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Washington�With billion-dollar frauds involving WorldCom, Enron and others as a backdrop, a smaller securities fraud case packing a potentially huge wallop for investors and corporations will unfold soon in the U.S. Supreme Court. The case, Dura Pharmaceuticals Inc. v. Broudo, No. 03-932, raises an issue fundamental to almost every civil securities fraud case: What is the standard by which plaintiffs must plead and prove loss causation-that misrepresentations or omissions caused the harm. Loss causation is an element of a securities fraud claim under Section 10b of the Securities Exchange Act of 1934. “We’re talking really about the elements of liability under one of the most heavily litigated statutes ever enacted by Congress,” said securities scholar Michael J. Kaufman of Loyola University Chicago School of Law. “Congress never created a private remedy under 10b, but the courts have. And once a term or so, the Supreme Court takes a question about one of the 10b elements because there is no guidance from Congress.” The seemingly dry legal question of loss causation, to be argued on Jan. 12, belies the high stakes in the case. Long-time allies, banks/investment houses and major public pension funds, stand on opposite sides. The U.S. Chamber of Commerce, Merrill Lynch Co., Securities Industry Association and Bond Market Association, among others, have joined Dura in urging the justices to reject what they call a too-lax standard adopted by the 9th U.S. Circuit Court of Appeals. The 9th Circuit’s position, they contend, unduly favors plaintiff class action lawyers and undermines reform efforts in the Private Securities Litigation Reform Act of 1995 (PSLRA). “That standard would lend itself to a greater number of cases being filed and more limits on the ability of defendants to get rid of the cases that don’t have any merits,” said Dura’s high court counsel, William F. Sullivan, a partner in Paul, Hastings, Janofsky & Walker’s San Diego office. But public pension funds, the AARP Foundation, the National Securities Administrators Association and the National Association of Shareholder and Consumer Attorneys counter that Dura’s proposed standard would eliminate a number of meritorious claims and make it more difficult for defrauded victims to recover. “Essentially, Dura and its amici are trying to limit their exposure to damages,” said Michael Broudo’s counsel, Patrick J. Coughlin, a partner in the Los Angeles office of San Diego-based Lerach Coughlin Stoia Geller Rudman & Robbins. “I don’t think it’s OK that those who lie once with fraudulent intent get to set the limit of their damages.” False statements Broudo and a group of investors say they purchased Dura’s stock on the strength of several public statements by the company in late 1997 and early 1998 about better-than-expected sales of its antibiotic, Ceclor CD, and satisfactory development of its Albuterol Spiros nebulizer for asthma patients. But on Feb. 24, 1998, Dura revealed much lower than forecasted revenues for 1998 and weak Ceclor sales. The next day, the company’s stock price collapsed-a 47% decline on 32 million shares of volume. In November 1998, the company also disclosed that the Food and Drug Administration would not approve its Spiros device. The stock sank to $8 per share. Broudo’s group says that in the months leading up to the first announcement in February, several Dura insiders sold more than 390,000 shares of Dura stock for more than $16 million. The group sued Dura, charging that the company deliberately misled the investing public into believing that Ceclor CD was selling better than it actually was-sales had begun dropping in spring 1997 and were down by 50% by mid-summer-and that the prospects for Albuterol Spiros were better than they in fact were: The device never worked properly in clinical trials and in-house testing. As a result of those material misrepresentations, the group said, the price of Dura’s common stock was artificially inflated, which caused damages to investors who purchased stock between April 15, 1997 and Feb. 24, 1998. The district court dismissed the suit after finding that the plaintiffs had failed to demonstrate that the company’s statements with respect to Ceclor were made with scienter (intent to deceive). It also said that with respect to the Spiros device, the plaintiffs had not satisfied the element of loss causation: failing to show that the misrepresentations or omissions caused the harm. There was no mention of the Spiros device in the Feb. 24, 1998, announcement, the court said, and the decline in the stock price was due to an expected revenue shortfall. The 9th Circuit reversed, remanding the question of scienter