Amicus Curiae Brief — Dura Pharmaceuticals, Inc. v. Broudo

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No. 03-932

IN THE

Supreme Court of the United States

DURA PHARMACEUTICALS, INC. ET AL.,

Petitioners,

Vv.

MICHAEL BROUDO ET AL.,

Respondents.

On Writ of Certiorari to the

United States Court of Appeals

for the Ninth Circuit

BRIEF OF THE CHAMBER OF COMMERCE OF

THE UNITED STATES AS AMICUS CURIAE

IN SUPPORT OF PETITIONERS

ROBIN S. CONRAD NEIL M. GORSUCH

STEPHANIE A. MARTZ Counsel of Record

NATIONAL CHAMBER PAUL B. MATEY

LITIGATION CENTER, INC. KELLOGG, HUBER, HANSEN,

1615 H Street, N.W. TODD & EVANS, P.L.L.C.

Washington, D.C. 20036 1615 M Street, N.W.

(202) 463-5337 Suite 400

Washington, D.C. 20036

(202) 326-7900

Counsel for Amicus Curiae

September 13, 2004

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TABLE OF CONTENTS

Page

CE deter cenicinircanennerennmentecnmememee iil

INTEREST OF THE AMICUS CURIAE................0..00s0000 l

RIES PU GUI IIIIIITT cccccccccncecsccnnescesesesescerevecconees 2

San Lisclasinschssnsssillihicsbtinienbhialiaauiiidibiniinianianisinhigtanmnntennenummenn 4

I. THE PRESSURE TO SETTLE EVEN

MERITLESS SECURITIES CLASS AC-

TIONS {MPOSES AN ENORMOUS TOLL

ON THE AMERICAN ECONOMY ................::00008 4

Il. THE NINTH CIRCUITS RULE WOULD

SIGNIFICANTLY EXACERBATE THE

PROBLEMS AND INCREASE THE SOCIAL

COSTS ASSOCIATED WITH MERITLESS

SECURITIES CLASS ACTIONS ...............::0s0000 10

| _______EEEnE ne DO ee eEE DENTS ESTED 17

TABLE OF AUTHORITIES

Page

CASES

BankAmerica Corp. Sec. Litig., In re, 95 F. Supp.

2d 1044 (E.D. Mo. 2000), affd, 263 F.3d 795

SL 10

Basic Inc. v. Levinson, 485 U.S. 224 (1988)...................-. 16

Bastian v. Petren Res. Corp., 892 F.2d 680

a cessnenenenens 3, 15, 16

Blue Chip Stamps v. Manor Drug Stores, 421 U.S.

TT 4,6

California Micro Devices Sec. Litig., In re, No. C-

94-2817-VRW, 1995 WL 476625 (N.D. Cal. Aug.

a cenomonononoonones 9

Daubert v. Merrell Dow Pharms., Inc., 509 U.S.

a cosnnnesonsooccs 14, 15

Emergent Capital Inv. Mgmt., LLC v. Stonepath

Group, Inc., 343 F.3d 189 (2d Cir. 2003) .................000. 3

Ferber v. Travelers Corp., 785 F. Supp. 1101

a ovensnscunece 7

Fruchter v. Florida Progress Corp., No. 99-6167CI-

20, 2002 WL 1558220 (Fla. Cir. Ct. Mar. 20,

a. sssstennnnonoooacovecs 9

General Elec. Co. v. Joiner, 522 U.S. 136 (1997)............. 14

Goldberger v. Integrated Res., Inc., 209 F.3d 43

a neteenenenes 8

Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999) ...... 14

Network Assocs., Inc. Sec. Litig., In re, 76 F. Supp.

ae er ee Cs Me iciiniceictestiinsaciasieinliitdaiali tate icin 3

Newton v. Merrill Lynch, Pierce, Fenner & Smith,

Inc., 259 F.3d 154 (3d Cir. 2001)............000000000..0000000000. 8

Quantum Health Res., Inc. Sec. Litig., In re,

962 F. Supp. 1254 (C.D. Cal. 1997)............ccccccccccssseeees 8

Qwest Communications Int'l, Inc. Sec. Litig., In re,

243 F. Supp. 2d 1179 (D. Ss 6

Robbins v. Koger Props., Inc., 116 F.3d 1441

Is ii aaa altace iad 3,13

SEC v. Texas Gulf Sulphur Co., 401 F.2d 833

PD Mtr acciinisncresiesitiiehiehitiiiteiiin dtitiartihasteatiaataeitahidliaaiiaceaaa 6

Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir.

STU UTTet cncchesiiehapiiiinhieaehe ahaa teak cialis cddaaiaes ia hia 3

West v. Prudential Secs., Inc., 282 F.3d 935

IIE: SIITITTT ccsincitatenstaiasiiasaiaileeniietindceieaiademiacathdiaiaineiaitatenal 7, 15

STATUTES AND RULES

Private Securities Litigation Reform Act of 1995,

Pub. L. No. 104-67, 109 Stat. 37.................c0000sseseeeee 5

Securities Litigation Uniform Standards Act of

1998, Pub. L. No. 105-353, 112 Stat. 3227............... 5

ie ie My ee ictininnii nant ehiadiatanttaaiatincinaaieiealainainniliatdiiicaass 14

8 en rN EE Re NEO See ee 1

LEGISLATIVE MATERIALS

Conference Report on H.R. 1058. Private Securities

Litigation Reform Act of 1995, 141 Cong. Rec.

