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

Heading: Loss Causation in a Fraud-on-the-Market Case

Text: 25 Of course, if the Defendants’ statements on February 23, 2005 (or on March 16, 2005) triggered no such disclosure obligation (an issue not raised in the summary judgment motion and not properly before us) -- for example, because disclosure of MIVA’s click fraud problems was not necessary to prevent the statements made on that day from being materially misleading -- then, naturally, any loss resulting from the Defendants’ omission on that date will not be cognizable. Omissions, absent a duty to disclose, are not actionable. Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988) (“Silence, absent a duty to disclose, is not misleading under Rule 10b-5.”); Thompson, 610 F.3d at 681 (“Under the plain language of Rule 10b-5, for the omission of a material fact to be actionable, there must have been a duty to disclose the fact.”); Ziemba, 256 F.3d at 1206 (“[A] defendant’s omission to state a material fact is proscribed only when the defendant has a duty to disclose.” (alteration in original) (internal quotation marks omitted)); see also Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. --, 131 S. Ct. 1309, 1322 (2011) (“[C]ompanies can control what they have to disclose . . . by controlling what they say to the market.”). 46 The loss causation element of a Rule 10b-5 claim requires that the defendant’s fraud be both the but-for and proximate cause of the plaintiff’s later losses. In re Omnicom Group, Inc. Sec. Litig., 597 F.3d 501, 510 (2d Cir. 2010); see also Bastian v. Petren Resources Corp., 892 F.2d 680, 683, 685 (7th Cir. 1990) (calling loss causation simply “an exotic name” for “the standard common law fraud rule” requiring the plaintiff to prove both factual and legal causation); 4 Thomas Lee Hazen, Law of Securities Regulation § 12.11 (6th ed. 2009) (section cited with approval in Dura, 544 U.S. at 342) (“Causation in securities law involves the same analysis of cause in fact and legal cause that was developed under the common law.”); cf. Dura, 544 U.S. at 344-45 (noting “common-law roots of the securities fraud action” and basing loss causation analysis on common-law tort causation). The plaintiff must show that the defendant’s fraud -- as opposed to some other factor -- proximately caused his claimed losses. Dura, 544 U.S. at 342-43; Bruschi v. Brown, 876 F.2d 1526, 1530 (11th Cir. 1989). However, the plaintiff need not show that the defendant’s misconduct was the “sole and exclusive cause” of his injury; he need only show that the defendant’s act was a “substantial” or “significant contributing cause.” Robbins v. Koger Properties, Inc., 116 F.3d 1441, 1447 (11th Cir. 1997) (quoting Bruschi, 876 F.2d at 1531). 47 The Plaintiffs’ claims here rely on a fraud-on-the-market theory of causation. Fraud-on-the-market claims derive from the so-called efficient market hypothesis, which provides, in the words of the Supreme Court, that “in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business.” See Basic, 485 U.S. at 241 (quoting Peil v. Speiser, 806 F.2d 1154, 1160 (3d Cir. 1986)). Because “millions of shares chang[e] hands daily,” id. at 243, and a critical mass of “market makers” study the available information and influence the stock price through trades and recommendations, id. at 248, an efficient capital market rapidly and efficiently digests all available information and translates that information into “the processed form of a market price,” id. at 244. A corollary of the efficient market hypothesis is that disclosure of confirmatory information -- or information already known by the market -- will not cause a change in the stock price. This is so because the market has already digested that information and incorporated it into the price. See Greenberg v. Crossroads Sys., Inc., 364 F.3d 657, 665-66 (5th Cir. 2004) (“[C]onfirmatory information has already been digested by the market and will not cause a change in stock price.”). A “fraud on the market” occurs when a material misrepresentation is knowingly disseminated to an informationally efficient market. Basic, 485 U.S. at 48 247. Just as an efficient market translates all available truthful information into the stock price, the market processes the publicly disseminated falsehood and prices it into the stock as well. See id. at 241-42, 243-44, 246-47. The market price of the stock will then include an artificial “inflationary” value -- the amount that the market mistakenly attributes to the stock based on the fraudulent misinformation. So long as the falsehood remains uncorrected, it will continue to taint the total mix of available public information, and the market will continue to attribute the artificial