The business press is always carrying stories about suits brought against companies because the company: made a public misstatement that affected the price of its publicly traded shares; the statement was later proven incorrect; and then the stock price fell and the purchaser of shares at the higher price suffered economic harm.  Such cases typically are brought as a “class action;” one or a few injured shareholders make a claim for themselves and for all other persons similarly harmed by the same facts.  Some law firms make their living by bringing such shareholder class actions.

When such suits are not settled and are looked at by the courts, many are thrown out.  The reason often is that the misstatements are not willful.  Generally speaking, to sustain such a suit it must be proven that a misstatement is untrue, is material, and was uttered with what is known in the law as “scienter,” an intent to defraud.  There are many cases where investors lose money based on relying on a statement about, say, a new product, wherein the statement proves false, loss is incurred, but the plaintiffs do not allege or cannot prove scienter.  A recent Massachusetts case against a company called Desktop Metal, Inc. was dismissed in part because there was no claim made that the statements about product quality and FDA compliance were uttered intentionally in order to defraud.

What if the company was just shooting from the hip by announcing that its new product was innovative and superior?  What if the announcement was believed by the company, but the company failed to investigate the marketplace and thus was negligent in its remarks? Scienter is absent, but the company did not do the right thing, and the investors did lose money through no fault of their own, in reliance on the company’s very own words.

The question of whether negligence, or gross negligence, can replace actual intent (scienter) has been much litigated and the details are beyond the scope of this blog, but at the risk of being simplistic let me tell you the answer (or at least “an” answer): Federal courts are divided on this issue, some insist on actual intent, while some will consider some severe degree of negligence (sometimes stated without clear definition as “recklessness”) as being the equivalent of scienter and thus justifying recovery for the shareholders.

I offer a take-away for all investors: be careful in relying on company pronouncements leading you to believe that share price will shoot up.  Most public companies do not want to mislead and all fear class actions, but it is possible that the investment community can receive from a company a patently incorrect statement of material fact which, on discovery of inaccuracy, tanks the share price, and not have any liability to injured shareholders.