EET Ti SUIT iccinsiorittarsicesesiieiniciniiabiniinaniaibeninenies

H.R. Rep. No. 106-320 (1909) ...............c.ccccscrsccccsscssseessees

Securities Fraud on the Internet: Hearings Before

the Permanent Subcomm. on Investigations of

the Senate Comm. on Government Affairs,

106th Cong. (Mar. 22-23, 1999), available at

OTHER AUTHORITIES

2003 PricewaterhouseCoopers Securities Litigation

Study (rel. Aug. 2, 2004), at http:/Awww.10b5.

IED ccnecninnittisirtittinicsisiinnitllaemtnmmnaatemmaiess

Janet Cooper Alexander, Do the Merits Matter?

A Study of Settlements in Securities Class

Actions, 43 Stan. L. Rev. 497 (1991) ...............2...00e0000

Janet Cooper Alexander, Rethinking Damages in

Securities Class Actions, 48 Stan. L. Rev. 1487

Jennifer H. Arlen & William J. Carney, Vicarious

Liability for Fraud on Securities Markets:

Theory and Evidence, 1992 U. Ill. L. Rev. 691 ...........

Elaine Buckberg et al., NERA, Recent Trends in

Securities Class Action Litigation: 2003 Early

Update (Feb. 2004) .............s.ccscsscessessecsesessecsesecseeneens 1,5

Guido Calabresi, Concerning Cause and the Law of

Torts: An Essay for Harry Kalven, Jr., 43 U.

Ss les a ncrrscnsissiiestnpnaininmantniiicaiaiiaiiieees

CNBC, CNBC TV, at http://moneycentral.msn.com/

nn. eceeieniemiasmaniiainmials 16

CNN, CNNfn on TV, at http://money.cnn.com/ontv........ 16

Frank H. Easterbrook & Daniel R. Fischel,

Optimal Damages in Securities Cases, 52 U.

Tn il 5, 10

Paul A. Ferrillo et al., The “Less Than” Efficient

Capital Markets Hypothesis: Requiring More

Proof from Plaintiffs in Fraud-on-the-Market

Cases, 78 St. John’s L. Rev. 81 (2004) ...........00.0000000.. 13

Kenneth R. Foster et al., Phantom Risk: Scientific

Inference and the Law (1993) ...............cccccceececeeeees 14, 15

FOXNews.com, FNC Shows, at http://www.

ES _S LTTE AOTC Fe RAE Le eT 16

W. Page Keeton et al., Prosser and Keeton on Torts

| Ee SAS reno omea? 4,15

Donald C. Langevoort, Capping Damages for Open-

Market Securities Fraud, 38 Ariz. L. Rev. 639

Christopher B. Mueller & Laird C. Kirkpatrick,

I re 14

Richard Painter et al., The Federalist Society for

Law and Public Policy Studies, Private Securi-

ties Litigation Reform Act: A Post-Enron

Analysis (2003), at http://www.fed-soc.org/pdf/

TST ERATE IIL AC: 8,9

Michael A. Perino, Did the Private Securities

Litigation Reform Act Work?, 2003 U. IIL L.

vii

Richard A. Posner, Economic Analysis of the Law

GI, TIE icrnnanithienienanicnnadensdeniniemeainininenensdetiens 12, 17

Press Release, Qwest Communications, Qwest

Communications Statement In Response to

Motion Filed by Milberg Weiss Bershad Hynes

BD ree Ee te & FI cccrctetitecseneseccnscneneeesesecescnns 6

Victor E. Schwartz et al., Federal Courts Should

Decide Interstate Class Actions: A Call for Fed-

eral Class Action Diversity Jurisdiction Reform,

36 Harv. J. on Legis. 483 (2000) .................cccceeeseeeeeeeees 7

Laura E. Simmons & Ellen M. Ryan, Cornerstone

Research, Post-Reform Act Securities Lawsuits:

Settlements Reported Through December 2002

Laura E. Simmons & Ellen M. Ryan, Cornerstone

Research, Post-Reform Act Securities Lawsuits:

Settlements Reported Through December 2003

Stanford Law School & Cornerstone Research,

Securities Class Action Clearinghouse, at

http://securities.stanford.edu/companies.html ............. 8

Jonathan Weil, Win Lawsuit — and Pay $300

Million, Wall St. J., Aug. 2, 2004, at C3 .................0000.. 4

Elliot J. Weiss & John S. Beckerman, Let the

Money Do the Monitoring: How Institutional

Investors Can Reduce Agency Costs in Securi-

ties Class Actions, 104 Yale L.J. 2053 (1995)................ 4

Woodruff-Sawyer & Co., A Study of Shareholder

Class Action Litigation (2002)...............:.:cssseeeeeeeeeeeeeees 4

INTEREST OF THE AMICUS CURIAE '

The Chamber of Commerce of the United States (the

“Chamber”) is the world’s largest business federation.

The Chamber represents an underlying membership of_

more than three million businesses and organizations of

every size, in every industry sector, and from every region

of the country. The Chamber regularly advocates the in-

terests of its members in court involving issues of national

concern to the American business community.

The Chamber has a substantial interest in the issu.

presented in this case: the proper application of the loss

causation principle in securities litigation. Securities

class action litigation imposes an enormous toll on the na-

tional economy, affecting virtually every public corpora-

tion in America at one time or another and costing Ameri-

can businesses billions of dollars in settlements every

year. Indeed, recent studies conclude that, over a five-

year period, the average public corporation faces a 9%

probability of facing at least one securities class action

lawsuit. See Elaine Buckberg et al., NERA, Recent

Trends in Securities Class Action Litigation: 2003 Early

Update 4 (Feb. 2004) (“2003 Early Update”). As Con-

gresswoman Anna Eshoo (D-Cal.) has put it, “Businesses

in my region place themselves in one of two categories:

those who have been sued for securities fraud and those

that will be.””

Because of pressures unique to securities class action

litigation, virtually all claims that survive initial motions

practice are settled. With little prospect that their claims

will be fully tested by the adversarial process, plaintiffs

' Pursuant to Supreme Court Rule 37.6, counsel for amicus repre-

sents that they authored this brief and that no entity other than

amicus, its counsel, or its members made a monetary contribution to

its preparation or submission. All parties have consented to the filing

of this amicus brief, and letters reflecting their consent have been filed

with the Clerk.

? Conference Report on H.R. 1058, Private Securities Litigation Re-

form Act of 1995, 141 Cong. Rec. H14039, H14051 (Dec. 6, 1995).

have a strong incentive to bring securities class action

claims without regard to their underlying merit. By di-

verting resources away from productive economic uses,

meritless securities actions threaten to slow the spread of

new investments, reduce the efficiency of capital markets,

and limit the competitiveness of the American economy.

The membership of the Chamber thus has a strong inter-

est in ensuring that the requirements of the federal secu-

rities laws are applied in a correct and uniform manner,

weeding out meritless suits as quickly and regularly as

practicable, in order to avoid undue harm to the nation’s

commerce and industry.

SUMMARY OF ARGUMENT

While the statutory and legislative history arguments

for reversal are familiar, what may not be so apparent is

the practical impact of the Ninth Circuit’s ruling in con-

temporary securities class action litigation. Simply put,

the court of appeals’ decision, if affirmed, would make

what is already a bad situation very much worse.

First, due to pressures unique to American securities

litigation, businesses are typically forced to settle even

meritless suits. Unless a case can be dismissed through

early motions practice, the subsequent threat of class cer-

tification forces corporate executives to choose between

staking the future of their companies on the outcome of a

single jury verdict, or settling even when they may have

no legal liability.

Securities class action suits, moreover, often benefit

class counsel more than they do class members, with set-

tlement payments simply involving a transfer of wealth

from current shareholders to former shareholders, minus,

of course, contingent attorneys’ fees that typically run be-

tween 19% and 45%. As one leading securities class ac-

tion plaintiff's lawyer has candidly admitted: “I have the

greatest practice in the world because I have no clients. I

bring the case. I hire the plaintiff. I do not have some

client telling me what to do. I decide what to do.”*

Second, into this environment the Ninth Circuit’s hold-

ing introduces a new legal rule that only further encour-

ages plaintiffs to file and companies to settle meritless

claims by removing a key safeguard against such suits.

Worse still, the Ninth Circuit’s rule encourages risky in-

vestment behavior, effectively forcing issuers to insure

against speculative losses having nothing to do with their

own conduct. Under the Ninth Circuit’s rule, an investor

can file a claim and obtain recovery even when the disclo-

sure of an aliegedly fraudulent statement has absolutely

no effect on the stock price. To estimate damages in the

absence of any contemporaneous real world stock price

movement, moreover, the Ninth Circuit’s rule requires

litigants (and courts) to resort to exactly the sort of “junk

science” economics this Court has consistently discour-

aged. And because it permits claims for any allegedly

false statement, without respect to demonstrated market

injury, the Ninth Circuit’s rule has the effect of chilling

investment advice and reporting within the securities

industry.

By contrast, the alternative loss causation rule en-

dorsed by the Government, petitioners, and four circuits‘

would avoid all of these problems while ensuring full re-

covery of real losses, consistent with the established tort

principle that, although “the consequences of an act go

3 See In re Network Assocs., Inc. Sec. Litig., 76 F. Supp. 2d 1017,

1032 (N.D. Cal. 1999) (quoting attorney William S. Lerach).

* The court of appeals below acknowledged that this interpretation

of the loss causation requirement differed from the standards articu-

lated by the Third and Eleventh Circuits. See Semerenko v. Cendant

Corp., 223 F.3d 165 (3d Cir. 2000); Robbins v. Koger Props., Inc., 116

F.3d 1441 (11th Cir. 1997). The court of appeals did not, however, cite

or discuss the additional conflicting decisions of the Second and Sev-

enth Circuits. See Emergent Capital Inv. Mgmt., LLC v. Stonepath

Group, Inc., 343 F.3d 189 (2d Cir. 2003); Bastian v. Petren Res. Corp.,

892 F.2d 680 (7th Cir. 1990).

forward to eternity, . . . legal responsibility must be lim-

ited to those causes which are so closely connected with

the result.” W. Page Keeton et al., Prosser and Keeton on

Torts § 41, at 264 (5th ed. 1984).

ARGUMENT

I. THE PRESSURE TO SETTLE EVEN MUDIT-

LESS SECURITIES CLASS ACTIONS IMPOSES

AN ENORMOUS TOLL ON THE AMERICAN

ECONOMY

This Court has long recognized that securities fraud Liti-

gation presents “a danger oi vexatiousness different in

degree and in kind from that which accompanies litigation

in general.” Blue Chip Stamps v. Manor Drug Stores, 421

U.S. 723, 739 (1975). Because the amount of damages

demanded can be so great, corporations are frequently

forced to forgo the adversarial process, settling even

meritless suits in order to avoid the prospect of bank-

ruptcy. Indeed, studies indicate that, unless a securities

class action is dismissed on the pleadings, it is virtually

certain to settle. See Elliot J. Weiss & John S. Becker-

man, Let the Money Do the Monitoring: How Institutional

Investors Can Reduce Agency Costs in Securities Class Ac-

tions, 104 Yale L.J. 2053, 2064 (1995); Woodruff-Sawyer

& Co., A Study of Shareholder Class Action Litigation 25

(2002) (83% of securities fraud cases are resolved through

settlement).

So great is the pressure on corporations to settle that,

even when defendants do succeed in obtaining a trial

court dismissal, the risk of losing on appeal can still lead

to enormous settlements. By way of example, just earlier

this year one securities defendant agreed to settle a pend-

ing class action for $300 million even after the suit was

dismissed on the merits with prejudice in the trial court.°®

° Jonathan Weil, Win Lawsuit —and Pay $300 Million, Wall St. J.,

Aug. 2, 2004, at C3.

To be sure, Congress has sought to address these prob-

lems, passing the Private Securities Litigation Reform Act

(“PSLRA”) in 1995 and the Securities Litigation Uniform

Standards Act in 1998. Despite these efforts at reform,

however, the number of securities class actions has not

declined. See Laura E. Simmons & Ellen M. Ryan, Cor-

nerstone Research, Post-Reform Act Securities Lawsuits:

Settlements Reported Through December 2003 (May 2004)

(“PSLRA Settlements”). Quite the opposite, in fact, has —

occurred: in the six years since the enactment of the

PSLRA, the mean number of securities fraud suits has

risen by an astonishing 32%. See Michael A. Perino, Did

the Private Securities Litigation Reform Act Work?, 2003

U. Ill. L. Rev. 913, 930. Another published study has con-

cluded that, following the enactment of the PSLRA, public

companies now face a nearly 60% greater chance of being

sued by shareholders. See 2003 Early Update. And the

dismissal rate of securities fraud lawsuits between 1996

and 2003 averaged only 8.4%, with dismissals in three of

the 11 federal circuits averaging just 4%, a result that

Congress hardly anticipated or intended. See id. at 5.

Just as the number of cases continues to rise despite

congressional efforts to rein them in, class members all

too often continue to find themselves in the unfortunate

position of losing regardless of the outcome of these cases.

Because payments come out of corporate coffers, securities

class actions frequently involve only “a transfer of wealth

from current shareholders to former shareholders.” Janet

Cooper Alexander, Rethinking Damages in Securities

Class Actions, 48 Stan. L. Rev. 1487, 1503 (1996). Thus,

6 See also Frank H. Easterbrook & Daniel R. Fischel, Optimal Dam-

ages in Securities Cases, 52 U. Chi. L. Rev. 611, 638-39 (1985); see also

Jennifer H. Arlen & William J. Carney, Vicarious Liability for Fraud

on Securities Markets: Theory and Evidence, 1992 U. Ill. L. Rev. 691,

698-700; Donald C. Langevoort, Capping Damages for Open-Market

Securities Fraud, 38 Ariz. L. Rev. 639, 650 & n.48 (1996); Perine, Did

the Private Securities Litigation Reform Act Work?, 2003 U. Ill. L. Rev.

at 921-22.

to the extent that class members still own shares in the

company at the time of the suit (as they often do), “pay-

ments by the corporation to settle a class action amount to

transferring money from one pocket to the other, with

about half of it dropping on the floor for lawyers to pick

up.” Jd. As Judge Friendly once remarked, securities

fraud litigation carries the risk of “‘large judgments, pay-

able in the last analysis by innocent investors, for the

benefit of speculators and their lawyers.’” Blue Chip

Stamps, 421 U.S. at 739 (quoting SEC v. Texas Gulf Sul-

phur Co., 401 F.2d 833, 867 (2d Cir. 1968)).

A recent case against Qwest Communications illus-

trates the phenomenon. There, plaintiffs’ counsel sought

to increase the pressure on defendants to settle by moving

to freeze approximately $400 million of potential proceeds

from a planned sale of a Qwest business unit.’ The plain-

tiffs’ lawyers claimed that the sale should be enjoined to

ensure that the as-yet-to-be certified class (and its coun-

sel) would get paid if they ultimately won the suit. But

Qwest badly needed the proceeds from the sale to avoid

bankruptcy.* The district court eventually denied the mo-

tion and expressly found that a freeze would not benefit

all putative class members or the company, but only for-

mer shareholders and the attorneys.’ According to the

court, entering the injunction sought would likely have

bankrupted the company and rendered worthless the

stock of thousands of would-be class members who were

still shareholders in Qwest.'° :

Securities class actions are also frequently filed so

quickly after a stock price decline that any reasonable fac-

7 In re Qwest Communications Int, Inc. Sec. Litig., 243 F. Supp. 2d

1179 (D. Colo. 2003).

