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Two years have passed since the U.S. Supreme Court, in Dura Pharmaceuticals v. Brouda, 544 U.S. 336 (2005), dismissed a Rule 10b-5 complaint for failure to adequately allege loss causation. Immediately, there was significant debate over its significance. William F. Sullivan, who argued Dura’s case before the Supreme Court, hailed the decision as “an important tool in defending expensive and often unmeritorious cases where stock prices fall for reasons unrelated to any wrongdoing.” William F. Sullivan, “No Judgement for Bad Judgement, Wall St. J., May 3, 2005, at B2. On the other hand, Patrick J. Coughlin, who represented the plaintiff, contended that the Duracourt “did not adopt draconian rules calculated to make recovery unreasonably difficult,” and that Duraset a standard “that should not prove overly burdensome to investors.” (Patrick J. Coughlin, et al., “What’s Brewing in Dura v. Broudo? Plaintiffs’ Attorneys Review the Supreme Court’s Opinion and Its Import for Securities-Fraud Litigation,” 37 Loy. U. Chi. L.J. 1, 2 (Fall 2005).) Two years later, it appears that Duradid not end the battle between plaintiffs seeking a relaxed standard for pleading loss causation and defendants advocating a strict standard. What Durahas done is to reframe the debate in the lower courts. Duraheld that a plaintiff in a Rule 10b-5 case had not adequately pleaded loss causation merely by alleging that he “paid artificially inflated prices for Dura securities” at the time of purchase. Id. at 339-40. The Supreme Court observed that an investor who purchases a stock at an artificially inflated price suffers no economic loss at the time of purchase. The loss occurs only when the truth is disclosed and the stock price falls as a result. Thus, a plaintiff who sells his shares “before the relevant truth begins to leak out” does not suffer any economic damage. Id. at 342. The plaintiff in Durafailed to allege that the “share price fell significantly after the truth became known,” and therefore the complaint had not alleged loss causation. Id. at 347. Despite requests by the defendant and the U.S. solicitor general, the Duracourt expressly declined to formulate precise standards for proving loss causation, leaving that to the lower courts. Today, the battle over loss causation has been cast in Dura‘s terms, centering on how to define the “relevant truth” and when that truth “became known.” What is ‘relevant truth’? How a court defines the “relevant truth” that the defendant fraudulently withheld often determines the outcome of the case. The stock-analyst cases provide a good example of the importance of how the “relevant truth” is defined. The claim in most such cases has been that the analyst dishonestly touted a particular stock when that was not the analyst’s genuine belief. Under Dura, these cases often have been dismissed because, in most instances, the analyst’s dishonesty comes to light after the price of the stock has declined substantially. By that point, the “bad facts” about the company have been absorbed by the market and, therefore, the plaintiffs cannot show that the disclosure of the analyst’s dishonesty caused any further decline in the stock price. This is illustrated by Joffee v. Lehman Bros., 410 F. Supp. 2d 187 (S.D.N.Y. 2006), aff’d, 2006 U.S. App. Lexis 31487 (2d Cir. Dec. 19, 2006). The court found that the “relevant truth” was “the alleged dishonesty of the [analyst's] opinions” and dismissed the complaint because the plaintiff could not show that the revelation that the analyst’s optimism was dishonest caused the company’s stock price to decline. Id. at 193-94. In analyst cases in which the “relevant truth” is that the analyst did not believe his own recommendations, Durais usually fatal. The analysis under Dura has been different when the court defines the “relevant truth” more broadly. In the recent case of In re Credit Suisse-AOL Sec. Litig., 465 F. Supp. 2d 34 (D. Mass. Dec. 7, 2006), another analyst case with similar facts, the court denied a motion to dismiss, holding that loss causation had been sufficiently pleaded. Interestingly, the opinion makes clear that it was “undisputed that knowledge of the CSFB [Credit Suisse First Boston] analysts’ alleged dishonesty never leaked to the market.” Id. at 47. Had the court regarded the dishonesty of the analysts’ recommendations as the “relevant truth,” then under Dura, the case would have been dismissed. The Credit Suissecourt instead chose a broad definition of relevant truth: “The relevant truth that CSFB allegedly concealed was the impact of the advertising market on AOL’s financial status.” Id. at 49. The defendants argued, unsuccessfully, that this could not be the relevant truth because, at the time the allegedly false analyst reports were published, the market already had access to the same information that CSFB had regarding the advertising market; therefore, this purported “relevant truth” had never been withheld. The court rejected this contention, finding that it was “a factual issue more suited to summary judgment” and pointing out that “Defendants have not submitted anything that suggests, much less establishes with any specificity, that the market was well aware that AOL would fail to hit its earnings targets because of the softening advertising market.” Id. at 50.
