Securities Litigation Reform Act, such as falsity and scienter, remain significant obstacles to maintaining a 10b-5 claim.