Wednesday, April 20, 2005 | 9:44 a.m.
WASHINGTON -- The Supreme Court ruled on Tuesday in a closely watched fraud case that an accusation that a company's misrepresentations caused an inflated share price was insufficient as a basis for a lawsuit.
Investors bringing such a suit must claim at the outset, the court ruled, that the artificially high stock price eventually caused their losses. Under the ruling, failure to include such accusations in the original complaint will result in dismissal of the lawsuit.
The decision, while a blow to plaintiffs' lawyers, was neither surprising nor, evidently, particularly difficult for the justices. In a unanimous opinion of only 11 pages, the Supreme Court aligned itself with a majority of the federal appeals courts, including the 2nd U.S. Circuit Court of Appeals, in New York.
Earlier this year, that court adopted the same approach in throwing out a lawsuit by investors who claimed that unduly positive reports by Merrill Lynch had been responsible for their losses in the stocks of Internet start-up companies.
Justice Stephen G. Breyer, writing for the Supreme Court on Tuesday, said that the purpose of permitting private lawsuits for securities fraud was "not to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause."
The decision overturned a 2003 ruling by the 9th U.S. Circuit Court of Appeals, in San Francisco, that had permitted a class-action lawsuit to proceed against Dura Pharmaceuticals for losses that the plaintiffs said were the result of misstatements about the prospects for government approval of a new spray device for the treatment of asthma.
The 9th Circuit's position was that plaintiffs need only represent that on the date of their stock purchase, the share price was higher than it would have been but for misrepresentations about a company's performance or prospects. The 9th Circuit was the only appeals court to have adopted such a pro-plaintiff interpretation.
Under the prevailing rule, which the Supreme Court endorsed, investors who claim that they paid too much for a stock because of fraudulent misrepresentation cannot recover damages unless they can show that the subsequent drop in price was tied directly to the original misrepresentation, through the issuance of a corrective disclosure, for example.
Breyer said that in the absence of proof, it was not logical to assume that an eventual drop in share price was the result of the misrepresentation.
He said the lower price could just as well reflect "changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions or other events."
In his opinion, Dura Pharmaceuticals Inc. v. Broudo, No. 03-932, Breyer also noted that the Private Securities Litigation Reform Act of 1995, which Congress passed to curb class-action securities-fraud suits, required plaintiffs to show that the defendant's misrepresentations "caused the loss for which the plaintiff seeks to recover."
The 9th Circuit had held in the case that "loss causation is satisfied where the plaintiff shows that the misrepresentation touches upon the reasons for the investment's decline in value."
But Breyer observed: "To 'touch upon' a loss is not to cause a loss, and it is the latter that the law requires."
The case now goes back to the U.S. District Court in California that had originally thrown it out for failing to meet the legal test of "loss causation."
Dura was a pharmaceutical company based in San Diego in the late 1990s when the events that led to the lawsuit took place. It later merged with the Elan Corp.
According to the plaintiffs' accusations -- which, because no trial has taken place, remain unproven -- Dura falsely claimed that its asthma product would soon receive approval from the Food and Drug Administration.
When Dura announced eight months later, in November 1998, that approval would not be forthcoming, its share price, which had already dropped sharply from a high of $53 during the period when the plaintiffs were buying it, fell to $9.75 from $12.75.
The Securities and Exchange Commission supported Dura's Supreme Court appeal, telling the Supreme Court that the 9th Circuit's approach "cannot be reconciled" with the Private Securities Litigation Reform Act.
Dura's lawyer, William F. Sullivan of the law firm Paul, Hastings, Janofsky & Walker, said the Supreme Court's decision would provide defendants in similar lawsuits "an important tool in avoiding expensive and often unmeritorious cases."
Patrick Coughlin, a lawyer with Lerach Coughlin Stoia Geller Rudman & Robbins who argued the case for the plaintiffs, predicted that when the case returned to the District Court, his clients would be able to meet the Supreme Court's test and keep the case alive.
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