David Wertheimer

The Second Circuit’s decision in Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017) has garnered attention for its rulings on the requirements for showing and rebutting market efficiency and the related presumption of reliance in class actions brought under §10(b) of the 1934 Securities Exchange Act. Less noticed—but no less important—is the court’s discussion of the damages that the certified class might recover. Specifically, the court, in the course of addressing the relevance of damages models to class certification, reached out to observe that class members’ harm included the stock price declines caused both by the announcement of a regulatory action revealing the misconduct at issue in the §10(b) suit and by the potential fines that might follow from such a regulatory action. Id. at 106. The court’s remark that these losses may be counted as damages—rather than requiring that they be disaggregated from recoverable losses in any damages calculation—appears contrary to its established rules on damages and loss causation and, although plainly dicta, may cause confusion among trial courts, leading them to permit a significantly expanded, but wholly unwarranted, scope of damages in §10(b) actions.

The Waggoner action focuses on alleged misstatements by Barclays PLC and related defendants concerning the operation of its “dark pool” alternative trading system (ATS). Barclays purportedly marketed its ATS as “transparent” and subject to safeguards that protected clients from predatory trading, such as “front running” by high frequency traders (HFTs). That description was materially misleading, plaintiffs claimed, because Barclays not only allowed HFTs in its dark pool “but it sought them out and gave them the information they needed to take advantage of other traders.” Strougo v. Barclays, 105 F. Supp. 3d 330, 335 (S.D.N.Y. 2015). Plaintiffs asserted that a suit by the New York Attorney General (NYAG) accusing Barclays of concealing information about its ATS operations alerted the public to the “truth” concerning Barclays’ purportedly deceptive statements and that the price of Barclays’ securities fell 7.38 percent in response to the news. Id. at 335, 339.

After their complaint survived Barclays’ motion to dismiss, the plaintiffs sought class certification, which Barclays opposed. Among its arguments, Barclays contended that plaintiffs had not shown that damages could be established on a class-wide basis because their expert’s damages model, which relied upon the stock price drop following the NYAG’s suit, failed to isolate that portion of the price drop (if any) caused by the revelation of the deceptive practices. As Barclays noted, plaintiffs’ expert conceded that “disclosure of a government investigation can, by itself, result in a statistically significant decline” in a stock’s price. Strougo v. Barclays PLC, 312 F.R.D. 307, 326 (S.D.N.Y. 2016), aff’d, 875 F.3d 79 (2d Cir. 2017). Accordingly, Barclays argued, the expert’s model should have (but failed to) disaggregate price declines due to the NYAG suit from those caused by the revelation of Barclays’ purportedly deceptive practices, as only the latter would satisfy §10(b)’s loss causation and damages requirements. Id. at 327. Plaintiffs disagreed, contending that disaggregation was unnecessary because any price declines caused by the regulatory action were compensable damages, since the “‘regulatory action constitutes a materialization of the risk caused by” Barclays’ alleged misconduct. Id. at 326 n.127.

The District Court avoided resolving the parties’ debate over loss causation and damages, holding that they were merits-related issues. Instead, the court focused on whether the expert’s damages model supported class certification under Comcast v. Behrend, 133 S.Ct. 1426 (2013), which it construed as requiring only that a damage model “‘measure damages resulting from the class’s asserted theory of [injury].’” Strougo, 312 F.R.D. at 327. The expert’s damage model met that test because, the court found, it measured damages based on the price drop following the NYAG’s suit, which supposedly disclosed the “truth” about Barclay’s deceptive practices. Indeed, the court noted, to the extent that model was flawed because it failed to disaggregate price declines that were not recoverable as damages, that flaw did not defeat certification “‘because it would affect all class members in the same manner.’” Id.

On appeal, the Second Circuit agreed that Comcast’s requirements had been met. The court could have stopped there, but it did not. Instead, without citing any precedent, it moved beyond the District Court’s reasoning to reject Barclays’ disaggregation argument. The Second Circuit explained that issues of “lack of management honesty and control” were matters of concern for Barclays’ investors because “such problems could result in considerable costs related to defending a regulatory action, and, ultimately, in the imposition of substantial fines.” Waggoner, 875 F.3d at 106. Accordingly, the Second Circuit concluded, the NYAG “regulatory action and any ensuing fines were a part of the alleged harm the Plaintiffs suffered, and the failure to disaggregate the action and fines did not preclude class certification.” Id.

The Second Circuit’s obiter dicta cannot be readily squared with its established rules governing damages and loss causation. Turning first to damages, the court has long recognized that “economic loss” in §10(b) cases is determined “by use of the ‘out-of-pocket’ measure for damages,” under which damages “‘consist[] of the difference between the price paid and the “value” of the stock when bought.’” Acticon AG v. China N. E. Petroleum Holdings Ltd., 692 F.3d 34, 38 (2d Cir. 2012).

Application of that rule does not permit consideration of the effect of collateral consequences—such as a lawsuit and fines—arising from a securities law violation. That is because the rule attempts to determine the “value” of the security at the time of purchase had the “truth” been known. In such a hypothetical circumstance, there would have been no fraud-related litigation—because no fraud would have occurred. Accordingly, by definition, the “value” of the security cannot reflect the market’s assessment of the costs of fraud-related litigation.

