The Supreme Court’s decision in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), holding that loss causation is an element of a Section 10(b) claim for damages, continues to have a significant impact on securities litigation. One aspect is in pleading the element as discussed in the recently completed occasional series that began here. As that series detailed, there is an emerging split in the circuits over the pleading requirements for loss causation.

Another area where Dura is having a significant impact is class certification. The Fifth Circuit recently applied its interpretation of Dura to that question, affirming the denial of certification in Fenner v. Belo Corporation, Case No. 08-10576 (5th Cir. Decided Aug. 12, 2009).

That case involved a securities fraud suit against Belo, a media company that owns television stations, websites, and newspapers, and its officers. The complaint claimed that the company engaged in a fraudulent scheme designed to inflate the circulation figures for the Dallas Morning News, a newspaper owned by the company. Plaintiffs alleged that Belo paid bonuses for achieving circulation targets, rigged audits of the circulation figures and had a no-return policy that eliminated any incentive for distributors to return unsold papers. Collectively, these actions caused the circulation figures to be inflation which led to higher advertising revenues for the Dallas Morning News and larger profits for the company.

On March 9, 2004, the company announced declining circulation rates. Subsequently, on August 5, Belo announced the results of an internal investigation which revealed questionable circulation practices. According to the press release, the claimed fraudulent practices resulted in a 1.5% daily paper declines and a 5% Sunday decline. The release also stated that the declines were coupled with the circulation declines announced in March and with lower anticipated circulation for the next six months. New controls were being put in place, according to the release. The next day the price of the stock dropped at the open by about $5 from over $23 to $18. In subsequent press releases, the company projected circulation declines.

To establish loss causation using the fraud on the market theory, a securities law plaintiff must demonstrate two points, the court held: 1) that the negative truthful information causing the decrease in price is related to the claimed false statement made earlier; and 2) that it is more probable than not that the negative truthful statement and not others “caused a significant amount of the [price] decline.” This proof at the summary judgment stage “should not be conflated” with the requirements at the pleading stage, the court cautioned.

In this case, the key question is the proof required when there are multiple sources of negative information. Under such circumstances the plaintiff must demonstrate that it is more probable than not that it is the negative statement revealing the truth, and not others, which caused the price decline.

In initially seeking class certification, plaintiffs relied on SEC reports, stock price charts and analyst reports along with similar information. They did not submit any expert testimony. This, the court held, is insufficient because it is “little more than well-informed speculation.” While this information is helpful, “the testimony of an expert — along with some kind of analytical research or event study — is required to show loss causation,” the court held.

Subsequently, both sides offered expert testimony on the question of loss causation. The testimony offered by plaintiff’s expert is flawed, the court found. The event study on which it is based viewed the key press release as having only one piece of news. This is incorrect, the court held, because in fact, on its face, it has three distinct items of information. Without the event study, the testimony is not sufficient and plaintiffs fail to establish the necessary link between the inflated price and the claimed loss. Here, it is clear that the price drop could have resulted from the long term decline in circulation of the newspaper.

The approach here is not dissimilar from that used by the Tenth Circuit in In re Williams Sec. Litig. — WCG Subclass, 558 F.3d 1130 (10th Cir. 2009). There, the court also rejected the expert testimony offered by plaintiffs and then concluded that loss causation has not been established.