LIABILITY IN SECURITIES FRAUD ACTIONS: Part XXII: The Impact of Dura – How Much Truth, Other Causes and By Whom?

A key question following Dura Pharmaceuticals, Inc., v. Broude, 544 U.S. 356 (2005) is whether the truth has been revealed. But how much truth? Must all be revealed or just some? This question was considered in In re Retek Sec. Litig., 2005 WL 3059566 (D. Minn. Oct. 21, 2005). There, the complaint alleged four deals as part of a financial fraud. When a press release was issued disclosing one deal, the price dropped. On a motion to dismiss, defendants argued that the disclosure was not sufficient. At the pleading stage, however, the court found the complaint adequate, holding: “While the thread of causation may be long and somewhat tortured, at this state … Plaintiffs have alleged enough … [there is] a corrective disclosure followed by a drop in the stock price … .”

In contrast, where the complaint alleged two separate schemes, the court held that the truth had to be disclosed as to each scheme – if the truth was only told about one scheme, only that part of the complaint could survive: “In essence, lead plaintiff’s position is that a corrective disclosure about any questionable conduct that impacts a company’s financial statements is sufficient … [this] would create a boundless rule, rendering meaningless the loss causation requirement … .” In re St. Paul Travelers Sec. Litig. II, 2007 WL 1589524 (D. Minn. June 1, 2007); accord Marsden v. Select Medical Corp., 2007 WL 1725204 (E.D. Pa. June 12, 2007).

Following Dura, another key question concerns who reveals the truth – the company or a third person. This question was addressed in In re Winstar Comm., 2006 WL 473885 (S.D.N.Y. Feb. 27, 2006). There, the complaint claimed financial fraud, misrepresentations about a relation with a vendor and the financial condition of the company. An analyst’s report based on public information revealed the truth about these issues and the stock price dropped. The court held that loss causation had been pled: “The key to this [materialization] is the veracity of the information, not the source.” The fact that the report is from public information “does not mean that a reasonable investor could have drawn those same conclusions.”

If, however, the stock price drops because of general economic news or cause other that the revelation of the truth, Dura has not been met. For example, in In re Acterna Corp., Sec. Litig., 378 F. Supp. 2d 561 (D. Md. 2005), the court found that a price drop of 94% during the class period was not sufficient to plead loss causation: “Not only do plaintiffs not allege that the rapid decline in Acterna’s share price was caused in some way by Defendant’s alleged misrepresentations or omissions, their complaint suggests otherwise, alleging that prior to the class period, the global communications industry experienced a severe economic slow down that continued throughout the class period … .” See also In re Tellium, Inc. Sec. Lit, 2005 WL 1677467 (D. N.J. June 30, 2005).

At the same time, plaintiff is not required to rule out all other causes. Rather, if the revelation is a substantial cause, it is sufficient. In In re Daou Systems, Inc. Sec. Litig., 411 F.3d 1006 (9th Cir. 2005), plaintiffs’ complaint alleged a financial fraud. According to the complaint, by the third quarter the financial condition of the company was deteriorating and when the results for that quarter were announced the stock price dropped. Analysts suggested that the company was cooking the books. The court found that plaintiff need not prove that the alleged cause is the only reason for the stock price drop to satisfy Dura: “To establish loss causation plaintiff must demonstrate a causal link between the fraud and the injury suffered. Plaintiff is not required to show that the misrepresentation was the sole cause. Rather, plaintiff must only demonstrate that it is ‘one substantial cause’ for the decline in value of the shares. The fact that there are other contributing causes will not bar the recovery.” See also In re Geopharma Inc. Sec. Litig., 2005 WL 2431518 (S.D. N.Y. Sept. 30, 2005).

Collectively, these cases and the other cases discussed in this series illustrate the significant impact of Dura in the two years since it was decided. Like the recent decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007), the approach used by the Supreme Court in these cases has generally tightened pleading standards and made bringing a private securities fraud case more difficult. These themes will undoubtedly come into play next week when the Court hears arguments in Stoneridge Inv. Partners, LLC. v. Scientific-Atlanta, Inc. and Motorola, Inc., No. 06-43, which addresses the potential scope of liability under Section 10(b). The concluding segment of this series will examine the impact of these themes on Stoneridge.

Next: The Conclusion – Stoneridge before the Supreme Court