to determine if the allegations concerning Ceclor were sufficient when considered collectively and holding that loss causation was satisfied. The appellate court said that a plaintiff in a fraud-on-the-market case satisfies loss causation by showing that the price on the date of the purchase was inflated because of the misrepresentation. No subsequent decline in share price associated with a company’s corrective statement is required, according to the court. “[I]t is not necessary that a disclosure and subsequent drop in the market price of the stock have actually occurred,” the court said, because “the injury occurs at the time of the transaction,” which is the time at which “damages are to be measured.” The 9th Circuit’s time-of-purchase standard is shared by the 8th Circuit, but the 2d, 3d, 7th and 11th circuits require demonstration of a corrective disclosure followed by a drop in stock price. The latter circuits, said Dura’s Sullivan, have the “more usual and commonsense approach to loss causation.” In the high court, Sullivan will share his argument time with the Bush administration, which also contends that the 9th Circuit standard is wrong. Sullivan argues that the 1995 PSLRA codified the loss-causation requirement in private securities fraud actions by specifically requiring that a plaintiff plead and prove, in the words of the statute: “that the act or omission of the defendant alleged to violate this chapter caused the loss for which the plaintiff seeks to recover damages.” The 9th Circuit standard-which only requires a plaintiff to plead that the stock price was artificially inflated at the time of purchase-takes “loss” out of loss causation, he said. It also conflicts with the act’s provision on limiting damages, which defines damages in terms of a post-transaction decline in value following a corrective disclosure. The government adds that by measuring the loss as of the time of purchase, and not requiring any allegation of a subsequent loss of value because of the fraud, investors who sold their shares before a corrective disclosure reduced or eliminated the artificially inflated price would get a windfall. Those investors would recover the portion of the purchase price attributable to the fraud on resale, and then they would be entitled to recover that same amount in damages. No windfall There would be no windfall, counters Coughlin, explaining that the 1995 act limits the investor in the government’s hypothetical to actual damages, which means his damages would be diminished by the inflation he recovers from his purchaser. More importantly, Coughlin said, in complex fraud cases, Dura’s standard actually gives an incentive to companies to delay corrective disclosures. Sophisticated individuals who commit market fraud, he said, are adept at concealing it. Issuing further false statements can reduce public expectations which, in turn, can reduce the fraud-related inflation of stock prices. “On Dura’s theory, simply concealing the fraud would reduce the recoverable loss-not the loss actually suffered,” said Coughlin. “And once expectations are lowered, even if the full extent of the fraud is then revealed, its disclosure’s impact on a stock’s price could be negligible. That’s why that rule is not in the statute. If the statute wanted to say causation is determined at a later period of time, it could have easily said that.” Sullivan disagreed, saying, “There’s mounting pressure from a host of areas to be accurate and prompt with your disclosures. If a drug is harmful or a product isn’t selling, that’s going to come out.” The high court case is not just about Dura and its investors or, as Dura’s amici contend, about lawsuit-happy plaintiffs’ lawyers, added Coughlin. “You have two of the largest players in our economy on opposite sides: the big bankers and Merrill Lynch trying to limit their exposure in Enron and such cases on one side, and the largest pension funds in the world on the other, saying don’t eviscerate our chance for recovery,” said Coughlin. “Eight months before WorldCom explodes, the banks are on the hook for commercial loans for $10 billion,” Coughlin said. “They do an offering, turning those loans into a debt offer of $11 billion and sell it to CalPERS [California's public pension fund] and others. They no longer have liability.” He added that “[i]nternally, they’re saying they have a problem and externally, they’re selling it. Eight months later, the whole thing explodes. The banks have literally walked away from potential loss. Now they want to measure the loss they’re liable for to a 50-cent drop in stock price after everybody’s in jail. The pension funds say, ‘Are you out of your minds?’ “

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