Corporate Governance

Using Loss Causation to Repeal Rule 10b-5: In re: Williams Securities Litigation (The Impact of Dura)(Part 3)

By J. Robert Brown

We are discussing In re Williams and the court's loss causation analysis. 

Any discussion of loss causation today must start with the Supreme Court's decision in Dura Pharms., Inc. v. Broudo, 544 U.S. 336 (2005), a fairly benign case that, in a sign of moderation, was a unanimous decision written by Justice Breyer.

In that case, the Court confronted a 9th circuit test holding that plaintiffs could meet the loss causation element by alleging that at the time the stock was purchased, the price was inflated by the undisclosed fraud.  The Court rightfully noted that merely purchasing shares at an artificially high price did not automatically mean the fraud had caused any harm.

The shares might have been sold the next day (or a week later), before the market knew about the fraud.  Thus, the seller overpaid but then sold the shares for an overpriced amount.  A wash, in other words, with no harm as a result.  At the same time, the mere fact that shares were sold at less than the purchase price did not mean the loss was related to the fraud.  Instead, the price might have fallen due to any number of other factors, entirely unrelated to the fraud.

The standard ultimately imposed by the Court (and one that united both liberals and conservatives) was fairly benign.  The failure of the parties in Dura was that the complaint failed to allege that the "share price fell significantly after the truth became known."   Presumably the degree to which share prices actually fell as a result of the awareness of the fraud by the market was a matter for the fact finder.  The Court did not say that, at the motion stage, a plaintiff had to exactly prove the amount of the decline or rule out all other causes that could have contributed to the decline.

In Williams, however, the court concluded that Dura required the plaintiff to bear the burden "of showing that his losses were attributable to the revelation of the fraud and not the myriad other factors that affect a company's stock price."  The sentence is true enough in that a factfinder will have to ultimately determine the degree to which a drop in price resulted from disclosure of the fraud or from other causes.  But the quote mixes up entirely what Dura held.  Dura was a case about pleadings. See Louis Loss & Joel Seligman, Fundamentals of Securities Regulation 276 (Supp. 2007) ("At its core, Dura is largely a case about pleading.").  

But to the extent the court was saying that plaintiff must isolate the impact of all other factors and quantify the precise amount of fraud with some degree of certainty (or reasonableness), the court was stretching Dura well behond its boundaries and usurping the role of the jury.  In fact, plaintiff's expert did demonstrate, in his opinion, that share prices had fallen as a result of the fraud.  To the extent there were other factors that might have explained some of the drop in share prices, they were appropriately introduced as part of the discrediting process at trial and were not a basis for dismissing the case at the summary judgment stage.   

With this standard in mind, we turn to the analysis used by the panel in In re Williams. 

We have some primary materials posted on the DU Corporate Governance web site. Oddly, the briefs are not available but are under seal.

Full post as published by The Race to the Bottom on March 21, 2009 (boomark / email).