Pleading and Proving Loss Causation: Litigating Securities Fraud in a Post‐Dura World William F. Sullivan, Christopher H. McGrath, Joshua G. Hamilton, John J. O'Kane IV and Adam M. Sevell, Paul, Hastings, Janofsky & Walker LLP In 2005, the U.S. Supreme Court handed down its connection between the revelation of truth first decision on federal securities laws in almost a following an alleged misstatement or omission to decade. Dura Pharmaceuticals, Inc. v. Broudo, 544 sufficiently plead loss causation. See Dura, 544 U.S. U.S. 336 (2005), addressed the important issue of at 347 (stating that a complaint fails to allege loss what a plaintiff must plead and prove to satisfy the causation if it does not "provide the defendants "loss causation" element of securities fraud under with notice of what the relevant economic loss the Securities and Exchange Act of 1934 (Exchange might be or of what the causal connection might be Act). By forcing plaintiffs to draw a causal between that loss and the misrepresentation . ."). connection between fraudulent acts or omissions The Supreme Court in Dura stopped short, and the subsequent loss, Dura demands that however, of identifying the extent to which plaintiffs aver more than artificial price inflation. plaintiffs must allege facts demonstrating loss While Dura's transformative effect has been causation to survive a motion to dismiss. undeniable, it was only the beginning of the evolution of the significance of loss causation to the The post‐Dura loss causation inquiry has been application of securities laws. Now, the loss generally described as considering whether "the causation analysis applies not only to the civil misrepresentations or omissions caused the harm." securities litigation practice, but also impacts See In re Daou Sys., Inc. Sec. Litig., 411 F.3d 1006 alleged criminal securities violations as well. This (9th Cir. 2005). It is clear that conclusory allegations article considers the approaches different circuits of loss will not suffice. See N.Y. City Employees' have taken in interpreting Dura and in applying it in Retirement Sys. v. Jobs, 593 F.3d 1018, 1024 (9th five important areas: motions to dismiss, summary Cir. 2010) (affirming the dismissal of plaintiffs' judgment, class certification, criminal sentencing, Exchange Act claims on the ground that plaintiffs and expert testimony. had failed to allege loss causation because plaintiffs' "dilution theory of economic loss"—whereby Motions to Dismiss dilution "reduces a shareholder's percentage of ownership"—averred only inadequate "conclusory The first area in which loss causation has been assertions of loss"); see also Metzler Investment vigorously applied is in motions to dismiss. Indeed, GMBH v. Corinthian Colleges, Inc., 540 F.3d 1049, Dura itself interpreted loss causation in that 1064 (9th Cir. 2008) (noting that Dura does not context. The law concerning loss causation is easily require a finding of fraud before loss causation can described—a plaintiff must allege a sufficient be properly pled, "[b]ut that does not allow a ________________ © 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 44 edition of the Bloomberg Law Reports—Securities Law. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. The discussions set forth in this report are for informational purposes only. They do not take into account the qualifications, exceptions and other considerations that may be relevant to particular situations. These discussions should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Any tax information contained in this report is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. The opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content contained in this report and do not make any representation or warranty as to its completeness or accuracy. plaintiff to plead loss causation through and the ultimate economic loss. See Lattanzio v. 'euphemism' and thereby avoid alleging the Deloitte & Touche LLP, 476 F.3d 147, 157‐58 (2d Cir. necessary connection between defendant's fraud 2007) (affirming dismissal of Exchange Act claims on and the actual loss"); see also Tricontinental Indus., the ground that plaintiffs had failed to allege "a Ltd. v. PricewaterhouseCoopers, LLP, 475 F.3d 824, sufficient connection between [defendant's] 844 (7th Cir. 2007) (noting that the complaint must misstatements and the losses suffered" because the allege a "causal connection between the material third‐party auditors' misstatements were less misrepresentation and the loss . not simply that numerous and consequential than similar the misrepresentation 'touches upon' a later misstatements made by the company itself); see economic loss") (citing Dura, 544 U.S. at 342‐43). also Lentell v. Merrill Lynch & Co., 396 F.3d 161, 174 (2d Cir. 2005) ("[I]f the connection is attenuated, or Beyond this, however, different circuits continue to if the plaintiff fails to demonstrate a causal grapple with the appropriate interpretation of the connection between the content of the alleged loss causation pleading standard set forth in Dura. misstatements or omissions and the harm actually At least one Ninth Circuit panel has adopted a suffered, a fraud claim will not lie") (citations plausibility standard. See In re Gilead Sciences Sec. omitted). Litig., 536 F.3d 1049, 1056‐58 (9th Cir. 2008) (holding that a more than three month gap Dura formulated the rule on pleading and proving between the time the alleged misrepresentation loss causation, but the contours of the rule continue was revealed and a subsequent decline in stock to be shaped. What is clear is that Dura's pleading price did not defeat loss causation because "so long requirements have resulted in the elimination of as the plaintiff alleges facts to support a theory that cases alleging only artificial inflation of stock price, is not facially implausible, the [district] court's without an actual loss tied to a disclosure. Dura also skepticism [regarding the plausibility of plaintiffs' forces plaintiffs to allege the particular factual claims] is best reserved for later stages of the revelation of an alleged false statement or proceedings . ."). Gilead indicates that, regardless omission. As discussed below, even if a plaintiff's of the temporal proximity of the misrepresentation claims survive a motion to dismiss, the loss and subsequent corrective disclosure, plaintiffs causation requirements will be in the cross‐hairs of must plead facts linking the alleged misstatements summary judgment and loss causation arguments. to a decrease in share price so as to maintain a theory that is "not facially implausible." See id. Summary Judgment The Fifth Circuit has taken a similar approach by Dura has also made surviving summary judgment demanding that a plaintiff plead a "facially more difficult for plaintiffs in securities fraud cases. 'plausible' causal relationship between the That does not, however, mean that courts have fraudulent statements or omissions and plaintiff's adopted a uniform approach regarding the precise economic loss." Lormand v. U.S. Unwired, Inc., 565 evidentiary showing required to establish loss F.3d 228, 258 (5th Cir. 2009) (requiring that plaintiff causation. aver only "enough facts to give rise to a reasonable hope or expectation that discovery will reveal The Second Circuit recently addressed loss evidence of the foregoing elements of loss causation analysis post‐Dura in In re Omnicom, Inc. causation") (internal citations omitted). Sec. Litig., 597 F.3d 501 (2d Cir. 2010). The facts and decision in that case demonstrate that plaintiffs will Under the Second Circuit's more exacting "sufficient not survive summary judgment without establishing connection" loss causation pleading standard, a strong causal link between an alleged fraud and plaintiffs must now aver facts tending to show a their loss.1 In that case, share prices fell in the wake very close nexus between the alleged misstatement of news coverage surrounding a director's © 2010 Bloomberg Finance L.P. All rights reserved. Originally published by Bloomberg Finance L.P. in the Vol. 4, No. 44 edition of the Bloomberg Law Reports—Securities Law. Reprinted with permission. Bloomberg Law Reports® is a registered trademark and service mark of Bloomberg Finance L.P. resignation over aggressive accounting tactics. The 49 (7th Cir. 1997). The Eleventh Circuit also Court found that "[f]irms are not required by the recognized the clear difference between those securities laws to speculate about distant, concepts prior to the decision in Dura. See Robbins ambiguous, and perhaps idiosyncratic reactions by v. Koger Props., Inc., 116 F.3d 1441, 1447 (11th Cir. the press or even by directors." Accordingly, 1997). Given Dura's requirement that plaintiffs negative news coverage regarding the director's must establish loss causation—not just a departure—and the investor reaction to that misrepresentation, or reliance upon the coverage which led to a drop in stock price—was misrepresentation, but a causal nexus between the too tenuously connected to the alleged accounting misrepresentation and the actual loss suffered—it fraud to support liability because the facts leading may be increasingly difficult for plaintiffs to to the resignation had been public for a year. 597 establish liability for stock price drops against the F.3d at 514. backdrop of a volatile or down market. See, e.g., Ray v. Citigroup Global Markets, Inc., 482 F.3d 991 The Ninth Circuit has not yet had occasion to fully (7th Cir. 2007) (affirming summary judgment in explicate, in a reported opinion, the impact of Dura favor of defendants because, despite plaintiffs' on private securities fraud claims in the summary attempts to establish that a broker had omitted judgment context.2 Thus, Dura's legacy remains to material facts and that investors had relied on the be written in that Circuit.