inflation to the stock, day after day. If and when the misinformation is finally corrected by the release of truthful information (often called a “corrective disclosure”), the market will recalibrate the stock price to account for this change in information, eliminating whatever artificial value it had attributed to the price. That is, the inflation within the stock price will “dissipate.” In a fraud-on-the-market case, the Supreme Court allows the reliance element of a Rule 10b-5 claim to be rebuttably presumed, so long as the defendant’s fraudulent misstatement was material and the market was informationally efficient. See id. at 247 (“Because most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentations . . . may be presumed for purposes of a Rule 10b-5 action.”). This presumption follows directly from the efficient market hypothesis. 49 Because an informationally efficient market rapidly and efficiently translates public information into the security’s price, the market price will reflect the defendant’s fraudulent statement, and everyone who relies on the market price as a reflection of the stock’s value in effect relies on the defendant’s misrepresentation.26 Id. at 241; see also Peil, 806 F.2d at 1161. “Misleading statements will therefore defraud purchasers of stock even if the purchasers do not 26 The Supreme Court explained the reasoning this way in Basic: The modern securities markets, literally involving millions of shares changing hands daily, differ from the face-to-face transactions contemplated by early fraud cases, and our understanding of Rule 10b-5’s reliance requirement must encompass these differences. In face-to-face transactions, the inquiry into an investor’s reliance upon information is into the subjective pricing of that information by that investor. With the presence of a market, the market is interposed between seller and buyer and, ideally, transmits information to the investor in the processed form of a market price. Thus the market is performing a substantial part of the valuation process performed by the investor in a face-to-face transaction. The market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price. Basic, 485 U.S. at 243-44 (footnotes and internal quotation marks omitted). 50 directly rely on the misstatements.”27 Basic, 485 U.S. at 241-42 (quoting Peil, 806 F.2d at 1160). While reliance focuses on the front-end causation question of whether the defendant’s fraud induced or influenced the plaintiff’s stock purchase, loss causation provides the “bridge between reliance and actual damages.” In re Cooper Cos. Sec. Litig., 254 F.R.D. 628, 638 (C.D. Cal. 2009). In a fraud-on-themarket case -- where the plaintiff’s claim is generally not that the initial investment transaction would not have occurred at all without the fraudulent misrepresentation, but only “that it would have occurred at a different price,” Hazen, supra, § 12.11 -- loss causation requires proof that the fraud-induced inflation that was baked into the plaintiff’s purchase price was subsequently removed from the stock’s price, thereby causing losses to the plaintiff. See Robbins, 116 F.3d at 1448 (holding that loss causation requires plaintiffs to show that the “price inflation was removed from the market price of [the] stock, causing 27 The fraud-on-the-market presumption can be rebutted by “[a]ny showing that severs the link between the alleged misrepresentation and either the price . . . paid . . . by the plaintiff, or his decision to trade at a fair market price.” Basic, 485 U.S. at 248-49. For example, the defendant can rebut the presumption of reliance by presenting evidence that the market price did not in fact reflect the misrepresentation, or that the particular plaintiff knew about the fraud but bought the stock at that price anyway for independent reasons. Id. The reliance element of a Rule 10b-5 action, therefore, patrols the question of whether the defendant’s fraud in fact affected (or inflated) the purchase price that investors paid. See id. at 247-48; Lipton v. Documation, Inc., 734 F.2d 740, 745 (11th Cir. 1984); Peil, 806 F.2d at 1161. 