The Land Of The Loss: The Supreme Court Will Rule On Loss Causation

On January 12, 2005, the U.S. Supreme Court will hear oral argument in one of the most significant securities law cases to come before that Court in some timea case concerning the parameters of "loss causation" (a key element of federal securities law claims) in "fraud-on-the-market" cases. The federal appeals courts have rendered conflicting decisions on this issue, and it was the Ninth Circuit's ruling in Broudo v. Dura Pharmaceuticals, Inc., 339 F.3d 933 (9th Cir. 2003) that prompted the Supreme Court to agree to step in and direct the courts as to the proper standard of loss causation.

Transaction and Loss CausationGeneral Principles

All private plaintiffs alleging a securities fraud claim under 10(b) or Rule 10b-5 must plead and prove that a defendant's conduct caused their loss. There are two elements to causation: "transaction causation" and "loss causation." The first element, "transaction causation," requires that plaintiffs show that a defendant's alleged misstatements caused them to enter into the transaction in question; that is, as one Court has put it, "but for the claimed misrepresentations or omissions, the plaintiff would not have entered into the detrimental securities transaction." E.g., Emergent Capital Investment Management, LLC v. Stonepath Group, Inc., 343 F.3d 189, 197 (2d Cir. 2003).

The second element, "loss causation," has been described as "the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff." Emergent Capital, 343 F.3d at 197. Courts analogize loss causation to the general tort concept of proximate cause and the related notion of foreseeability. Id. The doctrine holds that "the damages suffered by plaintiff must be a foreseeable consequence of any misrepresentation or material omission." Id. (quoting Castellano v. Young & Rubicam, Inc., 257 F.3d 171, 179 (2d Cir. 2001)). Congress codified loss causation as an essential element of a securities fraud case in the Private Securities Litigation Reform Act ("PSLRA"):

In any private action arising under this chapter, the plaintiff shall have the burden of proving that the act or omission of the defendant alleged to violate this chapter caused the loss for which the plaintiff seeks to recover damages.

15 U.S.C.A. 78u-4(b)(4).

Fraud-on-the-market

The Dura case pending before the Supreme Court involves a class action asserting the fraud-on-the-market theory. In essence, that theory provides a mechanism by which class actions in securities fraud cases may be certified without each class member having to plead and prove individual reliance on a defendant's alleged misrepresentations or omissions (transaction causation). Instead, in fraud-on-the-market cases plaintiffs are entitled to a rebuttable presumption that "(1)misrepresentations by an issuer affect the price of securities traded in the open market, and (2)...