Opinion ID: 3048173
Heading Depth: 3
Heading Rank: 4

Heading: Application to the Plaintiffs’ Evidence

Text: In opposing summary judgment, the Plaintiffs relied on the expert report of Dr. Hakala as evidentiary support for both loss causation and damages. The Defendants expressly assumed the admissibility of Dr. Hakala’s report for purposes of their summary judgment motion.30 (Dkt. 155, at 6). Dr. Hakala conducted an “event study” to demonstrate loss causation and to estimate damages. (Hakala Report, at 5-6, 10-11). “An event study . . . is a statistical 30 Although the Defendants moved in a separate motion to exclude Dr. Hakala’s report on the ground that his reasoning and methodology failed to comply with Federal Rule of Evidence 702 and Daubert v. Merrell Dow Pharmaceuticals., Inc., 509 U.S. 579 (1993), the district court denied the Defendants’ Daubert motion as moot upon granting summary judgment in the Defendants’ favor. See In re MIVA, 2009 WL 3821146, at . Notably, the district court never purported to reject Dr. Hakala’s report by finding that Hakala was not qualified by background and training to opine about loss causation or damages, or that his methodology was not sufficiently reliable, or that his testimony would not be helpful to the trier of fact. See United States v. Frazier, 387 F.3d 1244, 1260 (11th Cir. 2004) (en banc) (describing three-part inquiry a district court must conduct to admit expert testimony under Rule 702). Indeed, the district court did not even hold a hearing regarding Hakala’s expert qualifications. If the Defendants choose to renew their Daubert motion in light of this remand order, the district court must conduct the requisite Rule 702 inquiry before it may disregard the evidence offered by Dr. Hakala. 54 regression analysis that examines the effect of an event[, such as the release of information,] on a dependent variable, such as a corporation’s stock price.”31 United States v. Schiff, 602 F.3d 152, 173 n.29 (3d Cir. 2010) (internal quotation marks and alteration omitted). As acknowledged by the Defendants’ expert, event studies are a “common method” of establishing loss causation, “used routinely in the academic literature to determine whether the release of particular information has a significant effect on a company’s stock price.” (Dkt. 153-7, at 3-5, ¶¶ 9-11). Through his event study, Dr. Hakala concluded that MIVA’s stock price was inflated by 26.44 percent before and throughout the Class Period due to the false information in the marketplace that MIVA did not rely on click fraud to boost revenues. Dr. Hakala also concluded through his event study that immediately after the Company finally revealed the truth about its heavy reliance 31 Event studies can be used to determine retrospectively the cause of a stock price movement. The analyst first estimates a “predicted return,” based on the firm’s average return during a control period as well as on market and industry factors. If the actual stock price moves differently than the predicted return, the analyst then determines whether such “abnormal returns” are the result of chance or are instead statistically attributable to the information release. See In re Williams Sec. Litig., 496 F. Supp. 2d 1195, 1272 (N.D. Okla. 2007); 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, 167 (2007). The methodology of event studies has been sustained by many circuits. See, e.g., Archdiocese of Milwaukee, 597 F.3d at 341 (noting that event studies “demonstrate[] a linkage between the culpable disclosure and the stock-price movement”); Schiff, 602 F.3d at 173-74 & nn.29-31 (accepting as reliable under Daubert, 509 U.S. 579, an event study that linked a stock price drop with the revelation of fraud, for purposes of establishing materiality); Schleicher, 618 F.3d at 684 (affirming class certification based on expert’s event study). 55 on click fraud on May 5, 2005 -- admitting in an investor conference call that “a couple” of MIVA’s distribution partners had been employing “capabilities . . . to get additional traffic that just simply don’t adhere to our standards” (Compl. ¶ 103) -- the inflation in MIVA’s stock price dissipated, causing substantial losses to Class Period investors. (Hakala Report, at 7, 23-24, 29, Ex. B-1 at 9-10; Hakala Dep., at 58:2-4; Hakala Dec., Dkt. 172-1, at 3). Dr. Hakala excluded other possible explanations for the price drop following the May 5, 2005 disclosure, concluding that “the primary if not exclusive reason for the [price] drop [on May 5-9, 2005] was related to . . . the subject matter of the fraud . . . . [T]he confounding information in my analysis could not account for the drop -- did not account for the drop . . . .” (Dkt. 153-6, at 17 (Hakala Dep., at 58:2-19)). Reasoning that Class Period investors would not have suffered those losses if the Company had disclosed the truth at the beginning of the