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Federal Court Holds That Lack of Loss Causation Is Not a Defense Under Massachusetts Blue Sky Law

The United States District Court for the District of Massachusetts recently held in Massachusetts Mutual Life Insurance Co. v. Residential Funding Co., LLC, that lack of loss causation is not available even as an affirmative defense under the Massachusetts Uniform Securities Act, M.G.L. c. 110A, § 410, in contrast with Section 12 of the federal Securities Act of 1933.

M.G.L. c. 110A, § 410(a)(2) provides that any person who "offers or sells a security by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, the buyer not knowing of the untruth or omission, and who does not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of the untruth or omission, is liable to the person buying the security from him…."

Thus a plaintiff proceeding under Section 410(a)(2) need only establish that “(1) the defendant ‘offers or sells a security’; (2) in Massachusetts; (3) by making ‘any untrue statement of a material fact’ or by omitting to state a material fact; (4) the plaintiff did not know of the untruth or omission; and (5) the defendant knew, or ‘in the exercise of reasonable care [would] have known’ of the untruth or omission.” Marram v. Kobrick Offshore Fund, Ltd., 442 Mass. 43, 52, 809 N.E.2d 1017 (2004). In the event of such a material misstatement or omission, the statute permits the buyer to sue for rescission of the securities purchase or for rescissory damages.

The Massachusetts Supreme Judicial Court previously held in Marram v. Kobrick Offshore Fund that a plaintiff under Section 410(a)(2) “does not need to prove either negligence or scienter,” and “reliance and sophistication of the buyer are not elements of this statutory claim.” 442 Mass. at 53, 55. The court also observed that “Section 410 (a) (2) ‘provides a heightened deterrent against sellers who make misrepresentations by rendering tainted transactions voidable at the option of the defrauded purchaser,’ regardless of the actual cause of the investor's loss.” Id. at 51 (emphasis added) (quoting Casella v. Webb, 883 F.2d 805, 809 (9th Cir. 1989) (construing Section 12 of the Securities Act)). See also id. at 57, n. 24 (“The misrepresentation or omission need only be material; it need not be the cause of any loss. “). But the SJC did not address the issue of loss causation in depth, especially as an affirmative defense.

The Mass. Mutual case involved eleven related actions alleging that the defendants had made material misstatements and omissions in the offering documents for residential mortgage-backed securities. On a motion for partial summary judgment, the plaintiff sought a ruling that the defendants were barred as a matter of law from arguing that the alleged misstatements and omissions did not cause the plaintiff's losses. Judge Mastroianni agreed. He relied in part on the SJC's Kobrick opinion, observing that the statement that “a tainted transaction is voidable ‘regardless of the actual cause of the investor’s loss,’ especially when read in the context of the cases and secondary sources directly and indirectly referenced therein, strongly indicates that a loss causation affirmative defense is not available under section 410(a)(2).” He also noted an important distinction between Section 410 and the statute it was modeled on -- Section 12 of the federal Securities Act. Whereas Section 12 was amended by the Private Securities Litigation Reform Act of 1995 (PSLRA) to add lack of loss causation as an affirmative defense, the Massachusetts statute lacks any such language. While the defendants contended that the PSLRA amendment was merely intended to “clarify” a defense that already existed under Section 12, and hence under Section 410 as well, Judge Mastroianni found no support for that argument in the case law. He also cited recent decisions from the Southern District of New York that rejected a similar argument and concluded that lack of loss causation was not available as an affirmative defense under the Blue Sky laws of Virginia, the District of Columbia, Illinois and Texas. See Fed. Hous. Fin. Agency v. HSBC North Am. Holdings, Inc., 988 F. Supp. 2d 363 (S.D.N.Y. 2013); Nat’l Credit Union Admin. Bd. v. Morgan Stanly & Co., Inc., No. 13 Civ. 6705 (DLC), 2014 U.S. Dist. LEXIS 58751 (S.D.N.Y. April 18, 2014).

Since a plaintiff does not need to prove scienter or reliance to succeed on a claim under Section 410(a)(2), and lack of loss causation is not a defense, one might well ask if it is ever possible for a defendant to prevail against such a claim. Indeed, it is. As discussed by our colleague Joe Lipchitz in an earlier post, earlier this year the Massachusetts Appeals Court upheld a jury verdict in favor of the defendants on the plaintiff’s Section 410(a)(2) claim in the Kobrick case, which found that the defendants had made no misrepresentations.  See Crown v. Kobrick Offshore Fund, Ltd., 85 Mass. App. Ct. 214, 8 N.E.3d 281, rev. denied, 469 Mass. 1108 (2014). But between the SJC’s prior Kobrick decision and the federal district court’s decision in Mass. Mutual, it is clear that the Section 410 offers investors a relatively easy path to recovery where securities are offered or sold by means of a material misstatement or omission.



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Chip Phinney