Recent Wall Street accounting scandals launched a wave of lawsuits by investors alleging corporate fraud as a result of purchasing stock at "inflated" prices. One appellate court decision significantly lowered the burden for plaintiffs to prove their cases by eliminating the need to show a causal link between the company's action and losses suffered by the investor. This approach signaled a change in the traditional analysis of securities fraud lawsuits and potentially promised to open the litigation floodgates. However, in its recent decision in Dura Pharmaceuticals, Inc. v. Broudo, the U.S. Supreme Court rejected the new approach and reaffirmed that plaintiffs have the burden of proving that a defendant's misrepresentations actually caused the loss they seek to recover.
The case stemmed from claims by investors in Dura that the company falsely predicted the U.S. Food and Drug Administration (FDA) would grant approval to its new asthmatic spray device. Relying upon the prediction, the investors purchased Dura's shares at their peak prices.
The truth is that Dura did make positive statements concerning future FDA approval of its product - - but it later made negative forward-looking statements about corporate profits, generally. When Dura announced that its earnings would be lower than expected, principally because of slow drug sales, the company's shares plummeted from $39 per share to $21.
It wasn't until eight months later that Dura announced the FDA would not approve its drug dispenser product, after all. The company's share price tumbled, as one would expect, but it recovered almost fully within a week.
Individuals who had bought publicly traded stock in Dura at the time of the profits warning went on to bring a securities-fraud class action suit against the company in federal court. The investor-plaintiffs argued they purchased their securities at an "artificially inflated price" and suffered damages as a result of Dura's misrepresentations about the expected FDA approval of its product. But the U.S. District Court dismissed the complaint, finding the investors failed to adequately allege a "loss causation" between Dura's promise of FDA action and the investors' losses.
On appeal, the U.S. Court of Appeals for the Ninth Circuit reversed the lower court's decision and held that a plaintiff could, in fact, satisfy the "loss causation" requirement simply by alleging in the complaint - - and then proving - - that the price of the shares when purchased was inflated because of a company's misrepresentation. The Court lowered the legal bar by allowing a claimant damages by establishing that a misrepresentation led to an inflated purchase price, even if it didn't cause any economic loss.
The Ninth Circuit decision was appealed to the U.S. Supreme Court. The Court in a unanimous decision held, "In our view, this [the Ninth Circuit's] statement of the law is wrong." Justice Breyer, writing for the Court, stated that an inflated purchase price will not itself constitute or proximately cause the relevant economic loss. He went on to note that, "as a matter of pure logic, at the moment the transaction takes place, the plaintiff has suffered no loss; the inflated purchase payment is offset by ownership of a share that, at that instant, possesses equivalent value ... If the purchaser sells the shares quickly before the relevant trust begins to leak out, the misrepresentation will not have led to any loss. If the purchaser sells later after the truth makes its way into the market place, an initially inflated purchase price might mean a later loss."
The Supreme Court's opinion observed that the securities statutes seek to maintain public confidence in the marketplace. They do so by deterring fraud, in part, through the availability of private securities-fraud actions. The statutes aren't designed to provide investors with broad insurance against market losses, but only to protect them against those economic losses that misrepresentations actually cause. The Private Securities Litigation Reform Act expressly imposes on plaintiffs "the burden of proving" that the defendant's misrepresentations "caused the loss for which the plaintiff seeks to recover." Thus, the statute makes clear Congress' intent to permit private securities fraud actions for recovery only where plaintiffs adequately allege and prove the traditional elements of causation and loss.
In the case of Dura, the drop in share value could plausibly have been linked to poor earnings performance, rather than the company's misleading statements about the FDA's anticipated approval of its product. The Ninth Circuit approach would have allowed for recovery without the burden of having to link the loss in share value to the misrepresentations.
The Supreme Court opinion reaffirms the traditional burdens of proof in securities fraud litigation. The Court restated that for a plaintiff to recover for securities fraud, he or she must show that an economic loss was suffered and that there was a causal connection between the defendant's actions and the plaintiff's losses. Otherwise, there is the potential of transforming private securities actions into an after-the-fact policy broadly insuring against market losses.
The Dura case illustrates the value of a trusted professional financial adviser - - as well as the danger of relying on company press releases as the basis for making investment decisions. The Law Offices of Marc J. Lane and its investment affiliates are happy to help you achieve your legal and investment planning objectives.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.