Class Period instead of at the end, Dr. Hakala estimated total Class Period damages to be $22.24 million. (Hakala Report, at 28-31). Even though the Plaintiffs purported to demonstrate that the market substantially devalued MIVA stock upon learning the truth about the Company’s click fraud woes on May 5, 2005 -- a devaluation that the Plaintiffs claim would have occurred at the start of the Class Period if only the truth had been revealed 56 then -- the district court concluded that the Plaintiffs’ evidence was insufficient as a matter of law to demonstrate loss causation and damages. The district court explained its reasoning this way: “Dr. Hakala testified that the full amount of the alleged price inflation of the stock -- 26.44% -- existed . . . more than a year before either of the[se] statements . . . , and remained at that level after the statements at issue. Thus, the evidence from plaintiff establishes that the inflation in the stock price was caused by statements made prior to the class period in this case.” In re MIVA, 2009 WL 3821146, at . In other words, the basic logic underlying the district court’s grant of summary judgment is that, because the inflation in MIVA’s stock price predated the Class Period, the statements made by the Defendants during the Class Period -- even if knowingly and materially false or misleading -- could not have “caused” the inflation, and therefore could not have “caused” the Plaintiffs’ losses. This reasoning misapprehends the nature of market fraud.32 32 The analysis also appears to conflate the concepts of reliance and loss causation -- two distinct elements of a Rule 10b-5 claim. As noted above, reliance polices the front-end causation question of whether the defendant’s fraud in fact inflated the plaintiff’s purchase price, while loss causation polices the back-end causation question of whether the fraud-induced inflation in the plaintiff’s purchase price ultimately caused financial losses. To the extent the district court concluded that the Defendants’ fraud did not affect the purchase price the Plaintiffs paid -- because the inflation in the price predated the fraudulent statements -- this appears to be a conclusion drawn about reliance, not loss causation. Indeed, the Court in Basic presaged the Defendants’ argument here and expressly placed it under the rubric of reliance, saying that fraud-on-the-market defendants may rebut the presumption of reliance by showing that “the misrepresentation in fact did not lead to a distortion of price.” 485 U.S. at 248. This appears to be essentially what the Defendants argued 57 The district court erroneously assumed that simply because confirmatory false statements have no immediate effect on an already inflated stock price in an efficient market, these statements cannot cause harm. But the inflation level need not change for new investors to be injured by a false statement. Fraudulent statements that prevent a stock price from falling can cause harm by prolonging the period during which the stock is traded at inflated prices. We therefore hold that confirmatory information that wrongfully prolongs a period of inflation -- even without increasing the level of inflation -- may be actionable under the securities laws.33 That is, defendants can be liable for knowingly and intentionally and the district court accepted, albeit using the language of loss causation. On remand, the parties should clarify their causation arguments, and specify whether their dispute actually goes to reliance or loss causation. 33 The Fifth Circuit appears to have rejected this view, holding that confirmatory information cannot be actionable. See Greenberg, 364 F.3d at 665 (stating that “confirmatory information cannot be the basis for a fraud-on-the-market claim”); see also Archdiocese of Milwaukee, 597 F.3d at 337 (explaining Greenberg as holding that confirmatory statements are not actionable because “[c]onfirmatory information is already known to the market and, having been previously digested by the market, will not affect the stock price”), cert. granted sub nom. Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 856 (2011) (addressing different issue). No other circuit has embraced this view. The rule also appears to conflict with the Fifth Circuit’s own recognition in Nathenson v. Zonagen Inc., 267 F.3d 400 (5th Cir. 2001), that fraudulent information that confirms what the market already believes is actionable if it prevents the stock price from dropping to the level the market would set if the truth were revealed. In Nathenson, the court said: We also realize that in certain special circumstances public statements falsely stating information which is important to the value of a company’s stock traded on an efficient market may affect the price of the stock even though the stock’s market price does not soon thereafter change. For example, if the