® Press Release, Qwest Communications, Qwest Communications

Statement In Response to Motion Filed by Milberg Weiss Bershad

Hynes & Lerach LLP (Nov. 4, 2002).

® Qwest Communications, 243 F. Supp. 2d at 1186-87.

1° Td. at 1188.

tual investigation into the merits is simply impossible.

By way of example, one court found it “peculiar that four

of the lawsuits consolidated in this action were filed

around 10:00 a.m. on the first business day following [the

defendant’s] announcement” and that “[mJost of the com-

plaints are virtually identical (including typographical

errors).”'! At the hearing on the defendant’s motion to

dismiss, the judge inquired “How did you get to be so

smart and to acquire all this knowledge about fraud from

Friday to Tuesday? ... On Friday afternoon did your cli-

ent suddenly appear at your doorstep and say ‘My God, I

just read in the Wall Street Journal about Travelers.

They defrauded me,’ and you agreed with them and you

interviewed them and you determined that there was

fraud and therefore you had a good lawsuit, so you filed it

Tuesday morning, is that what happened?” The court

noted that “[cJounsel for the plaintiffs was not responsive

to this line of inquiry.”"”

Efforts at reform notwithstanding, virtually all securi-

ties class action cases continue to be settled with little or

no regard to their underlying merit. As Congress, the

courts, and commentators have all observed, “[t]oo fre-

quently, corporate decisionmakers are confronted with the

implacable arithmetic of the class action: even a meritless

case with only a 5% chance of success at trial must be set-

tled if the complaint claims hundreds of millions of dollars

in damages.” H.R. Rep. No. 106-320, at 8 (1999).'*° The

1! Ferber v. Travelers Corp., 785 F. Supp. 1101, 1106 n.8 (D. Conn.

1991).

12 Td. (brackets omitted).

13 See also West v. Prudential Sec., Inc., 282 F.3d 935, 937 (7th Cir.

2002) (noting scholarly concerns that “settlements in securities cases

reflect high risk of catastrophic loss, which together with imperfect

alignment of managers’ and investors’ interests leads defendants to

pay substantial sums even when the plaintiffs have weak positions”);

Victor E. Schwartz et al., Federal Courts Should Decide Interstate

Class Actions: A Call for Federal Class Action Diversity Jurisdiction

Reform, 37 Harv. J. on Legis. 483, 490 (2000) (“For defendants, the risk

magnitude of the continuing pressure to settle even strike

suits is perhaps most clearly exposed by the fact that,

since the PSLRA’s passage, more than 2,000" securities

fraud cases have been filed in federal court, yet defen-

dants have taken less than 1% to trial.!° As one observer

commented over a decade ago in words equally applicable

today, there is simply “no appreciable risk of non-

recovery” in securities class actions. Janet Cooper Alex-

ander, Do the Merits Matter? A Study of Settlements in

Securities Class Actions, 43 Stan. L. Rev. 497, 578

(1991).'© Merely “/gJetting the claim into the legal system,

without more, sets in motion forces that ultimately com-

pel a multi-million dollar payment.” Jd. at 569 (emphasis

added). Accord Hevesi v. Citigroup Inc., 366 F.3d 70, 80

(2d Cir. 2004) (noting “numerous courts and scholars have

warned that settlements in large [securities] class actions

can be divorced from the parties’ underlying legal posi-

tions”); Newton v. Merrill Lynch, Pierce, Fenner & Smith,

Inc., 259 F.3d 154, 164 (3d Cir. 2001) (discussing the “in-

ordinate or hydraulic pressure on [securities fraud] defen-

of participating in a single trial [of all claims], and facing a once-and-

for-all verdict is ordinarily intolerable.”) (internal quotation marks

omitted).

'* See Stanford Law School & Cornerstone Research, Securities

Class Action Clearinghouse, at http://securities.stanford.edu/

companies. html.

® Richard Painter et al., The Federalist Society for Law and Public

Policy Studies, Private Securities Litigation Reform Act: A Post-Enron

Analysis 8 (2003), at http://www.fed-soc.org/pdf/PSLRAF™NALII.PDF

(“PSLRA Analysis”).

confirm [Professor Alexander's] conclusion. Indeed, [Melvyn I.] Weiss

and his partner William S. Lerach of the Milberg firm have stated that

losses in these cases are ‘few and far between,’ and they achieve a ‘sig-

nificant settlement although not always a big legal fee, in 90% of the

cases [they] file.” Goldberger v. Integrated Res., Inc., 209 F.3d 43, 52

(2d Cir. 2000) (quoting Jn re Quantum Health Res., Inc. Sec. Litig., 962

F. Supp. 1254, 1258 (C.D. Cal. 1997)).

dants to settle, avoiding the risk, however small, of poten-

tially ruinous liability”).

