Part VIII: Securities Class Actions: Current And Emerging Trends

A key Supreme Court decision which impacts not just pleading, but also proof requirements is Dura Pharmaceuticals, Inc., v. Broudo, 544 U.S. 336 (2005). There, the Court held that plaintiffs must plead and proof loss causation to establish a Section 10(b) cause of action for damages.

Prior to Dura, the circuits had split over the question of loss causation. The Second, Third and Eleventh Circuits required more than price inflation to establish a link between the claimed misrepresentation or omission and injury. See, e.g., Emergent Capital Inv. v. Stonepath Group, 343 F.3d 189 (2nd Cir. 2003).

In contrast, the Eighth and Ninth Circuits held that the fraud on the market theory of Basic v. Levinson, 485 U.S. 224 (1988) (holding that where there is an efficient market there is a presumption of reliance on the integrity of the market), permitted the presumption that when stock prices were inflated, it made sense to conclude that plaintiffs were harmed by paying too much for the shares. See, e.g., Gebhardt v. ConAgra Foods, 335 F.3d 824 (8th Cir. 2003).

Dura rejected the notion that price inflation alone was sufficient to establish a Section 10(b) cause of action for damages. The complaint in Dura claimed that the company made false statements about its drug profits and future FDA approval of a new asthmatic spray device. Subsequently, the company announced that its earnings would be lower than expected, principally due to slow drug sales. The next day, its share price fell almost 50%. Eight months later, the company announced that the FDA would not approve its new asthmatic spray device. The share price fell temporarily, but almost fully recovered within one week. Plaintiffs claimed that their economic loss resulted from paying artificially inflated prices for Dura shares.

The district court dismissed the complaint, concluding that it failed to adequately allege scienter as to the drug profitability claim. As to the spray device claim, the court concluded that plaintiffs failed to adequately allege loss causation. The Ninth Circuit reversed on the causation question, holding that price inflation was sufficient because loss causation is established on the date of purchase.

The Supreme Court reversed, holding that price inflation alone is not sufficient to establish a causal link between the claimed fraud and injury. The Court’s opinion has six key points:

1. The elements of a private cause of action under Section 10(b) are based in part on common law principles and in part on those added by Congress. At common law a causal link was required between the claimed misrepresentation and the alleged injury, that is, loss causation.

2. As a matter of logic, an inflated price alone is not sufficient. While an inflated price might mean there is a loss, this does not necessarily follow.

3. Loss causation is consistent with the goals of the PSLRA of maintaining confidence in the markets but not insuring against loss.

4. The decision of the Ninth Circuit lacks precedent and is not supported by common law tort principles in which the Section 10(b) damage action is rooted.

5. Basic Rule 8(a) notice pleading requirements require that “fair notice” be given to the defendant as to the claim. This should not be that difficult of a burden for plaintiff. (This point in the opinion later became part of the rationale for the Court’s Twombly plausibility pleading requirement discussed earlier in this series here).

6. Absent loss causation, baseless claims could go forward.

On remand, the district court found that the complaint adequately pled loss causation because plaintiff’s “explained how the misrepresentations … caused economic loss.” This conclusion is based on the fact that plaintiffs amended the complaint regarding their medical device claim to allege that the misrepresentations inflated the stock price and that the share price dropped following corrective disclosures made on three different dates.

The precise impact of Dura is somewhat controversial. Most commentators would agree that the decision has had an impact. Some, however, argue that the Court left open more questions than it resolved.

Next: The impact of Dura