Last Friday, the Seventh Circuit issued an opinion overturning the lower court’s dismissal of a lawsuit brought against Hofer, an employee of AnchorBank, alleging  that, along with two other employees, Hofer engaged in a collusive trading scheme in violation of Sections 9(a) and 10(b) of the Securities Exchange Act of 1934 (“1934 Act”).  The two other employees settled with AnchorBank before the lawsuit was filed.

In its second amended complaint, AnchorBank alleged that Hofer and his two co-conspirators coordinated their purchase and sale of units in the AnchorBank Unitized Fund (“Fund”), which was an investment option in the AnchorBank 401(k) plan that held cash and company stock.  The alleged scheme involved the coordination of the sale of Fund units, triggering a payout from the Fund’s cash reserves to the suspected co-conspirators.  Since the trustee was required to maintain a particular cash-to-stock ratio in the Fund, it was then forced to sell AnchorBank stock on the open market to replenish the Fund’s cash reserves.  This heightened trading activity by the alleged co-conspirators caused the volume of AnchorBank stock on the market to be relatively high as compared to normal trading and, given the large volume of AnchorBank stock being sold at or around the same time, AnchorBank’s stock price declined.

The second step of the alleged scheme involved a coordinated purchase of Fund units which again disturbed the balance of the Fund’s cash-to-stock ratio. The trustee then purchased AnchorBank shares on the open market in an attempt to maintain the mandated cash-to-stock ratio and, given the large volume of stock being purchased at or around the same time, the AnchorBank stock price increased. After the AnchorBank stock price was artificially inflated on account of the trading activity initiated by the alleged co-conspirators, they would again conduct a coordinated sale of Fund units, repeating the alleged “illicit cycle.”

According to the complaint, the net result of the alleged 36 collusive trades was that Hofer and his co-conspirators enjoyed extraordinary gains  while the Fund and other Fund participants relied on artificially high and low Fund unit and stock prices to their financial detriment.

The lower court dismissed the plaintiffs’ second amended complaint in 2010, finding that the plaintiffs failed to adequately plead loss causation as to their claims.  On appeal, the Seventh Circuit ruled that, in order to satisfy the pleading requirements, the plaintiffs had to meet (i) the general pleading requirements of Federal Rules of Civil Procedure 8(a) and 9(b), (ii) the pleading requirements of Sections 9(a) and 10(b) of the 1934 Act; and (iii) the requirements of the Private Securities Litigation Reform Act (“PSLRA”).  The Court rejected Hofer’s argument that plaintiffs failed to adequately allege economic loss, loss causation, scienter and reliance.  Rather, it ruled that the plaintiffs’ second amended complaint met the “stringent” pleading requirements set forth above and, in doing so, reversed the lower court’s dismissal and remanded the matter back to the district court.

The opinion was authored by Judge Williams and is available at: