• U.S. Supreme Court Defines Plaintiffs' Burden to Plead and Prove "Loss Causation" in Securities Fraud Cases
  • July 14, 2005
  • Law Firm: DLA Piper Rudnick Gray Cary US LLP - Washington Office
  • Earlier this week, in a unanimous decision that could provide a significant defense in class actions alleging securities fraud, the United States Supreme Court held that plaintiffs in those actions must allege and prove that the defendants' allegedly false and misleading statements were the proximate cause of the plaintiffs' economic losses. The Court concluded that stockholder plaintiffs cannot rely on evidence that the price of an issuer's stock was inflated at the time it was purchased to satisfy this "loss causation" element. Justice Stephen G. Breyer authored the highly anticipated decision in Dura Pharmaceuticals, Inc. v. Broudo, No. 03-932, (Apr. 19, 2005).

    Decision Resolves Split Over Establishing Loss Causation

    Prior to the Dura Pharmaceuticals decision, federal appellate courts were divided as to what a plaintiff must show to establish loss causation. In earlier proceedings, the U.S. Court of Appeals for the Ninth Circuit had reasoned that loss causation could be established merely by alleging and proving that the price an investor paid for its stock was inflated at the time of purchase due to the defendants' false or misleading statements.

    The Supreme Court reversed this holding, finding that the federal securities laws expressly impose a heavier burden on plaintiffs. At the time a share is purchased, the Court reasoned, an inflated price "is offset by ownership of a share that at that instant possesses equivalent value" because the share could be resold at the market price. If the market price later declines, however, factors other than the alleged fraud -- such as general market conditions, different developments in the issuer's business or recent news about other companies in the industry -- might be the reason for that price decline. The Court held that under the federal securities laws, it is the stockholder plaintiff's burden to prove that the subsequent price decline is attributable to fraud rather than such extraneous factors. In a potentially helpful aside, the Court observed that securities actions were intended "not to provide investors with broad insurance against market losses but to protect them against those economic losses that misrepresentations actually cause."

    Implications for Defendants in Securities Class Actions

    The unanimous opinion in Dura Pharmaceuticals could substantially alter the landscape for securities class actions. Most significantly, the decision sends a clear message to trial courts that proving loss causation is a plaintiff's burden, thus increasing the likelihood that motions for summary judgment will be granted in favor of defendants on this issue absent presentation of compelling economic evidence that links a decline in the price of an issuer's stock directly to an earlier alleged fraud. In addition, defendants will have a strong argument in opposing class certification in these cases based on the possibility that fluctuations in an issuer's stock price at different times during an alleged "class period" were attributable to factors other than the defendants' alleged fraud. The decision also could provide an argument in favor of motions to dismiss complaints in cases where an issuer's disclosure is not followed by an immediate, significant decline in the market price of its stock.