Capital Markets

Investors Must Prove Loss in Fraud Suits

Securities statutes are not meant ''to provide investors with broad insurance against market losses,'' maintains the Supreme Court opinion.
Stephen TaubApril 20, 2005

The Supreme Court ruled unanimously that investors accusing a company of securities fraud must make a direct connection between the fraud and a subsequent decline in the company’s share price.

The ruling, which overturned an opinion of the U.S. Court of Appeals for the Ninth Circuit, stemmed from a lawsuit against Dura Pharmaceuticals. The suit sought damages on behalf of investors who bought Dura shares between April 15, 1997, and February 24, 1998. The company’s share price declined sharply in 1998 after earnings came in lower than expected, then again after the Food and Drug Administration failed to approve a new Dura asthma inhaler for sale.

Irish drug manufacturer Elan Corp. acquired Dura in 2000.

Shareholders had alleged that Dura’s stock price was artificially high because of earlier statements made by the company, and the appeals court found that shareholder lawsuits could prevail if they simply showed that company statements fraudulently inflated the stock price.

Securities statutes exist to maintain public confidence in the stock markets and to deter fraud, wrote Justice Stephen Breyer for the court, reported The New York Times. Breyer added, however, that the statutes are not meant “to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause.”

The Ninth Circuit’s found that misrepresentation “touches upon” a later economic loss, Breyer reportedly wrote. “To ‘touch upon’ a loss is not to cause a loss,” he added, according to the Times. “and it is the latter that the law requires.”

The ruling could undermine hundreds of lawsuits filed by shareholders who lost money during the stock market’s collapse in the early years of the new millennium, according to Bloomberg. The wire service observed that the ruling is also a big defeat for the California Public Employees’ Retirement System and New York City’s pension funds, which argued against lawsuit limits.

On the other hand, reported Bloomberg, the Bush Administration and Merrill Lynch & Co. have been pushing for more stringent rules when it comes to shareholder complaints.

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