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District Court Holds That “Negative Causation” Defense Bars Section 11 Liability Where Market Absorbs Disclosure Before Stock Price Drops Below IPO Price
April 17, 2025 Download PDF
On April 10, 2025, a California district court granted summary judgment to defendants in a Section 11 lawsuit based on the issuer’s evidence that the market absorbed any impact from a disclosure before its stock price dropped below the IPO price nearly two weeks later. The decision helpfully clarifies two important points of law for defendants facing post-offering securities class actions: first, that Section 11 plaintiffs cannot recover investment losses based on share price declines above the offering price, and second, that defendants are not required to affirmatively identify an alternative cause of a stock price decline to support a negative causation defense.
Background
In September 2021, Freshworks Inc., a software company, held an initial public offering in which it sold 28.5 million shares of its common stock at $36 per share. The company’s share price quickly rose following the IPO. Several weeks later, when the company disclosed relatively weak results for 3Q 2021, its share price dropped 14% and 8% on consecutive days, but remained above the IPO offering price. Approximately two weeks later, the company’s share price first dropped below its IPO price.
A shareholder brought claims under Section 11 of the Securities Act and alleged that Freshworks’ registration statement failed to disclose the company’s disappointing interim 3Q financials at the time of the IPO. Freshworks ultimately moved for summary judgment on the grounds that plaintiff could not recover for losses sustained above the $36 IPO price, and that any losses below that threshold were not caused by the alleged omissions in the registration statement.
The District Court’s Decision
The district court, Judge Breyer in the Northern District of California, granted defendants’ motion for summary judgment and held that no recoverable losses were caused by defendants’ alleged omissions. The court agreed with defendants that, as a matter of law, plaintiff could not recover investment losses under Section 11 based on stock drops above the company’s IPO price.
The court also credited defendants’ uncontested expert evidence that Freshworks’ stock traded in an efficient market and, therefore, that the market absorbed any impact from the issuer’s post-IPO disclosure in the two weeks between the disclosure and the date when the company’s stock price first dropped below the IPO price. Defendants thus proved their “negative causation” defense, i.e., that any investment losses below the IPO price were not caused by the alleged omissions.
Notably, the court rejected plaintiff’s argument that the negative causation defense required defendants to affirmatively identify an alternative cause of the stock drop below the IPO price, explaining: “Nowhere in the statute or the case law is there a requirement that the defendant affirmatively prove what caused the decline; all a defendant must show is that the decline was not caused by the alleged misstatement or omission.” As a result, any dispute of fact as to what caused the stock price to decline below the offering price was not material—and could not prevent summary judgment—because plaintiff had not offered any evidence to dispute defendants’ expert’s conclusion that the decline was not caused by the alleged omissions.
Implications
The decision joins a growing consensus that the plain language of Section 11 prohibits plaintiffs from recovering for investment losses sustained by stock drops above an offering price. The decision also rejects a common argument from plaintiffs that, to establish a negative causation defense, defendants must prove not only that their alleged misrepresentations were not the cause of a stock drop, but also affirmatively prove what was the cause of the stock drop. Issuers facing Section 11 lawsuits following a public offering should carefully review their stock price movement around the time of the offering and the alleged truthful disclosure to see if the arguments or defenses that persuaded the district court in this case may apply.
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