Dura Causation: Expert Testimony Excluded

In Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 342 (2005), the Supreme Court held that a securities law plaintiff must prove loss causation — that is, a causal link between the claimed injury and loss — in order to recover damages. In reaching its conclusion, the court reversed a decision of the Ninth Circuit which held that purchasing stock at an inflated price was sufficient. Alleging that the share price had been inflated by misrepresentations is not sufficient, the Court held, even if the plaintiff has suffered a loss, unless there is proof of a causal connection between the misrepresentation and the loss.

Dura did not establish what is required to prove loss causation. Rather, the Court only discussed what is not adequate — price inflation standing alone. Following Dura, two primary theories of loss causation have emerged: 1) Fraud on the market (the standard theory used in Dura, which requires proof of an artificial price and a decline in value when the truth is revealed); and 2) Materialization of risk (under this theory, a plaintiff must prove that it was the very facts about which the defendant lied which caused the injuries). Under each theory, a key question involves the impact of other factors which may affect the price and make it difficult or impossible to tie the claimed fraud to the loss.

In In re Williams Sec. Litig. — WCG Subclass, No. 07-54119 (10th Cir. Feb. 18, 2009), the court considered the question of whether plaintiffs had demonstrated that the claimed losses were caused by a revelation of the fraud and not other causes. The court considered this question on an appeal from a grant of summary judgment in favor of defendants where the district court concluded that, although there were disputes of fact regarding certain issues, plaintiffs failed to establish loss causation. In reaching this conclusion, the district court excluded plaintiffs’ proffered expert testimony on loss causation on a Daubert challenge, concluding that the testimony could not reasonably link the claimed loses to the revelation of the claimed misrepresentations. The Tenth Circuit affirmed.

The case is based on the spin-off by Williams Companies, Inc. (“WMB”) of its telecommunications subsidiary, Williams Communication Group (“WCG”) in 2000. At the time of the transaction, the company claimed that it represented the best way to ensure that its energy and communications businesses would be efficient and have access to the capital necessary for growth. Two years later, WCG tumbled into bankruptcy as its stock dropped to $0.06 per share. These class actions followed.

Plaintiffs attempted to establish Dura causation by offering alternate theories through their expert, Dr. Nye. The first is a “leakage theory,” while the second is a “corrective disclosures” theory. Under the first, Dr. Nye opined that the fraud was not revealed to the market by a single corrective disclosure. Rather, the true financial condition of WCG which had been concealed materialized through a series of small leaks. Under this theory Dr. Nye began his damage calculation with the $0.06 price at the time of bankruptcy and incorporated all price movement back to the first day of the class period which is July 24, 2000. Through this method, he concluded that the true share price at the time of the spin- off was not the $28.50 sale price but $0.56.

The court rejected this method as inconsistent with Dura. It is essential under any theory of loss causation that plaintiff demonstrate that by some mechanism the truth came out and was revealed. Likewise, other factors which may have caused the price to decline must also be considered. Here however, there was no demonstration of how the truth came out and almost all of the price decline is attributed to the fraud. There was no real effort to sort out other possible events which may have impacted the price.

Dr. Nye’s alternate theory suffered from similar flaws the court concluded. This corrective disclosure theory is based on four specific public disclosures: 1) An announcement on February 4 that the release of earnings would be delayed; 2) A February 4 announcement that the company may be in default; 3) A February 25 announcement that it was considering bankruptcy; and 4) An April 25 bankruptcy filing.

This theory suffers from two key flaws, according to the court. First, it fails to show new, company specific, and fraud related information which became available to the market after January 29, 2002 when the first class action complaint. That lengthy complaint detailed the alleged fraud, claiming that the company actually spun-off the subsidiary not for the reasons disclosed, but because it was a cash drain. Nevertheless, plaintiffs attempt to claim the impact of the price decline after the filing of the complaint in their damage calculation.

Second, to be a corrective disclosure it must at least relate back to the misrepresentation and not to some other negative information about the company. While the disclosure does not have to be a “mirror image” of the fraud, it must be “within the zone of risk concealed by the misrepresentations and omissions …” claimed by plaintiffs. Here, the claimed press releases did not fall in the “zone of risk.” Rather, each could have resulted from other factors. Accordingly, Dr. Nye’s testimony failed to meet the Dura test.

Finally, the court rejected plaintiffs’ claim that there was a dispute of fact precluding summary judgment regarding causation as to whether the price drop and loss came from the revelation of the fraud or other factors. The court concluded that no jury could find for plaintiffs based on this record because any finding that there was Dura causation would be nothing but speculation.