market believes the company will earn $1.00 per share and this belief is reflected in the share price, then the share price may well not change when the company reports that it has indeed 58 causing a stock price to remain inflated by preventing preexisting inflation from dissipating from the stock price. See Schleicher, 618 F.3d at 683-84 (“[Defendants are liable for securities fraud regardless of whether their] false statements (or . . . material omissions) propel the stock’s price upward . . . [or] were designed to slow the rate of fall.”). At bottom, it is irrelevant to securities fraud liability that the stock price was already inflated before a defendant’s first actionable misrepresentation; fraudulent misstatements that prolong inflation can be just as harmful to subsequent investors as statements that create inflation in the first instance. Inflation creates an ongoing risk of harm. Every investor who purchases at an inflated price -- whether at the earned $1.00 a share even though the report is false in that the company has actually lost money (presumably when that loss is disclosed the share price will fall). Id. at 419; see also Regents of Univ. of Cal. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372, 403 n.14 (5th Cir. 2007) (Dennis, J., concurring in the judgment) (“[T]here appears to be no basis in Nathenson or otherwise for Greenberg’s conclusion that false ‘confirmatory’ statements can never support a claim proceeding under a fraud-on-the-market theory.”). While we agree with the Fifth Circuit that confirmatory information will not likely move the market price at the time of its release -- because the market already digested the information when it was first released -- we do not agree that such confirmatory information can therefore never be actionable. If a company knowingly makes materially false representations with the purpose and effect of preventing the stock price from falling to the level that the truth would yield, the company is responsible for perpetuating inflation within the stock price. See Schleicher, 618 F.3d at 683-84 (holding that companies are liable for “stop[ping] a price from declining” because, “the fraud lies in an intentionally false or misleading statement, and the loss is realized when the truth turns out to be worse than the statement implied”); In re Cooper Sec. Litig., 691 F. Supp. 2d 1105, 1116 (C.D. Cal. 2010) (holding that a company can be liable for “caus[ing] artificial inflation to continue to be incorporated into the stock price, as opposed to revealing the truth, which allegedly would have caused the stock price to fall”). 59 beginning, middle, or end of the inflationary period -- is at risk of losing the inflationary component of his investment when the truth underlying the misrepresentation comes to light. Investors who quickly resell their stock during the inflationary period generally will not suffer any economic loss from the fraud, because, although they overpaid for their stock, they can recoup the amount they overpaid by selling at the same inflated price. See Dura, 544 U.S. at 342 (“[I]f . . . [a] purchaser sells the shares . . . before the relevant truth begins to leak out, the misrepresentation will not have led to any loss.”). When the truth underlying the falsehood is finally revealed, however, the market will digest the new information and cease attributing the artificial inflation to the price. At that time, investors who purchased at inflated prices (and who still hold their stock) will suffer economic loss, because they will no longer be able to recoup the inflationary component of their purchase price by reselling their stock in the newly calibrated marketplace. See Schleicher, 618 F.3d at 684 (“People who buy the stock after the [fraudulent] announcement, and before the truth comes out, pay too much; they will lose money when the [concealed] bad news emerges.”). Because thousands of shares of stock are purchased each day, the longer that inflation remains within a stock price, the more shares that are purchased at inflated prices, and the more shares that stand to lose when the inflation 60 subsequently dissipates from the price. Clearly then, a falsehood that endures within the marketplace for a longer period of time, all else being equal, will cause greater harm than one that endures for a shorter period of time. There is no reason to draw any legal distinction between fraudulent statements that wrongfully prolong the presence of inflation in a stock price and fraudulent statements that initially introduce that inflation. See In re Cooper, 691 F. Supp. 2d at 1116 (denying summary judgment to defendants on loss causation grounds on the basis that “it [was] disputed as to whether the [defendants’] statements caused artificial inflation to continue to be incorporated into the stock price, as opposed to revealing the truth, which allegedly