C. Damages for Individual Claims Brought Under the Securities Exchange Act of 1934

• Library: South Carolina Damages (SCBar) (2009 Ed.)

C. Damages for Individual Claims Brought Under the Securities Exchange Act of 1934

1. Stock Manipulation Liability Under § 9(e)

Section 9(e) provides that an "injured" securities seller or buyer may sue any willful participant in a manipulative act or transaction in violation of §9(a) through (c) "to recover the damages sustained as a result of any such act or transaction."¹⁹ In Piper v. Chris-Craft Industries, Inc.,²⁰ the United States Supreme Court suggested that the nexus between conduct and loss under this section could be established by proof that the defendant's pre-transaction conduct created a difference between the price and the value of the securities at the time of the transaction. The Court concluded that in drafting this language in section 9(e), Congress "focused . . .upon the amount actually paid by an investor for stock that had been the subject of manipulative activity."²¹

2. Misrepresentation in Filed Reports Under § 18

Section 18 of the 1934 Act provides an express private remedy against any person who makes or causes to be made any statement in any filing under the 1934 Act or any rule promulgated thereunder which was at the time it was made false and misleading under the circumstances.²² Similar to section 9(e), section 18 requires plaintiffs to prove both that they purchased or sold the security at a price "affected by" the misstatement and that their damages were "caused by" reliance upon the misstatement.²³

As is the case with other federal securities remedies, a plaintiff may sue under both section 18 and other applicable laws.²⁴

3. Proxy Statement Misrepresentation Under Rule 14a-9

Unlike remedies under sections 9 and 18, a claim brought under Rule 14a-9,²⁵ rests on an implied right of civil recovery. In J.I. Case Co. v. Borak²⁶ the Supreme Court recognized an implied private right of action for damages under the 1934 Act's proxy statement provision.²⁷ In Virginia Bankshares, Inc. v. Sandberg,²⁸ the Supreme Court held that minority shareholders, whose votes are not required to authorize the action at issue in the proxy solicitation, cannot establish damages caused by the misleading solicitation. Although proof of the fairness of the merger is not a defense to a 14a-9,²⁹ any plaintiff seeking to recover damages under the rule will need to prove loss causation.³⁰

Most cases brought under section 14a-9 arise in the merger setting. Typically, a shareholder of an acquired company is complaining that the acquiring company used deception to win votes for an unfairly sweet deal at the expense of shareholders of the acquired company. Damage calculations necessarily will be fact specific. In Gerstle v. Gamble Skogmo, Inc.,³¹ approval of the acquired company's shareholders to a merger was obtained by means of a proxy that contained inadequate disclosure regarding the value of the acquired company's assets which the surviving corporation intended to sell. The Second Circuit awarded damages under Rule 14a-9 equal to the profits that the surviving corporation realized in selling the undervalued assets shortly after the merger was completed. The Court denied recovery for appreciation on assets not sold but held by the surviving corporation after the merger.

Where a litigant is alleging that proxy deception caused a bad deal to take place, proof of actual financial loss is required. This translates to proving that the value of the investor's holdings prior to the transaction exceeded the value of the consideration received. In Mills v. Electric Auto-Lite, Inc.³² the Seventh Circuit wrestled with damage calculation difficulties in a merger case, and concluded that a deal yielding a fair result for the acquired company shareholders negated any claim of loss:

We . hold that the terms of the merger were fair and that plaintiffs should recover no damages. A numerical example may help to show the justice of this result. In early 1963, an Auto-Lite shareholder with one hundred shares and a Mergenthaler shareholder with 210 shares each owned stock worth approximately $5225. After the merger, the former Auto-Lite shareholder had 188 shares of Eltra preferred worth approximately $5839 while the former Mergenthaler shareholder had 210 shares of Eltra common worth approximately $5302. Both individuals benefitted from the merger, but the former Auto-Lite minority shareholder benefitted more.³³

