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.

New SEC Chairman Mary Schapiro continued to assemble her team this week, naming a new enforcement director. Nevertheless, controversy and scandal continued to follow the Commission’s enforcement program.

The SEC filed three significant cases this week. One is a settled civil injunctive action against UBS AG. Although the complaint cites violations of the broker and investment advisor registration provisions, it centers on what is essentially a tax evasion scheme. The Commission also brought an action against financier Robert Allan Sanford, alleging essentially that his banking operations are a Ponzi scheme and a settled option backdating case against Blackberry maker Research in Motion and four of its officers.

Wholesaler Costco disclosed that the U.S. Attorney’s Office in Seattle closed criminal probe into the options issuance practices of the company. STMicroelectronics NV prevailed in an arbitration against Credit Suisse, recovering over $400 million because of the improper sales practices used to market auction rate securities it purchased.

The SEC

The SEC continued to remake itself this week. On Thursday, Chairman Mary Schapiro appointed a new enforcement chief. Robert Khuzami will become the new Director of the Division of Enforcement, charged with rejuvenating a division with an illustrious past but facing current difficulties. Mr. Khuzami was the General Counsel for the Americas at Deutsche Bank AG. Prior to joining the bank he served for 11 years with the United States Attorney’s Office for the Southern District of New York.

While Ms. Schapiro assembles her team, scandals continue to engulf the agency.

• The Madoff scandal continues to haunt the Commission following congressional hearings where officials refused to discuss past investigative efforts as discussed here. More suits were filed by investors this week scrambling to try and recover funds. This week’s new cases include a suit by a pension fund against an asset management fund that invested with Mr. Madoff. Pension Fund for Hospital and Health Care Employees v. Austin Capital Management, Civil Case No. 2:09-cv-00615 (E.D. Pa. Filed Feb. 12, 2009).

• The alleged scam by financier Robert Allen Stanford (see below) is raising new questions about why this billion fraud was not found earlier. See, e.g., Stephen Labaton and Charlie Savage, SEC Fines Didn’t Avert Stanford Group Case,” New York Times (Feb. 19, 2009) (here, registration required). On Thursday the financier was served with papers by the FBI from the SEC’s suit in Virginia. No criminal charges have been brought to date.

• The Pequot scandal refuses to die. The SEC’s initial investigation ended amid claims of improper conduct followed by a congressional hearing and report which was highly critical of the Commission and a whistleblower suit by a former staff member as discussed here. Now, there is a criminal probe into the activities of the hedge fund, in addition to a renewed SEC inquiry, focused on the same conduct as the earlier investigation.

SEC enforcement

SEC v. UBS, AG, Case No. 1:09-CV-00316 (D.D.C. Filed Feb. 18, 2009). The SEC filed a settled civil injunctive action yesterday against financial giant UBS, alleging violations of Section 15(a) of the Exchange Act and Section 203(a) of the Investment Advisers Act. The SEC’s complaint alleges that from 1999 through 2008 UBS acted as an unregistered broker dealer and investment adviser to thousands of U.S. person and offshore entities with U.S. citizens as beneficial owners. The firm held billions of dollars worth of assets for these clients in what is essentially a tax evasion case.

UBS settled, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 15(a) and Section 203(a) of the Investment Advisers Act. The bank also agreed to pay $200 million in disgorgement, to be paid together with an additional $180 million in disgorgement that will be paid in the criminal case. The firm also agreed to terminate its U.S. cross-border business and to retain a consultant to conduct an examination of its termination of that business.

At the same time the bank entered into a deferred prosecution agreement with DOJ which described the case essentially as a tax fraud. As part of its agreement with DOJ, and based on an order by the Swiss Financial Markets Supervisory Authority, UBS agreed to identify its cross-border customers and terminate the business. The company also agreed to pay $780 million in fines, penalties, interest and restitution.

The day after the announcement of these settlements, the government filed suit against UBS seeking the disclosure of as many as 52,000 U.S. customers who allegedly had secret Swiss accounts concealed from tax authorities. The suit claims that U.S. customers have thousands of accounts at the bank which hold billions of dollars in assets. U.S. v. UBS, AG., Case No. 09-20423 (S.D. Fla.); see also Christian Baumgaertel, “UBS Falls as U.S. Sues to Get Names of More Accounts,” Bloomberg.com, (Feb. 19, 2009).

