On September 30, a federal judge dismissed a putative class action against New Energy Systems (“New Energy”), a lithium battery company with Chinese operations, finding that plaintiffs had failed to connect the dots between the alleged misrepresentation (overstated earnings) and any drop in stock price when the “fraud” was revealed.[1] Because there was no material change in stock price when New Energy amended its SEC filings thereby “revealing” the company’s problems, the plaintiffs attempted to tie their losses to an earnings press release, issued 8 months after the amended filings. The Court flatly rejected this later, “materialization of concealed risk” theory.

The Complaint focused on income discrepancies between New Energy’s 2008-2009 filings with the SEC and its filings with the Chinese equivalent of the SEC. Plaintiffs alleged that the revenue and earnings numbers in the SEC filings were hundreds and sometimes thousands of percentage points higher than the numbers in the Chinese filings. Both sets of numbers were publicly available to investors.[2]

Then, in March 2011, New Energy amended its Chinese filings such that they conformed to the higher numbers in its SEC filings. The market had no reaction whatsoever to the amended filings. In November 2011, however, New Energy issued a press release announcing a 42% decline in year-over-year revenues for the third quarter of 2011. The stock dropped 48.6%.[3]

Plaintiffs argued that the late 2011 drop after the press release was connected to an ongoing fraud dating back to 2008 and that New Energy had merely covered up past problems by moving such losses into its late 2011 numbers, rather than coming forth and admitting that the 2008-2009 amended filings were false. The Court rejected this late “materialization of concealed risk” as too tenuous, finding no link between the loss in late 2011 and the alleged misstatements about income for 2008-2009. Among other things, the Court noted that, “private securities fraud actions are available not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause.”[4]

Importantly, it does not appear that the Court completely shut the door – the Order does not state the complaint is dismissed with prejudice. It may be that the plaintiffs can try to amend or re-file with sufficient allegations to better tie the November 2011 “corrective disclosure” to a particular fraud. But the message is clear, would-be plaintiffs must allege facts sufficient to show that their losses are at least “within the zone of risk concealed by the misrepresentations and omissions” about which the plaintiff complains.

[1] In re: New Energy Systems Securities Litig., 12-cv-01041 (LAK), Dkt. No. 49 (S.D.N.Y. Sept. 30, 2014).

[2] See id. at 3-4.

[3] See id. at 4.

[4] See id. at 7.