It is well known, too, that the same few law firms bring

the great bulk of these claims. One recent study found

that, since the passage of the PSLRA, a single firm (re-

cently split into two) has been involved as lead or co-lead

plaintiffs’ counsel in over 50% of securities class action

settlements.'’ In the cases where competition for lead

counsel status does emerge, accusations are sometimes

exchanged by the plaintiffs’ bar that one or another firm

has offered to “pay off” competitors to withdraw their ap-

plications to serve as lead counsel, leading at least one

court to observe that

[w]hile over a dozen law firms participated early on in

this litigation, only two filed proposals to represent

the class, and only one of these proposals appears se-

rious. This suggests an understanding or collabora-

tion among plaintiff firms engaged in securities class

action litigation that many would choose not to bid for

this litigation .... The indicia of such cooperation

raises serious doubts about the conditions of competi-

tion in this segment of the legal services industry.'®

Commenting on the phenomenon of contemporary secu-

rities class action litigation, a Florida court described the

whole process as “the class litigation equivalent of the

‘Squeegee boys’ who used to frequent major urban inter-

sections and who would run up to a stopped car, splash

soapy water on its perfectly clean windshield and expect

payment for the uninvited service of wiping it off.”

Fruchter v. Florida Progress Corp., No. 99-6167CI-20,

2002 WL 1558220, at *10 (Fla. Cir. Ct. Mar. 20, 2002).

17 See PSLRA Settlements at 14 (discussing the Milberg Weiss Ber-

shad Hynes & Lerach firm, now divided into two separate partnerships

known as Milberg Weiss Bershad & Schulman, and Lerach Coughlin

Stoia Geller Rudman & Robbins); see also PSLRA Analysis at 15-16.

8 In re California Micro Devices Sec. Litig., No. C-94-2817-VRW,

1995 WL 476625, at *4 (N.D. Cal. Aug. 4, 1995).

Simply put, despite Congress’s clear intent and two ef-

forts at reform, American business continues to contend

with “precisely the sort of lawyer-driven machinations the

PSLRA was designed to prevent.” In re BankAmerica

Corp. Sec. Litig., 95 F. Supp. 2d 1044, 1050 (E.D. Mo.

2000) (criticizing the “outrageous” attempts of plaintiffs’

counsel to commandeer the class action for their own

benefit), affd, 263 F.3d 795 (8th Cir. 2001). The drain on

the American economy and its global competitiveness is

substantial. In the last four years alone, securities class

action settlements have exceeded two billion dollars per

year."® And the problem continues to grow. In 2002, the

average price of settling a securities fraud claim rose to

$24.3 million, a 68% increase from 2001. See Laura E.

Simmons & Ellen M. Ryan, Cornerstone Research, Post-

Reform Act Securities Lawsuits: Settlements Reported

Through December 2002, at 3 (May 2003). In 2003, the

average settlement value for accounting-related securities

fraud cases reached $26.5 million. 2003 Pricewater-

houseCoopers Securities Litigation Study (rel. Aug. 2,

2004), at http:/Awww.10b5.com/2003_study.pdf.

Il. THE NINTH CIRCUIT'S RULE WOULD SIG-

NIFICANTLY EXACERBATE THE PROBLEMS

AND INCREASE THE SOCIAL COSTS ASSOCI-

ATED WITH MERITLESS SECURITIES CLASS

ACTIONS

“The economics of sanctions starts from the proposition

that the objective of a legal rule is to deter certain unde-

sirable behavior without simultaneously deterring (too

much) beneficial behavior.” Easterbrook & Fischel, Op-

tional Damages in Securities Cases; 52 U. Chi. L. Rev. at

612. The Ninth Circuit's rule disregards this fundamen-

tal objective in many notable and problematic respects.

'? See PSLRA Settlements at 1. In 2000 alone, the total value of se-

curities fraud cases (adjusted for inflation) was estimated at $4.428

bilhon. Jd. Settlements in 2001 were estimated at $2.1 billion, rising

to $2.53°7 billon in 2002, and holding at $2.016 billion in 2003. Id.

A. Rather than holding companies liable for the dam-

age they inflict, as reflected by actual market events, the

Ninth Circuit’s rule permits liability to be found and

damages to be awarded even when the plaintiff can point

to no actual market price reaction to a corrective disclo-

sure. By way of example, suppose a plaintiff buys $50 of

stock in the defendant corporation. As time passes, the

value of the plaintiff's investment declines to $5. After

this decline, the defendant announces the restatement of

an accounting item, yet the plaintiff's shares remain at

$5. In most circuits, any subsequent securities class ac-

tion would be dismissed. By contrast, under the Ninth

Circuit’s rule, a plaintiff can proceed to trial simply by

hiring an expert to render an opinion on how much of the

price the plaintiff paid was “inflated” because of the un-

disclosed accounting issue. Plaintiffs and their lawyers,

thus, can obtain a recovery even where investors are not

demonstrably hurt by the alleged fraud — including in

cases where the plaintiffs sold before the alleged misrep-

resentation was exposed, or the misrepresentation was

never exposed at all, or it was exposed but the market did

not respond negatively. 7

Such a regime serves only to exacerbate the already-

intense pressure on companies to settle securities class

action suits without regard to their merit. Denying courts

any means for weeding out at the pleading stage suits

where the alleged fraud had no empirical effect on share

price, and thus imposed no demonstrable harm on class

members, the Ninth Circuit’s rule adds fuel to a fire in

which virtually every case is settled, wealth is transferred

away from current shareholders and productive economic

uses to former shareholders, and lawyers are enriched.

