Loss Causation in Fraud-on-the-Market Cases Post-Dura Pharmaceuticals

Abstract

As a critical matter, class action securities fraud plaintiffs employing the fraud-on-the-market theory of reliance must still plead and eventually prove loss causation and damages. The Supreme Court's April 2005 decision in Dura Pharmaceuticals v. Broudo disapproved of the Ninth Circuit's simple price inflation theory of pleading loss causation (namely that a plaintiff's loss occurs at the time she purchases stock at a price artificially inflated by fraud) without expressly sanctioning any of the other prevailing approaches to loss causation. This leaves open the question of precisely how courts should properly handle loss causation. Consequently, this Article critically examines the Dura Court's rationale, along with what it did not say and its context, in an effort to frame the best view of loss causation under Section 10(b) and Rule 1Ob-5. The author provides an analysis of the history of the loss causation element, and of Supreme Court and significant circuit court precedent, as well as a review of relevant basic principles of corporate finance. Ultimately, considering the Dura Court's emphasis on the common-law roots of the securities fraud cause of action, the Article demonstrates that at least two avenues for proof of a fraud-on-themarket plaintiff's damages must be available. First, as has been the case since before Dura, the plaintiff can plead and prove a corrective disclosure that results in a reduction in value of the plaintiff's investment, thereby causally linking the fraud to post-transaction losses. But equally consistent with Dura is the author's view that where fraud artificially inflates the price paid for a security--assuming plaintiffs plead and prove the inflation has been removed from the value of the stock for any reason-the fraud premium paid is itself a recoverable loss, irrespective ofpost-transaction price movement. tAnn Morales Olazfbal, Associate Professor of Business Law, University of Miami School of Business Administration. The author invites comments at aolazabal@miami.edu and wishes to thank Robert Prentice for his insight on an earlier draft of this Article at the 2005 Annual Meeting of the Academy of Legal Studies in Business. Berkeley Business Law Journal