After Dura: Causation in Fraud-on-the-Market Actions
Fox, Merritt B., Journal of Corporation Law
On April 19, 2005, the Supreme Court announced its unanimous opinion in Dura Pharmaceuticals, Inc. v. Broudo,1 concerning what a plaintiff must show to establish causation in a Rule 10b-5 fraud-on-the-market suit for damages. The opinion had been awaited with considerable anticipation, being described at the time of oral argument in the Financial Times, for example, as the "most important securities case in a decade."2 After the opinion was handed down, a representative of the plaintiffs' bar lauded it as a "unanimous ruling protecting investors' ability to sue."3 A representative of the defendants' bar equally enthusiastically hailed it as "a significant victory for public companies and others named as defendants in securities fraud cases."4 This Article seeks to ascertain the opinion's real significance and to provide a framework for resolving the issues that remain open to be decided by future courts. In the tradition of Bob Clark's treatment of Rule 10b-5 issuer misstatement cases, this framework recognizes that these issues involve difficult tradeoffs that defy perfect solutions.5
The Supreme Court's grant of certiorari in Broudo v. Dura Pharmaceuticals came against the backdrop of years of highly confusing lower court decisions concerning what a plaintiff needs to show to establish causation in a fraud-on-the-market suit. This confusion had arisen, I will argue, because the lower courts had tried to analyze causation in fraud-on-the-market cases using the twin concepts of "transaction causation" and "loss causation." These concepts had been originally developed in connection with causation determinations in cases based on traditional reliance. Traditional reliance-based cases, unlike fraud-on-the-market cases, involve the plaintiff establishing that defendant's misstatement induced the plaintiff to enter into what has turned out to be a losing transaction. In such cases, transaction causation was satisfied by the very showing of traditional reliance, i.e., that the plaintiff would not have purchased but for the misstatement.6 Loss causation in these cases involved, in turn, an additional showing that the purchased security declined in value from what was paid (or was sold at a loss) and that the decline or loss was in some way reasonably related to the falsity of the statement that induced the purchase.7 The function of the loss causation requirement, like the function of proximate cause in actions for negligence, was to prevent the wrongdoer from being responsible for all the consequences for which his action was a "but for" cause, i.e., all the losses, however unrelated to the misstatement, that the plaintiff might suffer over time as a result of purchasing this security.
Fraud-on-the-market actions such as Dura are very different from traditional reliance-based actions. The plaintiff in a traditional reliance-based action is typically a purchaser involved in either a face-to-face transaction in shares of a non-publicly traded issuer or an IPO. These are the only situations where plaintiffs are likely to be able to show traditional reliance. These are situations where there is no reason to assume that the price is an efficient one. In contrast, plaintiffs in fraud-on-the-market actions such as Dura are purchasers in active public secondary markets, where prices can be assumed to be efficient. Fraud-on-the-market actions involve a fundamentally different kind of causal connection between the defendant's misstatement and the plaintiffs injury. The defendant's misstatement injures the plaintiff not because it caused her to make a purchase that later, ex post, turned out to be a losing transaction. Rather, it injures her because, ex ante, it caused her to pay a purchase price that is higher than it would have been but for the misstatement. The purchase is one that she might well have made even if the defendant had not made the misstatement. This causal connection between the misstatement and an injury in the form of its effect on price at the time the plaintiff enters into the transaction was recognized by the Court when it originally approved fraud-onthe-market actions in Basic v. …