The facts of this case are illustrative. On February 24,

1998, Dura announced a revenue shortfall for the follow-

ing year, unrelated to any alleged fraud. By the next day,

shares in Dura dropped from $39.125 to $20.75 for a one-

day loss of 47%. Some nine months later, on November 3,

1998, Dura announced for the first time that the United

States Food and Drug Administration had declined to ap-

prove its Albuterol Spiros product — an announcement

that plaintiffs contend constitutes the first public disclo-

sure of the alleged fraud in this case. Following this an-

nouncement, however, Dura shares fell only slightly and

briefly. Share prices initially dropped from $12.375 to

$9.75, but, within 12 trading days, they recovered to

$12.438, ultimately climbing to $14.00 within 90 days of

the announcement.

Plaintiffs in this suit, however, never alleged damages

based on the brief and shallow $2.625 stock price dip after

the November 3 disclosure of the supposed fraud. Rather,

they demand recovery based on the much more significant

February 24 stock price decline of $19, even though plain-

tiffs themselves allege no corrective disclosure in that an-

nouncement. In short, plaintiffs in this case seek dam-

ages based on a decline in share value that occurred nine

months before the disclosure of the alleged fraud. And it

is beyond cavil that a company facing potential liability of

$19 per share is in a wildly different posture when it

comes to deciding whether to litigate or settle than one

facing potential liability of, at most, $2.625 per share.

B. Relatedly, the Ninth Circuit’s rule dangerously

skews investment incentives. To be sure, speculative in-

vestments are a natural — and even beneficial — part of

any free and open market: “[I]n stock trading, as else-

where, speculation serves the salutary purpose of ena-

bling the rapid adjustment of prices to current values.”

Richard A. Posner, Economic Analysis of the Law 458 (6th

ed. 2003). Because “[t]he speculator is the eager searcher

for undervalued and overvalued securities,” information

discovered through this search “diffuses rapidly through-

out the market.” Jd.

In particular, speculators may be attracted to what

economists refer to as “rational bubbles,” where a stock’s

price incorporates all publicly available information with-

out “represent[ing]} the true [market] value of the underly-

ing company.” Paul A. Ferrillo et al., The “Less Than” Ef-

ficient Capital Markets Hypothesis: Requiring More Proof

from Plaintiffs in Fraud-on-the-Market Cases, 78 St.

John’s L. Rev. 81, 114 (2004). Investors might reasonably

conclude that an overvalued stock will continue to appre-

ciate during the life of the bubble. See id. at 115. These

investors realize that “[e]ventually the bubble will burst,

of course, but it is always a fair investment until that

point.” Id.

Naturally, the significant potential benefits of specula-

tion also carry a correspondingly high degree of risk. Un-

der the Ninth Circuit’s rule, however, much of that risk is

transferred away. If the price of a stock investment de-

clines, the speculator can state a claim for relief, and

likely obtain a significant settlement, merely by alleging

that the defendant made a “misleading” statement — and

do so even if the stock failed to decline after a corrective

disclosure and moved downward only much later after

other news. Such a regime unnaturally encourages risky

investments by underwriting speculative losses unrelated

to the defendant’s conduct, and effectively serves to trans-

form the federal securities laws into “a system of investor

insurance that reimburses investors for any decline in the

value of their investments.” Robbins, 116 F.3d at 1447.

C. The Ninth Circuit regime also encourages, and in

fact depends upon, a return to the use of “junk science.”

Because the Ninth Circuit's rule allows recovery where

disclosures do not prompt any stock price decline, plain-

tiffs’ experts are, by necessity, forced to resort to a grab-

bag of speculative theories to estimate damages; and

without any negative market reaction to the actual disclo-

sure there is simply no objective way for courts, juries, or

opposing parties to check their work. See Robbins, 116

F.3d at 1448.

Such a result stands in marked contrast with the

Court’s repeated attempts to remove precisely this sort of

speculation about damages from the federal court system.

Cf. General Elec. Co. v. Joiner, 522 U.S. 136 (1997);

Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999);

Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579, 579

(1993). Indeed, the same concerns that spurred the pas-

sage of the PSLRA in 1995 — including an abundance of

frivolous suits, questionable claims of injury, and specula-

tive theories of causation — prompted the adoption of

Federal Rule of Evidence 702 and this Court’s holding in

Daubert.

Both Daubert and Rule 702 address the need to ensure

that the nexus between a plaintiff's injury and the alleged

cause of that injury is supported by reliable evidence.

Prior to Daubert, courts viewed relevancy under a loose

standard that tolerated almost any correlation between

cause and injury. Without a rigorous examination of the

causal nexus underlying the allegations, “marginal or un-

reliable” theories of causation regularly proceeded to trial.

See Kenneth R. Foster et al., Phantom Risk: Scientific In-

ference and the Law 433 (1993).

Daubert and Rule 702 provided courts with the tools to

screen out scientifically questionable claims in two ways.

First, Daubert allowed courts to determine whether a

claim is based on a proper temporal logic, where the al-

leged harmful act precedes the alleged injury. Second,

Daubert required plaintiffs to exclude other factors, be-

yond the alleged harmful act, that could have caused their

alleged injuries. Together, these guideposts “invite[d]

courts to take a hard look” at the causal basis underlying

a plaintiff's alleged injury and thus to “act with dispatch”

in rejecting speculative, unproven, and unprovable dam-

ages claims. Christopher B. Mueller & Laird C.