51 plaintiffs a loss”). In other words, proof of a fraudulently inflated purchase price only satisfies reliance; loss causation requires going a step further to supply “the logical link between the inflated share purchase price and any later economic loss.” Dura, 544 U.S. at 342; see also Robbins, 116 F.3d at 1448-49 (explaining that an inflated purchase price supports a finding of reliance, but not loss causation). Plaintiffs frequently demonstrate loss causation in fraud-on-the-market cases circumstantially, by: (1) identifying a “corrective disclosure” (a release of information that reveals to the market the pertinent truth that was previously concealed or obscured by the company’s fraud);28 (2) showing that the stock price 28 See In re REMEC Inc. Sec. Litig., 702 F. Supp. 2d 1202, 1266-67 (S.D. Cal. 2010) (“A ‘corrective disclosure’ is a disclosure that reveals the fraud, or at least some aspect of the fraud, to the market.” (internal quotation marks omitted)). A corrective disclosure can come from any source, and can “take any form from which the market can absorb [the information] and react,” Matthew L. Fry, Pleading and Proving Loss Causation in Fraud-on-the-Market-Based Securities Suits Post-Dura Pharmaceuticals, 36 Sec. Reg. L.J. 31, 64-71 (2008), so long as it “reveal[s] to the market the falsity” of the prior misstatements, Lentell v. Merrill Lynch & Co., 396 F.3d 161, 175 n.4 (2d Cir. 2005). In order to qualify as corrective, the disclosure must share the same subject matter as the prior misstatement; only then can the disclosure be said to have a “corrective effect,” rather than merely a “negative effect.” In re Initial Public Offering Sec. Litig., 399 F. Supp. 2d 261, 266 (S.D.N.Y. 2005); see also In re Williams Sec. Litig. -- WCG Subclass, 558 F.3d 1130, 1140 (10th Cir. 2009) (“To be corrective, the disclosure need not precisely mirror the earlier misrepresentation, but [its subject matter] must at least relate back to the misrepresentation and not to some other negative information about the company.”); Lentell, 396 F.3d at 173 (“[T]o establish loss causation, a plaintiff must allege that the subject of the fraudulent statement or omission was the cause of the actual loss suffered . . . .” (internal quotation marks and alteration omitted)). Moreover, because a corrective disclosure must reveal a previously concealed truth, it obviously must disclose new information, and cannot be merely confirmatory. See Catogas v. Cyberonics, Inc., 292 F. App’x 311, 314 (5th Cir. 2008). 52 dropped soon after the corrective disclosure; and (3) eliminating other possible explanations for this price drop, so that the factfinder can infer that it is more probable than not that it was the corrective disclosure -- as opposed to other possible depressive factors -- that caused at least a “substantial” amount of the price drop. See In re Williams, 558 F.3d at 1137 (“Loss causation is easiest to show when a corrective disclosure reveals the fraud to the public and the price subsequently drops -- assuming, of course, that the plaintiff could isolate the effects from any other intervening causes that could have contributed to the decline.”); Lentell, 396 F.3d at 175 (“[Loss causation is adequately pled by alleging] that the market reacted negatively to a corrective disclosure regarding the falsity of [the defendant’s prior statements].”).29 Thus, loss causation analysis in a fraud-on-the-market case focuses on the following question: even if the plaintiffs 29 See also Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330, 336-37 (5th Cir. 2010) (“Causation therefore requires the Plaintiff to demonstrate the joinder between an earlier false or deceptive statement, for which the defendant was responsible, and a subsequent corrective disclosure that reveals the truth of the matter, and that the subsequent loss could not otherwise be explained by some additional factors revealed then to the market.”); Glaser v. Enzo Biochem, Inc., 464 F.3d 474, 477 (4th Cir. 2006) (“Dura requires plaintiffs to plead loss causation by alleging that the stock price fell after the truth of a misrepresentation about the stocks was revealed . . . .”); In re REMEC Inc., 702 F. Supp. 2d at 1266 (“Price inflation alone is insufficient [to establish loss causation]; rather, a plaintiff must show that an economic loss occurred after the truth behind the misrepresentation or omission became known to the market.”); In re Intelligroup Sec. Litig., 527 F. Supp. 2d 262, 295 (D.N.J. 2007) (“[T]he holding of Dura makes it clear that, in order to establish loss causation, a plaintiff must allege that the subject of the fraudulent statement or omission was the cause of the actual loss suffered, i.e., that the misstatement or omission concealed something from the market that, when disclosed, negatively affected the value of the security.” (internal quotation marks and alterations omitted)). 53 paid an inflated price for the stock as a result of the fraud (i.e., even if the plaintiffs relied), did the relevant truth eventually come out and thereby cause the plaintiffs to suffer losses? See Dura, 544 U.S. at 347 (indicating that the plaintiffs -- who alleged that they had purchased stock at an inflated price -- would have successfully alleged loss causation if their pleading had also claimed that “[the company]’s share price fell significantly after the truth became known”).