What Is Necessary To Allege Loss Causation?

It has been a big summer for loss causation cases. A clear split in authority has developed between courts that believe plaintiffs must demonstrate a causal connection between the misrepresentations and a subsequent decline in the stock price (Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir. 2000); Robbins v. Koger Props, Inc., 116 F.3d 1441 (11th Cir. 1997)) and courts that believe plaintiffs merely need to allege that the misrepresentations artificially inflated the stock price (Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824 (8th Cir. 2003)).

In Broudo v. Dura Pharmaceuticals, 2003 WL 21789028 (9th Cir. Aug. 5, 2003), the Ninth Circuit clarified that it will not require plaintiffs to establish a causal connection between the misrepresentations and a decline in the stock price: loss causation “merely requires pleading that the price at the time of purchase was overstated and sufficient identification of the cause.” The facts of the case, however, underline the problems with this reasoning. Broudo is a securities class action on behalf of investors who purchased Dura stock between April 15, 1997 and February 24, 1998. The defendants allegedly made misleading statements during that time period about, among other things, the clinical trials necessary to obtain new drug approval from the FDA for Dura’s Albuterol Spiros delivery device for asthma medication. On February 24, 1998, Dura revealed that it expected lower-than-forecast 1998 revenues and 1998 earnings per share, but did not make any disclosures about its Albuterol Spiros delivery system. The February 24 announcement caused Dura’s stock price to decline by 47%. It was not until November 1998, nearly nine months after the end of the class period, that Dura announced the FDA had “found the Albuterol Spiros device not approvable due to electro-mechanical reliability issues and chemistry, manufacturing, and control concerns.” The district court found that the plaintiffs had failed to properly plead loss causation for his claims based on misleading statements concerning the Albuterol Spiros device because the complaint did “not contain any allegations that the FDA’s non-approval [of the Albuterol Spiros device] had any relationship to the February price drop.”

The 9th Circuit reversed. The court did not address the logical inconsistency of the plaintiffs’ argument that statements revealed to be misleading in November caused them to suffer losses the previous February. Instead, the court found that it was unnecessary for the plaintiffs to plead “that a disclosure and subsequent drop in the market price of the stock have actually occurred, because the injury occurs at the time of the transaction.”

The decision improperly conflates transaction causation and loss causation. Plaintiffs may have purchased on the basis of the alleged misrepresentations, but any loss requires the stock they purchased to decline in value. The practical problems created by the Broudo opinion are significant. As noted by Judge Pollack in the Merrill Lynch cases, “allowing plaintiffs in a fraud on the market case to satisfy loss causation simply by alleging that a misrepresentation caused the price to be artificially inflated without having to allege any link between the conduct and the decline in price would undoubtedly lead to speculative claims and procedural intractibility.” Moreover, the PSLRA expressly states that plaintiffs have the burden of establishing that their losses were caused by the defendants’ acts or omissions. How can plaintiffs’ claims be plead with particularity if they do not connect the alleged fraudulent conduct to any loss?

Holding: Reversed and remanded with leave to amend.

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