Kirkpatrick, Evidence § 7.17, at 740 (2d ed. 1999).

Loss causation under the PSLRA, as interpreted by

other circuit courts, achieves this same goal in the securi-

ties context. By subjecting securities claims to the re-

quirement of a decline in stock price close in time to the

disclosure of the alleged fraud, courts are able to test for

some reliable indication whether plaintiffs’ alleged dam-

ages were caused by fluctuations in the marketplace due

to causes other than the defendant’s putative fraud. Like

the gatekeeping function endorsed in Daubert, the loss

causation requirement helps to screen out securities fraud

actions built upon “phantom” injuries — cases involving

actual harms producing actual suffering, but for which no

single cause can be reliably identified. See Foster, Phan-

tom Risk 1.

Judge Easterbrook has discussed exactly this point in

the class vertification context, noting that, unless courts

insist on a firm “causal link between non-public informa-

tion and securities prices,” they are left with only a

“clash” of experts, a situation that amounts “to a delega-

tion of judicial power to the plaintiffs, who can obtain

class certification just by hiring a competent expert,” leav-

ing defendants subject to damages that have not been —

and cannot be — “verified empirically.” West, 282 F.3d at

938-40.

Such a result, invited by the Ninth Circuit’s reasoning,

defies the “universal requirement” that any claim sound-

ing in tort must include a sufficient allegation that the

defendant's conduct caused the plaintiff's injury, or,

stated simply, “[nJo hurt, no tort.” Bastian, 892 F.2d at

683-84; see also Guido Calabresi, Concerning Cause and

the Law of Torts: An Essay for Harry Kalven, Jr., 43 U.

Chi. L. Rev. 69, 79 (1975). And without a hard look by the

courts to ensure “some reasonable connection between the

act or omission of the defendant and the damage which

the plaintiff has suffered,” Keeton, Prosser and Keeton on

Torts § 41, at 263, litigants risk being exposed to “infinite

liability for all wrongful acts,” no matter how loos<ly con-

nected or unrelated such conduct may be to the actual

performance of a shareholder’s investment, id. at 264.

There is no reason to presume that Congress sought to

endorse such a rule, so alien to traditional tort principles

and this Court’s holdings in Daubert and its progeny,

when it codified the loss causation requirement in the se-

curities fraud arena.

D. The Ninth Circuit’s rule, if permitted to stand, will

also serve to chill investment advice and reporting and

the free flow of information in our capital markets. To

date, securities class actions typically have been aimed at

issuers and their executives. But without a requirement

that plaintiffs tie any alleged disclosure to a timely mar-

ket effect, no apparent barrier will remain to prevent fu-

ture litigants from bolder attempts to expand liability to

anyone even remotely connected to an investment deci-

sion. So long as the market price of a stock is deemed to

take account of the communication at issue pursuant to

the efficient market hypothesis endorsed in Basic Inc. v.

Levinson, 485 U.S. 224 (1988), investor reliance on that

communication is presumed and dissatisfied investors are

free to bring class action claims on them. See Bastian,

892 F.2d at 685. Accordingly, any allegedly false invest-

ment information from any source — not just issuers —

could conceivably become the basis for triggering liability

to all investors.

For example, media programs with “talking heads”

have become a popular feature on cable television.”°

Internet sites such as “The Motley Fool” also regularly

praise investments like Dura Pharmaceuticals. And, of

course, investment banks make buy and sell recommen-

dations. Without a legal rule limiting the scope of liabil-

ity to disclosures that bear a close causal link with spe-

cific stock price declines, dissatisfied investors could

conceivably bring claims against such sources simply by

finding some false statement recommending a stock made

before a wide public audience. See Bastian, 892 F.2d at

685.

20 See, e.g., CNN, CNNfn on TV, at http://money.cnn.com/ontv:

FOXNews.com, FNC Shows, at http://www.foxnews.com/business;

_ CNBC, CNBC TV, at http://moneycentral.msn.com/cnbc/tv/default.asp.

To avoid this consequence, corporations — along with

investment firm stock analysts, media sources touting

stocks, and others —- will have a strong incentive to limit

their discussions to the narrowest possible scope, or cease

publishing information on stocks altogether. Such a re-

sult, of course, is inconsistent with the very premise of an

open capital market, which depends on the freest possible

flow of information. See Posner, Economic Analysis of the

Law 457-58 (explaining that “[i]nformation that may mis-

lead some members of the audience may be valuable to

others”); see also Securities Fraud on the Internet: Hear-

ings Before the Permanent Subcomm. on Investigations of

the Senate Comm. on Government Affairs, 106th Cong. 79-

91 (Mar. 22-23, 1999) (testimony of Thomas M. Gardner,

founder of The Motley Fool, Inc.), available at 1999 WL

8085871 (“We believe that technology, especially the

Internet, allows people to obtain information that once

was the exclusive property of Wall Street professionals, so

that they can make their own financial decisions better

than the professionals they previously relied upon.”).

CONCLUSION

The decision of the court of appeals should be reversed.

Respectfully submitted,