In Loreley Fin. (Jersey) No. 3 Ltd. v. Wells Fargo Sec., LLC, 2015 U.S. App. LEXIS 12800 (2d Cir. July 24, 2015), the Second Circuit reversed the district court’s dismissal of state law fraud claims arising out of the sale of hybrid CDOs.  The court spent an extraordinary amount of time discussing the concept of loss causation, although to be honest, I’m not at all confident that the extended discussion actually clarifies matters, at least in those circuits that already follow Second Circuit law on the subject. 

(There is currently a circuit split on the definition of loss causation under the federal securities laws, and a newly-filed cert petition asking the Supreme Court to resolve it.  But I digress.)

What I actually was excited to see was the Second Circuit’s discussion of the conditions under which plaintiffs should be permitted to amend their pleadings.

As I previously posted, courts are all over the map about allowing amended pleadings in securities fraud cases.  Some courts are extremely permissive; others essentially grant plaintiffs only one bite at the apple (although that standard is usually more applicable to federal, rather than state, claims).  Many courts have held that if plaintiffs want the opportunity to replead their claims in order to meet particularity requirements, they must proffer their proposed amendments prior to the ruling on the motion to dismiss.  The theory is, plaintiffs should not be allowed to sit on relevant evidence, let the court make its ruling, and only then announce that they have new facts in their possession; instead, plaintiffs should promptly alert the court if they have additional facts that bolster their allegations.

That rule sounds logical but, as I argued in my prior post, is actually tremendously unfair in practice, because the particularity requirements for pleading securities fraud – whether under the federal rules or under the PSLRA – are so idiosyncratic that it is very difficult for plaintiffs to be able to tell, in advance, what deficiencies might exist in their complaint and what new facts might fill the holes.  Making matters worse, any newly-proffered facts offered prior to an initial ruling on the motion to dismiss would introduce extensive delays into the process.

Well, in Loreley, the Second Circuit agreed with me (vindication!!).  As the court wrote:

[T]he procedure by which the district court denied leave to amend was improper. The court required the parties to attend a pre-motion conference and to exchange, in preparation, letters of no more than three pages regarding Defendants’ anticipated motion to dismiss for failure to state a claim. The Federal Rules of Civil Procedure do not speak to the use of pre-motion conferences. Such conferences are not in themselves problematic, however, and indeed may in many instances efficiently narrow and/or resolve open issues, obviating the need for litigants to incur the cost of more extensive filings. The impropriety occurred not when the district court held the pre-motion conference but when, in the course of the conference, it presented Plaintiffs with a Hobson’s choice: agree to cure deficiencies not yet fully briefed and decided or forfeit the opportunity to replead. Without the benefit of a ruling, many a plaintiff will not see the necessity of amendment or be in a position to weigh the practicality and possible means of curing specific deficiencies.

Our opinion today, of course, leaves unaltered the grounds on which denial of leave to amend has long been held proper, such as undue delay, bad faith, dilatory motive, and futility—none of which were a basis for the denial here. No improper purpose is alleged. And while leave may be denied where amendment would be futile, the approach taken by the district court was not rooted in futility. Rather, the court treated Plaintiffs’ decision to stand by the complaint after a preview of Defendants’ arguments—in the critical absence of a definitive ruling—as a forfeiture of the protections afforded by Rule 15. This was, in our view, premature and inconsistent with the course of litigation prescribed by the Federal Rules…

I totally agree.