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On April 19, 2005, in a closely watched case, Dura Pharmaceuticals, Inc. v. Broudo, the United States Supreme Court resolved a dispute between Circuit Courts and held that in private actions alleging damages because of a securities fraud perpetuated on the market, a plaintiff must plead and prove a causal connection between an alleged misrepresentation and a subsequent decline in stock price in order to recover. In its opinion, the unanimous Court rejected a “price inflation” theory formulated by the Ninth Circuit Court of Appeals, under which a plaintiff only needed to prove that the price of the security was inflated at the time of purchase because of a misrepresentation. In Dura, a class of private plaintiffs that bought stock in Dura Pharmaceuticals, Inc., on the public securities market between April 15, 1997 and February 24, 1998 brought a securities fraud action against Dura. The class alleged that before and during the purchase period, Dura made false statements about future FDA approval of a new asthma spray device it had developed. On the last day of the purchase period, Dura announced lower than expected earnings, and its share price fell nearly by half. The lower earnings were a result of slow drug sales, and were unrelated to the spray device. Eight months later, when Dura announced that the FDA would not approve the spray device, the share prices temporarily fell, but recovered their value within a week. The class claimed loss not at the time when the misrepresentation about the spray device was revealed, but rather at the time when they purchased the shares. The district court dismissed the complaint, ruling the class failed to adequately allege “loss causation.” The Ninth Circuit reversed, holding that plaintiffs could establish loss causation if they showed the share prices on the date of purchase were inflated because of the misrepresentation. Broudo v. Dura Pharmaceuticals, 339 F.3d 933 (9th Cir. 2003). The Ninth Circuit ruled that plaintiffs could prove an injury at the time of the purchase itself, and did not need to show a corrective disclosure by the issuer of the shares and a subsequent drop in the shares’ market price. The class argued that the “inflated purchase price” standard protected investors who purchased shares that were overpriced because of misrepresentations, but which lost value before the misrepresentations were revealed. In those cases, recovery for the price drop of the already-devalued shares would not be as great as the higher prices the purchases paid because of the misrepresentations. In an opinion written by Justice Breyer, the Supreme Court flatly rejected the Ninth Circuit’s holding, ruling that plaintiffs must plead and prove that a defendant’s misrepresentation or other fraudulent conduct proximately caused their economic loss. The Court raised three concerns with the Ninth Circuit’s adoption of the “inflated purchase price” standard. The Court first stated that, as a logical matter, a plaintiff has not suffered any economic loss on the date of purchase because the plaintiff holds at that time a stock with a market value equal to the purchase price. Even if the share decreases in value over time prior to revelation of the misrepresentation, this pricing could simply reflect other changed economic circumstances unrelated to the misrepresentation. Second, the Court found no precedent for the Ninth Circuit’s holding. The Court noted that private securities fraud actions resemble common law deceit and misrepresentation actions, which historically required a plaintiff to prove that he suffered actual economic loss. Third, the Court found the Ninth Circuit’s approach overlooked an objective of the securities statutes, which is to maintain public confidence in the marketplace by deterring fraud. These statutes protect investors against economic losses that misrepresentations actually cause, but are not intended to “provide investors with broad insurance against market losses. The Court noted that the Private Securities Litigation Reform Act of 1995 (“PSLRA”), at 15 U.S.C. § 78u-4(b)(4), expressly imposes on plaintiffs “the burden of proving” that a defendant’s misrepresentations “caused the loss for which the plaintiff seeks to recover.” The Dura court then went further, incorporating the necessary elements of proof into the requirements for pleading. The Court conceded that F.R.C.P. 8(a)(2) imposes minimal pleading requirements, and assumed without deciding that neither the Rules nor the securities statutes impose “any special further requirement in respect to the pleading of proximate causation or economic loss.” However, the Court stated that even under Rule 8 a defendant is entitled to “fair notice” of the plaintiff’s claim, and that it “should not prove burdensome” for a plaintiff that has suffered an economic loss to provide the defendant with “some indication of the loss and the causal connection that the plaintiff has in mind.” The Court appeared concerned that plaintiffs that could not articulate a meritorious basis for recovery could blackmail settlements with the threat of discovery costs. The Court, however, has left the task for the lower courts to address the questions of how much particularity is necessary to adequately plead loss causation. The Court left two significant questions regarding pleading requirements unanswered in its opinion. First, because the Court ruled that plaintiffs in this case failed to satisfy the minimal pleading requirements of Rule 8, it did not rule whether Rule 9(b), which imposes heightened pleading requirements in cases of fraud, or the PSLRA impose heightened pleading requirements for pleading proximate causation or economic loss. Second, the Court did not state whether a plaintiff must plead the existence of a specific disclosure regarding the misrepresentation that led to a fall in stock price to survive a motion to dismiss. The Court’s decision to let the lower courts develop the requisite pleading standards suggests significant litigation throughout the country because these standards have not yet been clearly articulated. A threshold question will be whether the heightened pleading standards of Rule 9(b) will apply to questions of loss causation. The PSLRA requires heightened pleading standards consistent with Rule 9 for allegations of misleading statements and omissions, 15 U.S.C. § 78u-4(b)(1), and a defendant’s requisite state of mind. 15 U.S.C. § 78u-4(b)(2). However, the PSLRA only imposes upon a plaintiff the “burden of proo[f]” regarding loss causation, and is silent as to whether any heightened pleading standard is required. 15 U.S.C. § 78u-4(b)(4). The Court limited its analysis to loss causation, and nothing in the Court’s opinion lessens the pleading requirements for the other elements of a securities fraud claim. However, the Court did not give any guidance as to whether this heightened standard should carry over into the element of loss causation, or what particular pled facts would be necessary to survive a motion to dismiss under either pleading standard. Another implication of the Dura decision is that damage experts may necessarily play a greater role in securities cases. Plaintiffs will need to establish in the case in chief through expert testimony that the reduced share value was directly related to the misrepresentation or omission at issue. Plaintiffs will also need to rebut through expert testimony the defendants’ assertions that the reduced share value was instead related to extraneous market forces. Ostensibly, defendants that are unable to completely disprove a causal connection between an alleged misrepresentation or omission and a drop in share price should still be able to attempt to reduce their damages exposure by establishing that the majority of the reduced share value was attributable to other market forces. Plaintiffs’ experts, if having successfully established the existence of loss causation, may then be called upon to counter assertions that other market forces were responsible for the majority of the decline in stock price. Dura Pharmaceuticals, Inc. v. Broudo, No. 03-932, 125 S.Ct. 1627 (2005) (decided April 19, 2005) This e-mail note is a summary for general information and discussion only and is not intended as legal advice or as a legal opinion. This note is not intended to represent the views of the Firm or its clients. Attorneys David Burrowes and Patrick Carlson in Chicago and Evan Shapiro in New York contributed to the content of this note; the views expressed are those of the authors. For more information or to discuss this matter further, please do not hesitate to contact any of the authors or your usual BSWB contact. |
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