The Supreme Court's Latest Guidance on Causation

The Supreme Court's Latest Guidance on Causation


Lawyers have struggled with causation issues since the origins of tort litigation. Recognizing the potential in terrorem effect of even a weak securities case that survives a motion to dismiss, the Supreme Court in Dura Pharmaceuticals, Inc.v. Broudo, 544 U.S. 336 (2005) has reinforced the importance of this issue. Viewing the notion that a simple drop (even a precipitous one) in the price of a stock is enough to withstand a motion to dismiss stock as a form of "investor's insurance," the Supreme Court held that stock purchasers cannot recover losses under Rule 10b-5 unless they properly allege (and establish) the traditional common law element of loss causation. This Commentary, written by Elliot Cohen and Robert M. Carmen, co-authors of two treatise chapters addressing the federal securities laws (published by Matthew Bender/LexisNexis), discusses the significance and lower court interpretations of this watershed decision.
  
The authors write: The Dura court unanimously held that a private plaintiff cannot satisfy the loss causation (i.e., proximate cause) element of a Rule 10b-5 action by merely alleging that the price of the security in question was inflated on the date of purchase as a result of defendant’s alleged misrepresentations. According to the Supreme Court, the objective of private actions under the securities laws is to protect investors “against those economic losses that misrepresentations actually cause,” but “not to provide investors with broad insurance against market losses.”
 
In Dura, the plaintiffs alleged, inter alia, that defendant pharmaceutical company (and various individuals) falsely claimed that FDA approval of a new product was expected thereby leading plaintiffs to purchase the company’s securities at an artificially inflated price. While the Ninth Circuit found that plaintiffs adequately alleged loss causation (and economic loss) by claiming that the price of the company’s stock was inflated at the time of purchase because of the “misrepresentation,” the Supreme Court reversed this decision. In this regard, the Supreme Court observed that normally in “fraud on the market” cases an inflated purchase price by itself does not establish the necessary causal connection between alleged wrongdoing and economic
loss because:
 
1.     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.” Accordingly, if “the purchaser sells the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss.”
               
2.     Even when a stock sale occurs at a lower price after the truth makes its way into the marketplace, it does not necessarily follow that the initially inflated purchase price was the proximate cause of any relevant economic loss. Numerous other factors or intervening causes, such as an industry specific market collapse, may have caused, or at least impacted, the drop in the value of the stock. In addition, the longer the time between purchase and sale, the more likely it is that factors unrelated to the initially inflated purchase price are the reason for all or some of the decline in the stock’s market value.
 
The Dura decision resolved a clear split among the circuits by overturning the position of the Ninth Circuit (and the Eighth Circuit) that loss causation could be alleged by simply asserting that a stock’s price was artificially inflated on the date of purchase in favor of the stricter view of the Second, Third, Fifth, Seventh and Eleventh Circuits which had rejected the inflated purchase price approach to establishing loss causation. While the Supreme Court indicated that the Dura complaint was fatally defective because it did not assert that the “share price fell significantly after the truth became known,” the opinion did not set forth the level of detail that is required to properly allege (and prove) loss causation. As discussed below, counsel must look to lower court decisions applying Dura to obtain this type of practical guidance. [citiations omitted]