a § 12(2) suit brought by the court-appointed receiver of a securities dealer against other sellers who allegedly participated with the dealer in his fraud. Id. at 1420. Scholes claimed that the receivership entities he represented had sold the securities in reliance on misrepresentations made by defendants, the other sellers. Recognizing that defendants' wrongdoing had actually enriched the receivership estates, the court dismissed Scholes' § 12(2) claim, explaining that "it is incumbent on Scholes to explain how the seller of securities can make such a 1933 Act § 12(2) claim . . . in light of the principles of loss causation stated in Bastian v. Petren Resources Corp." Id. at 1423-24 (citations omitted). Because this was a unique situation of a seller (through its receiver) bringing suit instead of a buyer, the court directed that Scholes address and explain his standing to seek recovery against others with whom the architect of the fraud structure had conspired. The Scholes court did not specifically hold that loss causation is a requirement of § 12(2), and does not weigh in favor of or against including loss causation in a § 12(2) claim.
Defendants correctly assert that the support for Plaintiffs' position provided by Pommer v. Medtest Corp., 961 F.2d 620 (7th Cir. 1992), is dicta. (Defendants' Reply, at 4-5.) Plaintiffs in Pommer brought a fraud claim under § 10(b) and Rule 10b-5, not under § 12(2). 961 F.2d at 622. Pommer does suggest a rationale supporting Plaintiffs' position, however. In discussing damages under the federal securities acts, the Pommer court observed that while § 12(2) uses the same starting point for damages as does § 10(b), it "also allows the defendant to reduce the award by demonstrating that the misstatement did not cause the decline in value." Id. at 628 (emphasis added). By recognizing that a plaintiff may recover some damages even if the misstatement was not the cause of loss, the court implies that plaintiff may have a cause of action even without loss causation. Id.; see also Ackerman v. Schwartz, 947 F.2d 841, 845 (7th Cir. 1991) (distinguishing § 12 claims from other securities fraud claims and noting that "missing [in § 12] is any reference to causation and contribution".) Further, at least one court in this district has expressly distinguished § 12(2) from § 10(b) as not requiring a showing of loss causation. Coe v. Nat'l Safety Assocs., Inc., 131 F.R.D. 252, 254 (N.D. Ill. 1991).
Defendants here argue that a plaintiff who shows no loss causation under Pommer will have no claim because the damages would be mitigated to nothing. (Defendants' Reply, at 5.) That argument addresses only the issue of damages, however, a matter quite distinct from that of liability. Pommer thus does lend support for the argument that there may be liability under § 12(2) without loss causation and that the absence of loss causation will be relevant only to the damages award.
Case Law in Other Circuits
Addressing the question more directly, courts in two other circuits have held that a plaintiff is not required to plead loss causation in order to state a claim under § 12(2): "Statutory sellers 'may now be liable under section 12 whether or not scienter or loss causation is shown.'" Polycast Technology Corp. v. Uniroyal, Inc., 792 F. Supp. 244, 259 (S.D.N.Y. 1992) (quoting Wilson v. Saintine Exploration and Drilling Corp., 872 F.2d 1124, 1126 (2d Cir. 1989)). More recently, the Fourth Circuit held that neither loss causation nor transaction causation is a required element of a claim under § 12(2): "A claim under § 12(2) may be grounded on untrue statements and omissions that make a memorandum misleading, whether or not the plaintiff relied on the memorandum or even read it, and may justify rescission, whether or not the plaintiff was damaged." Caviness v. Derand Resources Corp., 983 F.2d 1295, 1305 (4th Cir. 1993). In Caviness, plaintiffs invested in oil and gas wells managed by defendants. Id. at 1298. Dissatisfied with the returns on their investment and seeking rescission, plaintiffs claimed that defendants' private placement memoranda on which they relied to make their investment decisions were misleading because of untrue statements and omissions. Id. at 1298-99, 1304. The court held that plaintiffs had stated a valid claim for rescission of a sale of a security under § 12(2), even though plaintiffs' complaint made no allegation that the misleading statements caused their loss. Id. at 1305.
