Securities fraud litigation--lost in causation: investors not entitled to presumption of loss causation in fraud-on-the-market cases--Dura Pharmaceuticals, Inc. v. Broudo, 125 S. CT. 1627 (2005).

• Author: Shea, Mackenzie

To protect investors, the federal securities laws provide for a private cause of action when a company has engaged in fraud. (1) In particular, investors can recover where the company has made any "untrue statement of material fact" or has omitted any material fact "necessary in order to make the statements made ... not misleading." (2) To be successful in such an action, investors must prove, among other elements, that the defendant's fraud caused their economic loss. (3) In Dura Pharmaceuticals v. Broudo, (4) the United States Supreme Court considered whether investors are entitled to a presumption of loss causation, requiring only that they establish that the price of the security on the date of purchase was inflated because of the misrepresentation. (5) In rejecting such a presumption, the Court held that investors must specifically prove that the defendant's misrepresentation caused the loss for which they seek to recover. (6) Investors must now allege and prove not that the misrepresentation caused inflation of the security's price, but rather that the misrepresentation caused a subsequent decline in its price. (7)

Dura Pharmaceuticals, Inc. ("Dura") develops and markets pharmaceutical products for the treatment of allergies, asthma, and other respiratory conditions. (8) During the late 1990s, Dura was in the process of developing Spiros, a drug delivery system for asthma patients. (9) As Dura was conducting clinical trials of Spiros, the plaintiffs purchased stock in the company. (10) The plaintiffs purchased their shares between April 15, 1997 and February 24, 1998, during which time Dura's stock price climbed from $28.00 to $39.00 per share. (11) Over this period, Dura issued several press releases (the "1997 Press Releases") about Spiros and one of its other products, Ceclor. (12) In these announcements, Dura claimed that it would complete satisfactory testing of Spiros and soon receive Food and Drug Administration ("FDA") approval, and would see increasing sales of its respiratory drug Ceclor. (13) However, on the last day of the class period, February 24, 1998, Dura announced that its earnings would be lower than expected, primarily because of slow drug sales, particularly of Ceclor. (14) On February 25, Dura's stock price plunged from $39.00 to $20.00, a 47% one-day loss. (15) Dura's business continued to decline throughout 1998 and in November, the company announced that Spiros would not receive FDA approval. (16) With this announcement, Dura's stock price further declined, but eventually recovered the following week. (17)

In their complaint, the plaintiffs claimed that Dura and its executives knew that the content of its 1997 Press Releases was false. (18) In particular, the plaintiffs alleged that Dura issued the 1997 Press Releases to persuade investors that its drug sales were increasing and that it was successfully completing the development and testing of Spiros; when in fact, the company knew both to be untrue. (19) According to the plaintiffs, the issuance of the 1997 Press Releases was a scheme by Dura's executives to bolster the company's stock price. (20) The plaintiffs filed several class actions claiming that Dura violated Section 10(b) of the Securities and Exchange Act and Rule 10b-5, promulgated thereunder by the Securities and Exchange Commission ("SEC"). (21) The District Court for the Southern District of California dismissed the complaint finding that the plaintiffs had not properly alleged the loss causation element of a Section 10(b) and Rule 10(b)-5 action. (22) The district court focused on the last day of the class period, February 24, 1998, and stressed that the complaint did not establish that the "FDA's non-approval of [Spiros] had any relationship to the February price drop."23 The Court of Appeals for the Ninth Circuit reversed, finding that the complaint adequately alleged "loss causation."24 According to the Ninth Circuit, "plaintiffs establish loss causation if they have shown that the price on the date of purchase was inflated because of the misrepresentation." (25)

Under the federal securities laws, investors may file a private cause of action where a company has made any untrue statement of material fact. (26) In filing such an action, investors must prove several elements, one of which is causation. (27) The causation element has two parts; it includes both transaction causation, also known as reliance, and loss causation. (28) Loss causation requires investors to establish a connection between the company's misrepresentation and their economic loss. (29)

Over time, courts developed various theories for establishing loss causation in fraud-on-the-market cases.30 Some courts focused the on the date of realization--when the market learned of the company's fraud--and required a showing that the price dropped on that date because of the misrepresentation. (31) Other courts focused on the date of purchase--when investors purchased their shares--and required a showing that the price was inflated on that date because of the misrepresentation. (32) The Court of Appeals for the Second Circuit followed the on-the-date-of-realization or "causal connection" theory in Emergent Capital. (33) In that case, the Second Circuit rejected the on-the-date-of-purchase theory as being nothing more than paraphrased transaction causation. (34) According to the court, the on-the-date-of-purchase theory explained why investors purchased their shares, but not why they lost money on the transaction. (35) The court held that investors must answer the latter question--why they lost money on the transaction--to be successful in proving loss causation. (36) Thus, the court required investors to show that the ultimate decline in the security's price was reasonably related to the company's correction of its misstatement or omission. (37)

In contrast, the Court of Appeals for the Ninth Circuit followed the latter on-the-date-of-purchase or "price...