SEC v. Stanford International Bank, Case No. 3-09CV0298-L (N.D. Tex. Filed Feb. 17, 2009) alleges that the defendants committed an $8 billion fraud which apparently has gone on for years. The defendants are Robert Allen Stanford, Stanford International Bank, an Antigua based company, Stanford Group Company, a Huston based broker-dealer and investment adviser and Stanford Capital Management, an investment advisor. The court granted a temporary freeze order at the SEC’s request.

The alleged scheme centered on the sale of “certificates of deposit” which promised “high return rates that exceed those available through true certificates of deposits offered by traditional banks.” Those returns were achieved through what was supposed to be a unique investment strategy that yielded double-digit returns over the past 15 years.

In a second part of the scheme Stanford Allocation Strategy, a so-called proprietary mutual fund wrap program, took in over $1 billion in investor funds. This program was marketed based on false investment data, according to the SEC.

Financier Robert Allen Stanford, recently interviewed by CNBC about how it feels to be a billionaire, was served with the SEC’s papers on Thursday in Virginia. No criminal charges have been filed to date.

The ABA journal on line reported on Thursday that the SEC filed its action against Mr. Stanford and his entities days after outside counsel for the affiliated investment firm made a “noisy withdrawal.” Counsel reportedly disaffirmed information he had given to investigators and withdrew from his representation.

SEC v. Research in Motion Ltd., Case No. 1:09-cv-00301 (D.D.C. Filed Feb. 17, 2009) is an option backdating case brought against the company and four of its senior executives. The executives are former CFO Dennis Kavelman, former VP of finance Angelo Loberto, and CEOs James Balsillie and Mike Lazaridis.

The suit alleges that millions of stock options were backdated so that they would be in the money over a period from 1998 through 2006. Specifically, some 1,400 option grants for nearly seven million shares were backdated. This resulted in false disclosures in the annual reports of the company as well as in registration statements. The financial statements of the company also materially understated the compensation expenses of the company as a result of the scheme.

To resolve the case, the company consented to the entry of permanent injunction prohibiting future violations of the antifraud and books and records provisions. The settlement with the company takes into account its cooperation.

The injunctive orders regarding Messrs. Kavelman and Loberto prohibit future violations of the antifraud provisions along with the internal control sections and included Exchange Act Section 13(b)(5) and Rule 13b2-1, the misrepresentation to auditors provision of Rule 13b2-2. In addition, Mr. Kavelman consented to an order prohibiting him from violating the certification provision of Rule 13a-14. Messrs. Kavelman and Loberto also agreed to the entry of an officer director bar for five years and, in of an anticipated administrative proceeding, from appearing and practicing before the Commission as accountants for five years.

Messrs. Balsillie and Lazaridis consented to the entry of injunctions prohibiting future violations of Securities Act Sections 17(a)(2) and (3), along with the internal controls and books and records provisions of Section 13(b)(5) and Rule 13b2-1.

The individuals will pay civil penalties of: $500,000 for Mr. Kavelman; $425,000 for Mr. Loberto; $350,000 for Mr. Balsillie; and $150,000 for Mr. Lazaridis. Each also agreed to disgorge the in the money value of the backdated options they had exercised plus interest. The disgorgement is satisfied by their previous payments to RIM. A similar action was brought against the defendants by the Ontario Securities Commission.

Other actions

Options backdating probe closed: Costco Wholesale Corporation released a statement noting that the U.S. Attorney’s Office for the Western District of Washington has closed its criminal investigation into the stock option practices of the company.

Auction rate securities: STMicroelectronics NV prevailed in an arbitration against Credit Suisse Group AG based on claims relating to its purchase of auction rate securities. Credit Suisse will pay more than $400 million to resolve claims that it misled the STMicroelectronics regarding the purchase of the securities.

PCAOB

The PCAOB issued staff questions and answers on the registration of auditors of nonpublic broker dealers on February 19, 2009.

Web cast

On Tuesday, February 24, 2009, at noon, West Legal Education Center will air a web cast entitled Current Trends in SEC Enforcement — 2009.