Authority from outside this Circuit thus suggests that Plaintiff may challenge the deceptive statements in the Prospectus, even without demonstrating that the misstatements caused their loss.
Defendants raise some policy arguments in support of their position that § 12(2) requires a showing of loss causation. They urge that § 12(2) was not intended to provide investors with an "insurance policy against nonspecific risks and losses." (Defendants' Reply, at 2-3.) As the Supreme Court has recognized, however, while Congress certainly did not enact the Securities Exchange Act of 1933 as an insurance policy, the Act may have precisely this incidental effect in its legitimate application:
We may therefore infer that Congress chose a rescissory remedy when it enacted § 12(2) in order to deter prospectus fraud and encourage full disclosure as well as to make investors whole. Indeed, by enabling the victims of prospectus fraud to demand rescission upon tender of the security, Congress shifted the risk of an intervening decline in the value of the security to defendants, whether or not that decline was actually caused by the fraud.
Randall v. Loftsgaarden, 478 U.S. 647, 659, 92 L. Ed. 2d 525, 106 S. Ct. 3143 (1986).
The Second Circuit echoes this interpretation: "In drafting Section 12(2), Congress obviously sought to provide a heightened deterrent against sellers who make misrepresentations, by rendering tainted transactions voidable at the option of the defrauded purchaser regardless of whether the loss is due to the fraud or to a general market decline." Wilson v. Ruffa, 844 F.2d at 86.
By providing a heightened deterrent, Section 12(2) may appear to function as an "insurance policy," but such an appearance is incidental to the legitimate goal of deterring misrepresentations. Another related incidental effect of this heightened deterrent is that windfall awards may be bestowed upon plaintiffs whose loss was not caused by defendants' misrepresentations; as the Seventh Circuit has already recognized, however, such windfalls may be a permissible result under § 12(2). See Bastian, 892 F.2d at 685. The fact that Plaintiffs' securities underwent a severe decline in market value not caused by the misrepresentation itself need not preclude an award of damages under § 12(2).
Defendants suggest that the purpose of § 12(2), "to prevent the price of a security from being artificially inflated through mis representations affecting the value the public would place on the security," is not undermined by the omission of loss causation as an element. (Defendants' Reply, at 2.) Omission of that requirement does, however, permit plaintiffs to challenge misrepresentation even without establishing a causal link that may be difficult or impossible to prove. The heightened deterrent provided by this standard thus will induce sellers to be more careful in representing the security -- a measure that will, over time, reduce the number of artificially inflated securities.
Finally, Defendants argue that the imposition of a loss causation requirement for § 12(2) claims would prevent abusive lawsuits in which defendants are harassed or forced into settlement. (Defendants' Reply, at 3.) That argument loses sight of the purpose of § 12(2). Even without a loss causation requirement, a plaintiff must still prove that the defendant made a false representation in order to proceed under this section. Thus, a seller can avoid an abusive lawsuit with a carefully drafted prospectus -- precisely what the heightened deterrent of § 12(2) is intended to induce. The policy considerations articulated by Defendants do not require that this court read a loss causation element into § 12(2).
The weight of authority supports a conclusion that loss causation is not an element which must be pleaded and proved by Plaintiffs under § 12(2). Although Seventh Circuit case law is inconclusive, other circuits (including one Second Circuit case cited with approval by our Court of Appeals) have directly addressed the issue and found "loss causation" to be unnecessary. In enacting § 12(2), Congress evidently intended to provide extra protection to investors against false statements. Such protection is enhanced by a determination that a plaintiff may proceed under § 12(2) even without a specific showing that the challenged statement actually caused his or her loss. Thus, after limited reconsideration, this court again recommends that Defendants' Motion to Dismiss Count III be denied.
REBECCA R. PALLMEYER
United States Magistrate Judge
Date: August 6, 1993