The recent havoc in the markets might make it seem a propitious time to be a securities lawyer. However, plummeting stock prices present their own set of challenges to plaintiffs pursuing fraud claims under the federal securities laws. Even when there appears to be ample evidence that executives misled investors about business prospects, market-wide share price declines can make it difficult to prove that the revelation of the truth about these deceptions caused the losses suffered by shareholders. As a result, lawyers and the courts are increasingly focused on the proper methodology for determining whether investor losses are caused by fraud. This new scrutiny has highlighted the benefits—and significant limitations—of the event study, long the mainstay for loss causation analysis.
Proof of loss causation, that is, a causal connection between material misrepresentations and investor losses, was a bone of contention in securities fraud cases long before the current downturn in the markets. In Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), the U.S. Supreme Court reviewed a decision by the U.S. Court of Appeals for the Ninth Circuit permitting plaintiffs to plead loss causation by alleging that the price of the security on the date of the purchase was artificially inflated because of the misrepresentation. The Supreme Court rejected this view, holding that an inflated purchase price does not, in itself, constitute the relevant economic loss. Id. at 345-46. The Court found the complaint to be legally insufficient because it failed to allege that the stock price fell significantly when the truth became known. Id. at 348.