Litigation-related losses should also be excluded from §10(b) damages under loss causation principles, which permit recovery of an investment loss only “if the risk that caused the loss was within the zone of risk concealed by” a misrepresentation. Lentell v. Merrill Lynch & Co., 396 F.3d 161, 173 (2d Cir. 2005). That “zone of risk” does not encompass all foreseeable risks that were a cause-in-fact of an investor’s loss. Rather, the zone of risk is defined by the concept of “proximate cause,” which limits compensable losses to those whose recovery furthers “the purposes of the securities laws.” In re Omnicom Group Sec. Litig., 597 F.3d 501, 513 (2d Cir. 2010). That purpose is to ensure that “‘buyers of securities get what they think they are getting’” by requiring disclosure “adequate to allow investors to make judgments about a company’s intrinsic value.” Id. at 513, 514.

Consistent with these principles, costs arising from litigation over purported securities law violations should not be recoverable because such litigation is not a risk properly subject to disclosure under the securities law. First, because investors know that litigation might follow from a securities law violation, the general risk of that potential litigation need not be disclosed. See Seibert v. Sperry Rand, 586 F.2d 949, 952 (2d Cir. 1978) (“‘there is no duty to disclose information to one who reasonably should already be aware of it’”).

Moreover, it is well-established that there is no duty to disclose “matters that are merely speculative.” Pa. Pub. Sch. Emp. Ret. Sys. v. Bank of Am., 874 F. Supp. 2d 341, 351 (S.D.N.Y. 2012). For that reason, courts have held that there “is no duty to disclose litigation that is not ‘substantially certain to occur.’” In re Lions Gate Entm’t Sec. Litig., 165 F. Supp. 3d 1, 7 (S.D.N.Y. 2016) (collecting cases).

Because there is no duty to disclose the risk of litigation, losses caused by the materialization of that risk must fall outside the “zone of risk” recoverable under §10(b). See Omnicom Group, 597 F.3d at 514 (losses stemming from risks about which a firm would need to speculate are not recoverable). Put differently, although a securities fraud may be the “cause-in-fact” of litigation arising from that fraud—and of any market losses the litigation engenders—the fraud is not a “proximate cause” of the loss because the litigation was not within the “zone of risk” subject to disclosure.

That conclusion should not change simply because Barclays’ investors purportedly were concerned by the costs of a regulatory action and related sanctions that might result from management misconduct. Waggoner, 875 F.3d at 106. The alleged misstatements in Waggoner did not touch on any regulatory (or other) investigation and thus did not trigger a duty of disclosure concerning a potential regulatory action. Compare Lions Gate, 165 F. Supp. 3d at 8 (duty to disclose exists when an issuer makes “a material misrepresentation about the existence of an investigation”). Rather, the NYAG suit was simply a consequence of Barclays’ supposedly deceptive ATS operations. While investors may well have been concerned by the prospect of litigation arising from such conduct, information need not be disclosed “simply because it may be relevant or of interest to a reasonable investor.” Resnik v. Swartz, 303 F.3d 147, 154 (2d Cir. 2002). Indeed, if investor concern over the potential litigation risk of concealed misconduct was the touchstone for disclosure, then companies would be required to speculate over the possibility of such litigation and its consequences. Courts, however, have long held otherwise. See, e.g., In re Par Pharm. Sec. Litig., 733 F. Supp. 668, 678 (S.D.N.Y. 1990) (firm “not obligated to speculate as to the myriad of consequences, ranging from minor setbacks to complete ruin, that might have befallen the company if the [illegal] scheme was discovered, disclosed or terminated”).

Furthermore, allowing recovery for losses arising from risks “caused-in-fact” by a fraud but not subject to disclosure threatens to significantly expand damages under §10(b). For example, stock price declines following the revelation of “bad news” by a company may reflect, in part, the market’s valuation of anticipated securities litigation costs, including anticipated legal fees, settlement payments, management distraction and reputational injury, among others. Janet C. Alexander, “The Value of Bad News in Securities Class Actions,” 41 UCLA L. Rev. 1421, 1435 (1994).

There is good reason to exclude these litigation-related losses from recoverable damages. For example, permitting damages to be defined not only by the market’s valuation of previously concealed information but also by its estimate of a securities fraud claim’s settlement value is “a classic case of bootstrapping.” Id. at 1439. Moreover, the market’s valuation of the various litigation-related costs is little more than speculation untethered to any legal principles defining recoverable damages. Nonetheless, the (assumed) securities fraud is a “cause-in-fact” of the losses, no different than the losses purportedly resulting from the NYAG suit in Waggoner. The reason both sets of losses should be excluded from §10(b) damages is because recovery does not further the purposes of the securities laws, since none of the losses stem from risks that should have been disclosed.


Section 10(b) is intended to protect investors “against those economic losses that misrepresentations actually cause” but not provide them with “broad insurance against market losses.” Dura Pharm. v. Broudo, 544 U.S. 336, 345 (2005). The Waggoner decision contravenes that guiding principle by allowing recovery for losses arising from risks that are not subject to disclosure under the securities laws, thereby converting §10(b) into a scheme of investor insurance. Accordingly, when the issue of litigation-related losses is next squarely before the Second Circuit, it should reconsider its recent obiter dicta and hold that such losses are not recoverable consistent with its precedents.

David Wertheimer is a partner at Hogan Lovells.