4. Tender Offer Fraud Under § 14(e) and Rule 14e-3

Section 14(e)³⁴ makes it illegal to deceive in connection with a tender offer. The Supreme Court, however, has ruled that the hostile bidder has no private action for damages, as opposed to injunctive relief, in section 14(e) cases.³⁵ The Ninth Circuit has held that Section 14(e) implicitly authorizes shareholder-offerees to bring private causes of action for violations of Section 14(e).³⁶ The Ninth Circuit in Plaine, in contrast with the fairness-grounded formulation used by the Seventh Circuit in its 14a-9 ruling in Mills, authorized a broader measure of damages under section 14(e). In Plaine, the defendants arranged a two-step transaction by which the offeror would tender for the outstanding shares of the target corporation and, thereafter, squeeze out its minority shareholders. As required by state law, the California Corporations Commissioner held a hearing on the "fairness" of the proposed merger.³⁷ The Commissioner determined that the merger price was within a range of "fairness" over the plaintiff's objection.³⁸ The Court of Appeals granted preclusive effect to the Commissioner's decision on the issue of fairness, but nevertheless held the damages awarded to a successful section 14(e) plaintiff may go beyond a determination of a "fair price."³⁹ The court stated:

The purpose of the 1934 Act is to compensate plaintiffs injured by violations of the Federal Securities Laws whether the measure of damages is out of pocket loss, benefit of the bargain, or some other appropriate standard. . . . "[A]ctual damages" may include loss of possible profit, unless wholly speculative, from securing a merger agreement more favorable to plaintiff.⁴⁰

Although it considered the merger price to be fair, the court suggested the plaintiff might be able to show that had section 14(e) been fully complied with, the shareholders improved negotiating position would have produced better terms for the shareholders.

The SEC adopted Rule 14e-3 on the heels of the Supreme Court's holding in Chiarella v. United States.⁴¹ The Court ruled in Chiarella that the defendant, who was exploiting confidential information about impending tender offers, did not violate 10b-5 by defrauding investors when he traded on inside information. Rule Thus, 1 4e-3 was swiftly adopted to make insider trading illegal in the tender offer context. Congress approved the SEC's promulgation of Rule14e-3 when it enacted the Insider Trading Sanctions Act of 1984,⁴² providing treble damages for Rule 14e-3 violations.⁴³ This 1984 legislation, now found in section 20A of the 1934 Act,⁴⁴ now gives contemporaneous traders a right to recover from various persons who run afoul of the 1934 Act's inside trading prohibitions. Damages are capped at the wrongdoer's "profit gained or loss avoided in the [violative] transactions."⁴⁵ Furthermore, damages awarded to private investors will be reduced by any amount ordered disgorged under 15 U.S.C. § 78u.

5. Short Swing Trading Under § 16(b)

Section 16(b)⁴⁶ is designed to discourage short-swing ("in-and-out") trading by officers, directors, and ten percent beneficial owners of stock issued by public companies. It accomplishes this goal by requiring such parties to disgorge to the issuer any "profits" they make based on trading in the issuer's stock. The measure of profit in section 16(b) cases is sometimes referred to the LIHO approach, standing for "lowest in, highest out." This method, designed to soak the defendant, was established in Smolowe v. Delendo Corp.⁴⁷ In Smolowe, the court concluded that the goals of section 16(b) require that all possible profit be squeezed from the transaction.⁴⁸ The court therefore adopted the LIHO approach, specifically rejecting other methods, finding them susceptible to manipulation by the insider to avoid liability.⁴⁹ This method of profit calculation can impose liability for short-swing profits even in cases where the insider suffered a loss.⁵⁰ Nonetheless, Smolowe's LIHO approach has been adopted by subsequent courts.⁵¹

6. 10b-5 Causes of Action

It has been aptly observed that:

The law relating to private remedies available under rule 10b-5 is confused. Commentators list up to a dozen separate measures of recovery that prospective plaintiffs may pursue if defrauded in connection with the purchase or sale of security. Courts mix and match these measures in a way that both obscures their substantive and historical backgrounds and creates difficulty for subsequent courts and scholars seeking a coherent body of law.⁵²

From a remedial standpoint, 10b-5 offers little clarity. On the other hand, the Rule may be attractive to lawyers suing on behalf of injured investors.

The chief beauty of a 10b-5 cause of action is that standing is so easily achieved. One need only be a defrauded purchaser or seller of a security in transaction where the mails or an instrumentality of interstate commerce were used. Section 3(a)(17)⁵³ expressly provides that "intrastate use of ...any ...interstate instrumentality" suffices to provide the needed nexus to interstate commerce. As a practical matter and in light of the 1934 Acts liberality, virtually all securities transactions sufficiently involve the jurisdictional means to give rise to a Rule1b-5 violation, assuming the rule's other requirements are present.

Very little is absolutely clear about damage measures in Rule10b-5 cases except that punitive damages and attorneys fees are not allowed,⁵⁴ which is the case with all federal securities causes of action under the 1933 and 1934 Acts. However, punitive damages or fees may be...