COMPLEX LITIGATION • The next big thing may be very small • What ‘Dura’ didn’t resolve • Credit security law spurs suits • Depositions as defense tool

The contrast between the Joffeecase and the Credit Suissecase shows that in the post- Duraenvironment, the viability of a 10b-5 claim, at least at the pleading stage, can hinge to a great extent upon a party’s ability to persuade the court of its vision of the “relevant truth.” The importance of defining “relevant truth” is not limited to stock-analyst cases. The 7th U.S. Circuit Court of Appeals recently affirmed the dismissal of a securities fraud case under Durain which it was alleged that Tricontinental Industries Ltd., the plaintiff, sold its assets to Anicom Inc. in exchange for Anicom stock, relying on Anicom’s 1997 financial statements. Tricontinental alleged that the 1997 financials, audited by the defendant accounting firm, had been false. Tricontinental Indus. v. PricewaterhouseCoopers, 475 F.3d 824 (7th Cir. Jan. 17, 2007). Tricontinental’s asset sale to Anicom closed in 1998, before Anicom’s 1998 and 1999 financials were released. Nearly two years later, Anicom announced that it was investigating accounting irregularities that could result in revision of its 1998 and 1999 financial statements by as much as $35 million, and that those statements could no longer be relied upon. Soon afterward, Anicom filed for bankruptcy. Anicom never stated that its 1997 financial statements (on which Tricontinental had relied) were inaccurate. Like the plaintiff in Credit Suisse, Tricontinental attempted to reframe the definition of “relevant truth,” arguing that it did not matter that the 1997 financials were never specifically revealed to be false. What had happened, according to the plaintiff, was that in 1996 Anicom had begun engaging in a scheme to inflate sales and revenues by using improper accounting procedures. That Anicom only disclosed the final two years of this scheme, not the final three years, should not, according to Tricontinental, preclude recovery; the relevant truth was that Anicom engaged in continuous accounting fraud, and when that was disclosed, Anicom’s share price plummeted, causing Tricontinental’s loss. The 7th Circuit rejected Tricontinental’s argument as incompatible with Dura. The court focused on the Durarequirement that a plaintiff specify “a causal connection between the material misrepresentation and the loss,” and not merely identify a misrepresentation that “touches upon” a later loss. Dura, 544 U.S. at 342-43. The 7th Circuit interpreted this language to mean that plaintiffs have very little leeway in characterizing the relevant truth. Once the relevant truth had been defined narrowly as the falsity of the 1997 financials, the Tricontinentalcourt had no difficulty concluding that there was no loss causation. When is the truth known? Just as defining the “relevant truth” has proved critical, equally important is the determination of what it means for the truth to “become known.” A formal disclosure by the company is not necessary, and the Duracourt acknowledged the possibility that the relevant truth might “leak out.” But this does not resolve how clear or credible the leak has to be, or how explicitly the truth must be spelled out in order for it to have “become known.” Courts that have grappled with these questions generally have not equated “the truth becoming known” with a full mea culpa. In In re Veritas Software Corp. Sec. Litig., Civ. No. 04-831, 2006 U.S. Dist. Lexis 32619 (D. Del. May 23, 2006), the company’s disclosure that it would not meet its previously issued earnings estimates was enough for the truth to “become known” for Durapurposes. The Veritascourt was not troubled that the company’s disclosure “did not specifically disclose the improper revenue recognition” on which the earlier forecasts had been based. According to the court, the defendant’s statement “did disclose that the guidance would be less than anticipated,” and this was sufficiently related to the improper-revenue-recognition issue. Similarly, in In re Bradley Pharms. Inc. Secs. Litig., 421 F. Supp. 2d 822, 828 (D.N.J. 2006), the court held that loss causation had been adequately pleaded when the company issued a generically phrased announcement of an informal U.S. Securities and Exchange Commission (SEC) inquiry regarding “revenue recognition,” which was followed by a 26% drop in share price. Two months later, when the company disclosed the details and restated its financials, the stock price did not move significantly. Nevertheless, the court denied the defendants’ motion to dismiss for failure to allege loss causation, rejecting the defendants’ “rigid and dogmatic” interpretation that the truth could not have become known, for Durapurposes, through the earlier announcement of the SEC inquiry. Courts generally have not required plaintiffs to allege that the defendant disclosed every detail of the alleged fraud in order to plead loss causation. Although the truth can “become known” without a detailed confession of wrongdoing by a defendant, courts applying Dura have recognized that purported revelations of truth, at some point, become too general to form a basis for loss causation. For example, in In re Odyssey Healthcare Inc. Secs. Litig., 424 F. Supp. 2d 880, 883 (N.D. Texas 2005), a company that operated hospice facilities allegedly defrauded investors by concealing illegal Medicare billing and related misdeeds. The company then announced, among other things, that its chief executive officer was stepping down in connection with “operational challenges.” The plaintiff contended that this announcement equated to a disclosure of the truth regarding the company’s billing misconduct. The court rejected this argument, holding that the announcement of the chief executive’s departure lacked “the requisite specificity to be taken as corrective of any more specific alleged misstatements.” Id. at 888. In order to qualify as a disclosure of the truth regarding an alleged fraud, “the disclosure must at minimum be of a nature that would cause recipients to identify which representations were the false prior representations. In other words, loss causation would not be established if a defendant simply said ‘something we told you last year isn’t true,’ because that is insufficient to show that stock prices were inflated due to a specific misrepresentation and the market reacted when the misrepresentation became known.” Id. at 888. The Odyssey standard represents one effort to limit how general a truth disclosure can be for purposes of Dura. This point will continue to be hotly contested in securities fraud litigation. Duraprovides a framework for assessing loss causation in 10b-5 cases, and makes clear that price inflation is not sufficient to allege loss causation. The debate has shifted to defining the “relevant truth” that was fraudulently withheld, and understanding how the truth can “become known.” Courts will continue to struggle with the implications, and with the challenge of applying these principles to real-world cases, where the alleged misconduct is often complex and the truth is not always revealed in a single, direct disclosure. Still, Durahas reinforced the need for courts to examine closely whether plaintiffs are meeting their obligation to show a loss directly attributable to the fraud they allege. Bertrand C. Sellier is a partner, and John H. Snyder is an associate, in the New York headquarters of Proskauer Rose. They specialize in securities litigation.

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