Reputation Matters! A Critique of the Event-Driven Suits Model

• Pages: 263-292
• Date: 01 April 2024
• Published date: 01 April 2024
• Author: Marc I. Gross
• Subject Matter: Derecho Público y Administrativo

#Reputation Matters!

A Critique of the Event-Driven Suits Model

By Marc I. Gross

*

How should courts address class action securities cases arising from non-accounting re-

lated fraud, e.g., catastrophic events or illegal conduct? A recent article published in this jour-

nal proposed creating a different model for “event-driven” cases, essentially compelling plain-

tiffs to not just plead, but to statistically demonstrate at the pleading stage the materiality of

misconduct; and to do so by determining what would have been the stock price impact had

defendant remained silent rather than spoken deceptively. In further support of this model,

the authors propose jettisoning altogether the “half-truth” and “price maintenance” doctrines.

This article critiques this paradigm-shifting model, and seeks to demonstrate not only

that it is contraryto well-reasoned case law, but that it alsoignores the signif‌icant impact

a company’s “reputation” for integrity and reliability has upon its stock price. Empirical

studies have shown that reputation contributes at least 50 percent to a company’s stock

price, and that damage to reputation causes upwards of 66 percentof stock price declines

upon revelation of wrongdoing. As such, “reputation” should be considered in any anal-

ysis of materiality, causation, and damages.

In Event-Driven Suits (EDS),

1

two distinguished law professors propose a model

for determining materiality in securities fraud class actions arising from catastrophic

events (such as oil rig explosions and dam disasters) and “event-driven” claims

(such as illegal conduct by investment banks). The authors further assert that the

EDS model should be applied to all fraud-based claims, including those based on

f‌inancial disclosures mandated by the U.S. Securities and Exchange Commission

(SEC). The article warrants close examination given that, inter alia, application of

the EDS protocol would signif‌icantly alter the litigation terrain by (i) requiring plain-

tiffs to demonstrate the price impact of misleading statements or omissions at the

pleading stage; and (ii) requiring that any such impact be identif‌ied by determining

how the stock would have reacted if the company had been silent, rather than had it

told the truth. Using this protocol, if the estimated price impact is insuff‌icient (per-

haps using a threshold of statistical signif‌icance), the authors assert that the case

* Senior Counsel at Pomerantz LLP and former President of the Institute of Law and Economic

Policy (ILEP). The author wishes to thank the following contributors to this article: Steven Cleveland,

Merritt Fox, Joshua Mitts, Donald C. Langevoort, David Tabak, Tamar Weinrib, Brian Calandra, and

Simon Hall.

1. Merritt B. Fox & Joshua Mitts, Event-Driven Suits and the Rethinking of Securities Litigation,78

BUS.LAW. 1 (2023).

263

should be dismissed for lack of materiality. As such, the EDS model would create

yet another hurdle for investor claims, requiring plaintiffs to particularize at the

pleading stage not only falsity and scienter, but also demonstrate suff‌icient price im-

pact to warrant extended engagement by courts and counsel.

Underlying this potential paradigm shift is a radical assertion that there is no

express duty to disclose information under section 10(b) of the Exchange Act—

only a duty not to mislead. While section 13 of the Exchange Act specif‌ies infor-

mation that must be disclosed periodically, the authors emphasize that there is

no private right of action under that section, and thus no basis for investors to

sue for failure to disclose the itemized data. Given this perspective, the authors

remarkably urge jettisoning the “half-truth” doctrine (volunteering information

gives rise to a duty to disclose all relevant information related thereto).

The authors do not hide their underlying concern that the present regime has

“exposed misstatement-making issuers to a much larger chance of needing to pay

out substantial sums.”

2

Among other things, they believe that focusing on the

signif‌icant price drops following corrective disclosures results in over-estimating

the price impact of the misstatements when they were f‌irst made, especially in

cases arising from sudden disasters. Recognizing that the EDS model may curtail

some potentially actionable claims, the authors suggest the gap can be f‌illed by

“SEC enforcement ...orcriminal prosecution.”

3

This article critiques the EDS model. Part I focuses on its lynchpin: the default

to a “silent” counterfactual. The authors argue that, at least in cases where defen-

dants have volunteered information not otherwise mandated by statute, stock-price

inf‌lation should be measured by hypothesizing how analysts would have reacted

if the information had not been volunteered, and that the company had been “si-

lent.” The authors challenge application of the “half-truth” doctrine, which the

authors assert that courts have “sleepwalked” in applying to many cases.

4

In so doing, the EDS model departs from case law that has consistently held

that price impact should be measured by looking at what would have happened

if the company had been truthful, not just abstained from lying. The model also

fails to account for claims asserted under Rule 10b-5(c),

5

which creates liability

2. Id. at 9. Concerns about class actions’ overreach and draconian damages are longstanding and

prompted Congress to enact the PSLRA nearly thirty years ago. See A.C. Pritchard, Stoneridge Invest-

ment Partners v. Scientif‌ic-Atlanta: The Political Economy of Securities Class Action Reform, 2008 CATO

SUP.CT.REV. 217. For scholarship regarding alternative damage models, see Bradford Cornell & R.

Gregory Morgan, Using Finance Theory to Measure Damages in Fraud on the Market Cases, 37 UCLA L.

REV. 883 (1990); Allen Ferrell & Atanu Saha, The Loss Causation Requirement for Rule 10b-5 Causes of

Action: The Implications of Dura Pharmaceuticals, Inc. v. Broudo, 63 BUS.LAW. 163 (2007); Bradford

Cornell & James C. Rutten, Collateral Damage and Securities Litigation, 2009 UTAH L. REV. 717.

3. Fox & Mitts, supra note 1, at 5. So long as (i) the SEC is limited to recovery of f‌ines; (ii) the SEC

is unable to compensate defrauded investors (except in rare insider trading cases); and (iii) private

class actions recover ten times the SEC cases, further restrictions on private suits are unwarranted,

particularly given increased participation by public institutional investors in major class actions.

4. Id. at 17 n.37.

5. 17 C.F.R. § 240.10b-5(c) (2024) (“It shall be unlawful for any person. . . [t]o engage in any act,

practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.”).

264 The Business Lawyer; Vol. 79, Spring 2024