In Re Williams Securities Litigation-wcg Subclass: Publicly Traded Corporations Win Leniency in Their Representations After the Tenth Circuit Redefines Loss Causation in Private Actions for Securities Fraud

• Jurisdiction: United States,Federal
• Citation: Vol. 43
• Publication year: 2008

43 Creighton L. Rev. 563. IN RE WILLIAMS SECURITIES LITIGATION-WCG SUBCLASS: PUBLICLY TRADED CORPORATIONS WIN LENIENCY IN THEIR REPRESENTATIONS AFTER THE TENTH CIRCUIT REDEFINES LOSS CAUSATION IN PRIVATE ACTIONS FOR SECURITIES FRAUD

IN RE WILLIAMS SECURITIES LITIGATION-WCG SUBCLASS: PUBLICLY TRADED CORPORATIONS WIN LENIENCY IN THEIR REPRESENTATIONS AFTER THE TENTH CIRCUIT REDEFINES LOSS CAUSATION IN PRIVATE ACTIONS FOR SECURITIES FRAUD

I. INTRODUCTION

In 1933 and 1934, the United States Congress passed the Securities Act of 1933(fn1) and the Securities Exchange Act of 1934,(fn2) which Congress designed to reign in the securities markets and industry.(fn3) In consideration of Congress's criminalization of securities fraud, the Supreme Court of the United States long recognized an implied private right of action for securities fraud.(fn4) Among the elements that a plaintiff investor ("investor") must prove to establish a successful private action for securities fraud is the element of loss causation.(fn5) Federal courts borrowed the common law test of proximate cause often used in tort cases as the appropriate test to establish loss causation in a securities fraud case.(fn6) Federal courts further established that, in the spirit of the common law rule of proximate cause, an investor may recover for those losses that can be attributed to fraudulent conduct and that an investor need not prove that the entirety of the investor's losses resulted from the fraudulent conduct.(fn7) In the only Supreme Court case to address the issue of loss causation, the Court in Dura Pharmaceuticals, Inc. v. Broudo(fn8) affirmed the common law roots of the loss causation requirement and stated that although an inflated purchase price itself did not constitute proximate cause, an investor still only needed to prove proximate cause to recover damages in a private action for securities fraud.(fn9)

In In re Williams Securities Litigation-WCG Subclass,(fn10) the United States Court of Appeals for the Tenth Circuit stated that an investor in a securities fraud action must show that all losses are attributable to the alleged fraudulent conduct and that the losses cannot be attributed to any other factors that could ultimately affect a security's price.(fn11) In Williams, the Williams Communications Group ("WCG") Subclass, a subclass of investors in the company's stock ("investors"), brought a class action suit for securities fraud against a company, its subsidiary, and select corporate officers on the grounds that the company and its officers actively misrepresented the reason for creating a spin-off corporation, the financial footing of the spin-off corporation, and the future prospects of the spin-off corporation.(fn12)The Tenth Circuit in Williams determined that the investors did not adequately establish the necessary element of loss causation because they did not show that their losses were attributed solely to the alleged fraudulent conduct.(fn13) Citing Dura, the Tenth Circuit reasoned that the Supreme Court's precedent required an investor to prove that all losses sustained could not be attributed to any factor other than the alleged fraud.(fn14) The Tenth Circuit further reasoned that because there are other elements that could have also affected the price of the stock, such as an industry-wide decline in telecommunications stock values, allowing the investors to equate their losses with the alleged fraudulent conduct would turn securities regulation laws into a sort of insurance policy that allows investors to recover for losses in almost all instances.(fn15) The Tenth Circuit concluded that the Williams investors failed to establish loss causation because the element "demands" that an investor prove that the losses sustained are not attributable to outside factors but only to the alleged fraudulent conduct.(fn16)

