The Court reasoned that, at the time an investor purchases a stock inflated by fraud, the investor has suffered no loss: “the inflated purchase payment is offset by ownership of a share that at that instant possesses equivalent value.” Id. If the investor sells “the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss.” Id. Additionally, the Court noted that, even if a shareholder sold the stock at a loss after the “relevant truth” was revealed, the investor may not have suffered a recoverable loss under the securities laws because that “lower price may reflect, not the earlier misrepresentation, but changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events, which taken separately or together account for some or all of that lower price.” Id. at 343.
The securities laws, held the High Court, were meant “not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause.” Id. at 345. And a misrepresentation will “actually cause” a loss only when the “relevant truth” of that misrepresentation has been revealed, and where a plaintiff can show that the revelation itself – as opposed to other factors unrelated to the disclosure – resulted in the loss. Id.
Although the decision did not directly address damages calculations in securities fraud cases,6 opponents of the percentage method seized on the Court’s discussion of loss causation principles to argue that the percentage method is an inappropriate method of measuring damages. Specifically, they have argued that the percentage approach is fundamentally inconsistent with the holding in Dura because it posits that a shareholder may suffer (and recover for) a “loss” that occurred before the “relevant truth” is revealed – a “loss” which, by definition, could not have been “actually caused” by the fraud.7
The ‘Williams’ Decision
Although the opponents of the constant percentage method viewed Dura as the proverbial nail in the coffin for the constant percentage method, courts still were reluctant to address the issue head-on.8 That changed in the Williams Securities Litigation case. See 496 F.Supp.2d 1195 (N.D. Okla. 2007). Williams was a §10(b) case brought by purchasers of securities issued by the Williams Communications Group Inc., a company in the fiber optics business. The price of the company’s stock, like the stock of its competitors in the telecommunications industry at the time, was on a steady decline during the class period (July 2000-April 2002). Indeed, by the time of the first alleged corrective disclosure (Jan. 29, 2002), the company’s stock price was only $1.60.
Plaintiffs alleged that management of the company and the company’s auditors misrepresented the financial condition of the company. In support of their claims, plaintiffs submitted expert testimony on the issues of materiality, loss causation and damages. Defendants moved to exclude that testimony on the grounds that it did not pass muster under Daubert v. Merrell Dow Pharmaceuticals Inc., 509 U.S. 579 (1993). One of the damages scenarios (“Scenario 2″) set forth by plaintiffs’ expert was premised on the constant percentage method. Due to the fact that the stock was declining – indeed, was in a free fall – during the class period, the expert’s constant percentage model showed shareholders being damaged prior to the first alleged corrective disclosure.
Recognizing that this result would be in conflict with Dura’s holding that damages are not recoverable prior to the disclosure of the “relevant truth,” plaintiffs’ expert modified his constant percentage approach by only allowing damages to shareholders who held stock past the first corrective disclosure (identified by plaintiff as Jan. 29, 2002). 496 F.Supp.2d at 1260. The court noted that, although the modification attempted to make the model Dura-compliant, it resulted in an internal inconsistency:
Furthermore, the court noted that the constant percentage method, even with the plaintiffs’ expert’s proposed adjustment, resulted in a situation where an investor who sold her stock after the first corrective disclosure was recovering not just for the “loss” caused by that corrective disclosure, but for “losses” suffered prior thereto (a period during which the entire telecommunications sector was suffering massive losses):
([U]nder [Damages] Scenario 2, an investor who sold on Jan. 28, 2002 gets no recovery, while an investor who sold on Jan. 29 recovers for all of his loss of per-share value for the entire class period (nearly $25 per share for an investor who bought at the beginning of the class period), even though the price of the stock had already declined 94 percent, to $1.60 before (as postulated in Scenario 2) ‘the relevant truth’ emerged. (emphasis in original).