would have caused the stock price to fall” (emphasis added)); In re Scientific Atlanta, Inc. Sec. Litig., 754 F. Supp. 2d 1339, 1380 n.12 (N.D. Ga. 2010) (“Plaintiffs argue persuasively that the class period inflation includes . . . the pre-class period inflation that would have been removed from the stock price had [the company] accurately provided information about [the relevant truth at the start of the class period].”); In re Bristol-Myers Squibb Sec. Litig., No. Civ.A. 00-1990(SRC), 2005 WL 2007004, at  (D.N.J. Aug. 17, 2005) (stating, in the materiality context, that “it is conceivable that [an 61 affirmative] misstatement could serve to maintain the stock price at an artificially inflated level without also causing the price to increase further”).34 According to the Plaintiffs, MIVA’s stock price was already inflated before the Class Period because the market erroneously believed that MIVA did not rely on click fraud to boost revenues. The Plaintiffs allege that this information was materially false; in fact, MIVA suffered from rampant click fraud. According to the Plaintiffs, the Defendants had a duty to disclose the corrective truth about MIVA’s click fraud problems at the start of the Class Period. If the Defendants had revealed the truth then, the market would have digested this information and the artificial inflation within MIVA’s stock price would have dissipated. Instead, the Plaintiffs allege, the Defendants wrongfully continued to withhold this material truth from the market by making knowingly false or misleading statements to the public on February 23, 2005 and March 16, 2005, in which they failed to disclose the extent of MIVA’s reliance on click fraud and even affirmatively misrepresented that MIVA actively policed click fraud and “d[id] not 34 Cf. Matrixx Initiatives, 131 S. Ct. at 1313-16 (holding that plaintiffs had adequately pled a Rule 10b-5 claim -- where defendant had disputed the sufficiency of the allegations with respect to the elements of scienter and materiality -- by alleging that defendant had forestalled a stock price drop by making affirmative statements confirming the market’s impression that defendant’s leading product was safe, despite defendant’s awareness of evidence suggesting a significant risk that the nasal spray led to loss of sense of smell; when the risk was finally (belatedly) disclosed, the stock price plummeted). 62 rely on ‘spyware’ for any purpose.” (See Compl. ¶¶ 89, 91). According to the Plaintiffs, in so doing, the Defendants’ statements caused the market to continue to overvalue MIVA’s stock, based on its mistaken belief that MIVA did not rely on click fraud.35 Meanwhile, each day that MIVA’s stock price remained purportedly inflated, investors purchased thousands of shares of MIVA stock at inflated prices. These investors thus “overpaid” for MIVA stock based on the false information that MIVA did not rely on click fraud to generate Internet traffic. When the alleged truth about MIVA’s click fraud was revealed to the market on May 5, 2005, each of those investors who still held his stock lost the inflationary component of his purchase price -- at that time, the market ceased attributing inflation to the stock, and investors who had purchased at inflated prices were no longer able to recoup their overpayment by reselling their stock in the marketplace. Therefore, investors who purchased MIVA stock during the Class Period and still held their stock when the truth came out at the end of the Class Period paid inflated prices for their investment -- prices they would not have paid but for the defendant’s purported fraud -- and lost this inflationary overpayment 35 When a defendant issues an intentionally false statement, “the purpose and effect is to cause the market to attribute artificial inflated value to the stock. That market reaction is by definition a foreseeable consequence of fraud.” Madge S. Thorsen, Richard A. Kaplan & Scott Hakala, Rediscovering the Economics of Loss Causation, 6 J. Bus. & Sec. L. 93, 99 (2006). 63 when the revelation of the truth caused the market to drain the inflation from the stock price. The securities laws do not immunize defendants who knowingly disseminate materially false or misleading information simply because their fraud concerns false information already believed by the market. Defendants whose fraud prevents preexisting inflation in a stock price from dissipating are just as liable as defendants whose fraud introduces inflation into the stock price in the first instance. We decline to erect a per se rule that, once a market is already misinformed about a particular truth, corporations are free to knowingly and intentionally reinforce material misconceptions by repeating falsehoods with impunity. Defendants who commit fraud to prop up an already inflated stock price do not get an automatic free pass under the securities laws.