Co-authored by Elizabeth Langdale.

The U.S. Court of Appeals for the Second Circuit recently considered whether a stock’s share price recovery soon after the fraud became known defeats an inference of economic loss in a securities fraud suit at the pleading stage.

Acticon AG (Acticon), lead plaintiff in a consolidated putative class action suit against China North East Petroleum Holdings Limited (NEP), brought this suit under the Securities Exchange Act of 1934 and SEC Rule 10b-5, alleging that NEP misled investors about its reported earnings, oil reserves and internal controls. Acticon further alleged that NEP revealed this information through a series of corrective disclosures and that in the trading days after each disclosure was made, NEP’s stock price dropped. NEP argued that these allegations were not sufficient to allege economic loss because Acticon could have sold its holdings on days the stock price had recovered and avoided a loss. The District Court held that because Acticon had foregone multiple opportunities to sell its shares at a profit, it had not suffered an economic loss and dismissed the action.

The Second Circuit reversed the District Court’s decision and found that the fact that the price of the stock recovered soon after it had dropped did not negate an inference of economic loss at the pleading stage. The Court reasoned that at this early stage in the litigation, because it did not know whether the price rebounds represented gains unrelated to the fraud, the Court could not determine whether it was proper to offset the price recovery against Acticon’s losses in calculating the economic loss. Accordingly, the Second Circuit found that the recovery of the stock price did not negate the inference that the lead plaintiff had suffered an economic loss.

Rosado v. China North East Petroleum Holdings Ltd. et al., No. 11-4544-cv (2d Cir. Aug. 1, 2012).