Risk & Compliance

Supreme Court to Rule on Securities Law

Shareholders who bring class-action securities lawsuits against companies for alleged fraud may face more stringent requirements to prove their cases.
Craig SchneiderJanuary 12, 2005

A new case taken up today by the U.S. Supreme Court will determine how stringent to make a standard of pleading and proof for securities fraud class-action lawsuits — and the eventual ruling may have broad ramifications for how well companies can fend off future claims.

Broudo v. Dura Pharmaceuticals is being called by some observers the most important securities case the high court has looked at in at least a decade. To be sure, courts have always required plaintiffs in such cases to show causation; the question is how to show it. The Supreme Court will decide whether it’s enough to show that investors purchased stock at a time it was allegedly inflated, or whether investors are required to show a stronger link between their losses and the decline in the value of the stock. Federal appeals courts have rendered conflicting decisions on this issue.

In Dura, plaintiffs allege that Dura Pharmaceuticals fraudulently promoted the satisfactory development and testing of its asthma-drug device Albuterol Spiros on April 15, 1997. On February 24, 1998, Dura reported lower-than-expected revenue and earnings for the year, which caused shares of Dura to fall 47 percent the next day. Nine months later, Dura announced that the Food and Drug Administration had rejected Albuterol Spiros due to questions about the device’s reliability.

Michael Broudo and a group of investors brought suit against the company, claiming that they purchased Dura Pharmaceuticals on the strength of its positive statements. Dura was later acquired by Dublin-based biotech Elan Corp. Plc in 2000.

According to the district court, Broudo would be required to prove a causal connection between the alleged fraud and a subsequent decline in stock price. The Ninth Circuit Court of Appeals reversed that decision and adhered to a “loss causation” standard that does not require such proof.

The high court’s eventual ruling could have a big impact on shareholders’ ability to bring future securities claims. “If the Supreme Court were to agree with the Ninth Circuit [court of appeals] approach, it may be more difficult for companies to end litigation at the motion-to-dismiss stage,” says Keara Bergin, partner at New York-based law firm Dewey Pegno & Kramarsky LLP. Dismissal motions that are denied, she adds, lead to an expensive discovery phase and then trial.

Several pension funds argue that the high court should adopt the more flexible loss-causation standard for the initial pleading stage of securities fraud lawsuits. If the Supreme Court reverses the Ninth Circuit, it would be issuing a “draconian interpretation” of the standard of pleadings and burden of proof, inhibiting the ability of shareholders to pursue claims against the most egregious of fraudulent companies, notes Jay Eisenhofer, whose firm Grant & Eisenhofer represents funds such as the California Public Employees Retirement System (Calpers).

“The court needs to walk a fine line so it does not choke off legitimate claims,” Eisenhofer said in a statement. He called the case before the Supreme Court a “back-door attempt by the U.S. Chamber of Commerce and others to rewrite the securities laws in a way that is highly injurious to investors.”

Bergin believes that Dura, which is technically a fraud-on-the-market case, will have ramifications only for that group. She also maintains, however, that most securities-fraud class-action lawsuits are fraud-on-the-market cases, so they can be certified without the need for each class member to plead and prove individual reliance on a defendant’s alleged misrepresentations or omission. “This decision will have a great impact in the Ninth Circuit,” she says, adding that “there are a lot of cases across the country.”

There were 212 “traditional” class-action filings in 2004, according to Cornerstone Research, compared with an average of 190 filings per year between 1996 and 2003.