Court Doesn't Make It Easy To Sue For Securities Fraud

The U.S. Supreme Court refused last week to make it easy for investors to recover on a “fraud on the market” theory.

The San Francisco-based 9th Circuit had ruled that Dura Pharmaceuticals could be sued if the price of its stock was inflated due to fraud, even if a later stock decline could not be attributed to any misrepresentation.

But, in the first major securities case to go before the justices in a decade, the court unanimously rejected that claim. Instead, the justices said that securities fraud plaintiffs must plead and prove that a company’s “misrepresentation (or other fraudulent conduct) proximately caused the plaintiff’s economic loss.”

Sullivan

William Sullivan of Paul Hastings in San Diego, who represented Dura Pharmaceuticals, told Compliance Week that the Supreme Court’s decision was “very sound” and showed an understanding of the concerns of corporate defendants.

“It was nice to see the Supreme Court reinforce what has gotten lost in a lot of securities litigation—that securities litigation is not an insurance policy for market issues. There is still risk in the stock market,” Sullivan said.

Although the investors suing Dura Pharmaceuticals lost in the Supreme Court, plaintiffs’ attorneys were grateful that the court didn’t make it even more difficult for those bringing securities action to establish “loss causation.”

Weiss

Melvyn Weiss, of Milberg Weiss Bershad & Schulman in New York, said he was “very relieved” that the justices limited their ruling to upholding what had been the rule in most of the country until the 9th Circuit reinstated the suit against Dura Pharmaceuticals.

“It could have been a lot worse,” said Weiss, who noted that the U.S. government had urged the court to make it very difficult for “fraud on the market” plaintiffs by requiring them to show that price inflation resulting from a misrepresentation was reduced or eliminated by a subsequent disclosure of the true state of facts.

According to Weiss, who has represented securities plaintiffs in a number of high-profile suits, the Supreme Court’s ruling will not preclude viable cases from going forward. “We feel that, in virtually every one of our cases, we will be able to allege loss causation in a better way then in [the Dura] case,” he said.

Positive Statements About Asthma Device

The Dura Pharmaceuticals lawsuit was filed by a group of investors who claim they purchased the company’s stock after a series of positive statements about its development of Albuterol Spiros, a delivery device for asthma medication. Ultimately, the Food & Drug Administration did not approve the device, citing concerns about reliability.

The investors sued under Section 10(b) of the Securities Exchange Act, arguing that Dura had indicated satisfactory development and testing of the device despite knowledge of significant reliability issues. A federal judge in California dismissed the suit on the ground that the complaint failed to allege a causal connection between any fraud and a subsequent decline in stock price.

But the 9th Circuit reinstated the lawsuit, holding that Section 10(b) does not require a causal connection between the fraud and a stock price decline. Instead, the plaintiffs merely had to show that the “price on the date of the purchase was inflated because of the misrepresentation,” the circuit court said in a ruling that was out of step with decisions by other courts around the country.

After oral arguments before the Supreme Court in January, most observers felt that the justices would conclude that the 9th Circuit got it wrong—a prognostication that turned out to be accurate.

Writing for his eight colleagues, Justice Stephen Breyer said the 9th Circuit’s “basic reasoning” was “wrong.”

“[A]s 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. Moreover, the logical link between the inflated share purchase price and any later economic loss is not invariably strong. Shares are normally purchased with an eye toward a later sale. But if, say, the purchaser sells the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss,” Breyer wrote.

On the other hand, “[i]f the purchaser sells later after the truth makes its way into the market place, an initially inflated purchase price might mean a later loss. But that is far from inevitably so. When the purchaser subsequently resells such shares, even at a lower price, that lower price may reflect, not the earlier misrepresentation, but changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events, which taken separately or together account for some or all of that lower price. …Other things being equal, the longer the time between purchase and sale, the more likely that this is so, i.e., the more likely that other factors caused the loss.”

Breyer said the justices “need not, and do not, consider other proximate cause or loss-related questions.”

Sullivan, Dura Pharmaceutical’s lawyer, said “it would have been a mess” if the Supreme Court had agreed with the 9th Circuit. Instead, the high court has provided “a pretty good roadmap” as to what securities plaintiffs must allege in order to go to trial on a “fraud on the market” theory.

“What this does for guys like me—who handle these cases a lot—is it gives us some tools at the threshold to flush out the unmeritorious cases,” Sullivan said.