This Note will first examine the facts and holdings of Williams and review the reasoning the Tenth Circuit employed to conclude that the investors failed to establish the element of loss causation.(fn17) This Note will then discuss the federal case law concerning the issue of loss causation as it was settled prior to the Williams decision, the recognition of the implied private right of action for securities fraud as well as the development and treatment of the loss causation element in the federal courts leading up to the Supreme Court's decision in Dura, followed by a discussion of Dura and its treatment of the loss causation element.(fn18) This Note will illustrate how the Tenth Circuit in Williams failed to follow federal precedent when it additionally required the investors to prove that their losses could not be attributed to any cause other than the alleged misrepresentation.(fn19) This Note will further demonstrate how the court in Williams misinterpreted the loss causation rule outlined in Dura, thereby unintentionally creating an altogether different rule.(fn20) This Note will then illustrate how the court in Williams abandoned the common law roots of the loss causation element as affirmed in Dura and inadvertently made it substantially more difficult for investors to exercise their implied right to bring a private action for securities fraud.(fn21) Lastly, this Note will conclude with a discussion of the impact of the Williams decision, as well as a suggestion as to how future federal court decisions can avoid the outcome reached in Williams.(fn22)

II. FACTS AND HOLDING

In In re Williams Securities Litigation-WCG Subclass,(fn23) The Williams Companies, Inc. ("WMB") was an energy and natural gas company that produced and transported natural gas for both residential use and to power the generation of electricity on a national scale.(fn24)WMB operated a network of over 14,500 miles of pipeline.(fn25) During the 1980s WMB started to utilize unused pipeline within its network to run fiber-optic cable, successfully forming a national subsidiary company in the telecommunications industry.(fn26) WMB sold the telecommunications subsidiary in 1995 and, per a temporary non-compete clause, stayed out of the telecommunications industry until 1998. (fn27)During WMB's absence from the industry, telecommunications stocks continued to rise sharply in value, increasing forty-two percent in 1997 alone.(fn28)

In 1998, upon the expiration of the non-compete clause, WMB formed Williams Communications Group ("WCG"), a telecommunications subsidiary created to again utilize the unused pipeline that WMB still owned.(fn29) In the fall of 1999, WCG initiated an initial public offering ("IPO") in an attempt to earn capital to put toward expanding its network.(fn30) On March 7, 2000, WCG's stock price peaked at $61. 81 and on March 10, the telecommunications index peaked at 1248. 06. (fn31) From that point on, both WCG's stock price and the telecommunications index began to fall, with WCG's stock value declining more than fifty percent and the value of the index declining twenty-eight percent by July 21, 20 00.(fn32) Three days later, on July 24, 2000, WMB announced its intentions to separate WCG from WMB and make WCG its own stand-alone telecommunications company in an effort to maximize the efficiency and effectiveness of its telecommunications and energy businesses.(fn33) On the day of WMB's announcement, WCG's stock traded at $28.50.(fn34)

In its discussion of the facts, the United States Court of Appeals for the Tenth Circuit stated that from the date of the spin-off announcement to WCG's filing bankruptcy in April 2002, there seemed to be a continual dichotomy of information being shared with WCG's public investors about the company's future financial footing versus the actual reason for the spin-off and the information presented to its corporate officers in the boardroom.(fn35) For example, WMB issued an optimistic press release claiming that the spin-off of WCG benefited the growth of both companies while boardroom discussions centered around the necessity of disposing of WCG in a timely manner because of its harmful effects on the WMB balance sheet.(fn36) Furthermore, WMB Chief Executive Officer Keith Bailey assured investors of WCG's strong financial footing because the company already had the funds necessary for its capital needs, while other corporate officers internally reported that WCG was underfunded by close to $800 million at the end of 2001. (fn37) Even after the spin-off occurred in April 2001, WCG publicly announced optimistic cash flow projections in August 2001, while at the same time internally reporting that WCG's cash flows did not meet the amount required to pay off the company's debt.(fn38) By the end of 2001, WCG's stock sold at $2. 35 a share, with the telecommunications index at 236. 63. (fn39)

Beginning in January 2002, WMB and WCG began to issue public statements regarding WCG's financial struggles, beginning with a statement that WMB intended to delay its earnings report for the previous year until WMB's obligations with respect to WCG could be as-sessed.(fn40) In February 2002, WCG announced publicly that its lenders informed the company of its potential default and later that month declared the company was considering filing bankruptcy.(fn41) WCG eventually filed bankruptcy on April 22, 2002, and its stock fell to $0.06 a share, down from $1. 63 prior to its first January announcement.(fn42)

On January 29, 2002, WCG investor Milberg Weiss filed the first lawsuit in the United States...