Corporate Governance

Using Loss Causation to Repeal Rule 10b-5: In re: Williams Securities Litigation (Part 5)

By J. Robert Brown

We are discussing the loss causation analysis in In re Williams Securities Litigation.

This case invovles a spin off by The Williams Companies, Inc. ('WMB') of its Communications Subsidiary (Subsidiary). Plaintiff essentially alleged that WMB had misrepresented the adequacy of the Subsidiary's capital at the time of the spin off.

Plaintiffs' expert provided other scenarios that attempted to show the necessary causation between the share prices and the fraud.  The court dismissed these as well.

This is a case where the courts accepted the presence of material mistatements about the adequacy of the Subsidiary's capital to meet its business needs.  While officers of the parent were speaking in glowing terms about the Subsidiary's prospects, the internal communciations told a bit of a different story. 

• Internally, however, there seems to have been much more pessimism about the continuing availability of enough capital to satisfy WCG's appetite. Officers were warning that WCG was 'still approximately $800 million under-funded through the end of 2001,' and that WCG did not have 'any choice at this point other than going on a rigid, essential need only capital diet while [it] restore[d] capital capacity through operating performance and selling non core assets.'

It belies common sense that these types of statements wouldn't have influenced shareholders and share prices.  Thus, this is not a close call where the statement invovled a relatively insignificant part of the company's business and, in fact, the representations may not have affected share prices.

Given this situation, the burden of showing an impact on share prices shouldn't have been a particularly high bar.  Yet that is exactly what the 10th Circuit imposed.  Clearly the court has indicated a distate for a leakage approach to showing causation.  The opinion made it more or less made clear that injured shareholders would have a tough time showing causation unless they could point to a specific disclosure (or materialization of a concealed risk) and a specific drop in share prices.  The idea that share prices could drop gradually as the market figures out the fraud will not find much favor in those courts that follow the reasoning in Williams.  

The impact of Williams is to make it harder to bring meritorious fraud suits.  It is an approach not required by the antifraud provisions and not required by Dura.  It is consistent with the position of this Blog that the new administration may discover that the biggest obstacle to reform lies not in Congress but in the courts.

We have some primary materials posted on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on March 24, 2009 (boomark / email).