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

———j. am US

J FILED

(Z) SEP 13 2004

OFFICE OF THE CLERK

No. 03-932

Jn 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 FOR MERRILL LYNCH & CO., INC.

AS AMICUS CURIAE IN SUPPORT OF

PETITIONERS

ANDREW L. FREY STEPHEN M. SHAPIRO

KENNETH S. GELLER Counsel of Record

Mayer, Brown, Rowe & TiMoTHyY S. BISHOP

Maw LLP JOSHUA YOUNT

1909 K Street, N. W. Mayer, Brown, Rowe &

Washington, D.C. 20006 Maw LLP

(202) 263-3000 190 South LaSalle Street

Chicago, Illinois 60603

(312) 782-0600

QUESTION PRESENTED

Whether a securities fraud plaintiff invoking the fraud-

on-the-market theory must demonstrate loss causation by

pleading and proving in a reliable and non-speculative

manner that the defendant’s fraud actually caused the

plaintiff injury.

(1)

ll

TABLE OF CONTENTS

Page

QUESTION PRESENT BID 00ccccesvsccssescscstesencsessanannanan i

INTEREST OF THE AMICUS CURIAE...............0000006. l

SUMMARY OF ARGUMENT. ....:ccsssscccssesscccssosessscssesensess 2

ARISUIMGINT ..0000007sscccessscssonsossennessesnsessainiaiaininannnnnnn 4

I. PLAINTIFFS IN PRIVATE SECTION 10(b)

DAMAGES SUITS MUST PLEAD AND PROVE

IN A NON-SPECULATIVE MANNER THAT

DEFENDANT’S FRAUD CAUSED PLAINTIFFS’

TIN FIR BISD «cccccosccccscosocsesonesenesonnenehesneeninniinninnnnnnn 4

A. Section 10(b) Claimants May Not Rely On

Speculative Theories Of Causation But Must

Plead And Prove That Defendant’s Misconduct

Actually Caused Them Injury..............::ccccccceeeeeees 7

B. Permitting Section 10(b) Class Actions To

Proceed On The Basis Of Speculative Theories

Of Causation Would Do “More Harm Than

GeO” .......ccccccscesscssesenssescensnesensieianninnnann 12

C. Hundreds Of Post-Bubble Section 10(b) Damages

Actions Illustrate The Need For Rigorous Loss

Causation Standards That Weed Out Meritless

Cases At The Dismissal Or Class Certification

II. ARIGOROUS LOSS CAUSATION STANDARD

THAT GUARDS AGAINST BLACKMAIL

SETTLEMENTS AND WINDFALL RECOVERIES

WILL NOT UNDERMINE THE DETERRENCE

AND COMPENSATION POLICIES OF THE

SECURITIES LAWS. .ccccccccessscssssossseesecsenensmnsiammnintn 24

IN LBIUIIN ...ccccccccccccsecssssressssnessesennntemmeesammmnniiial 30

ili

TABLE OF AUTHORITIES

C

“ases: Page

A,

{kerman v. Oryx Communications, Inc.,

| 21

A

{mchem Prods., Inc. v. Windsor, 521 U.S. 591

A

\sher v. Baxter Int'l Inc., 377 F.3d 727

EE TE 15

tasks Inc. v. Levinson, 485 U.S. 224

ESL 15, 20, 21, 22, 30

astian v. Petren Resources Corp., 892 F.2d 680

i rciaccnstccemnncmanssenenccccecceceees 9,10

Pair v. Equifax Check Servs., 181 F.3d 832

nA 23

‘Blue Chip Stamps v. Manor Drug Stores,

i a TTD scccneceeemscensncncscccees 4, 5,8, 11, 12,22

‘Cammer v. Bloom, 711 F. Supp. 1264

hrc certncencenccnnsncncnocccnsonecs 22

‘Central Bank v. First Interstate Bank,

a 5, 14,18

‘Citibank, N.A. v. K-H Corp., 968 F.2d 1489

cre oe 10

‘DeMarco v. Lehman Bros., 222 F.R.D. 243

I

iv

TABLE OF AUTHORITIES-Continued

Page

Dep't of T-ansp. v. Public Citizen, 124 S. Ct. 2204

CEE ccnecssrsscsinsenetmientiiniieiiiéianiaiiinninissiianmsiibammeiainmamnate 12

Dirks v. SEC, 463 U.S. 646 (1983) .........ccccccecceees 8, 15, 16

Elkind v. Liggett & Myers, In... 535 F.2d 156

8 ee 21

Emergent Capital Inv. Mgmt., LLC v. Stonepath

Group, Inc., 343 F.3d 189 (2d Cir. 2003)...............c0000: 9

Ernst & Ernst v. Hochfelder, 425 U.S. 185

CIO cxcnncessnasncmansnecsisniiccsnnsiniasiniitanissiisiiniinitidaiiiliia 5,12

First Nationwide Bank v. Gelt Funding Corp.,

Og 9,10

Fogarazzo v. Lehman Bros., 2004 WL 1151542

OO ene 1]

Gariety v. Grant Thornton, LLP, 368 F.3d 356

Se 22, 23, 24

Grace v. Rosenstock, 228 F.3d 40 (2d Cir. 2000)............ 17

Greenberg v. Crossroads Sys., Inc., 364 F.3d 657

OSE 21

Hevesi v. Citigroup, Inc., 366 F.3d 70

oo) > ee 20

Holmes v. SIPC, 503 U.S. 258 (1992) ........cccccccccseeceeeennees 8

Vv

TABLE OF AUTHORITIES-Continued

Page

Howsam v. Dean Witter Reynolds, Inc., 537 U.S. 79

SUED wmeysinnsnnennicnnnapiititinniesinsiiiniaieiaiiieaitueniibiaisiaieeeiama 28

IPO Sec. Litig., In re, No. 21 MC 92 (S.D.N.Y.)............. 19

Lowe ¥. SEC, 472 U.S. 181 (1DCS) .....cccccccccecccsccsscceseceecee 16

Merrill Lynch & Co., Inc. Research Reports Sec. Litig.,

In re, 273 F. Supp. 2d 351 (S.D.N.Y. 2003) .............. 17

Merrill Lynch & Co., Inc. Research Reports Sec. Litig.,

In re, No. 02 MDL 1484 (S.D.NLY.) ..0.00....000ccccccccceees 20

Moore v. PaineWebber, Inc., 189 F.3d 165

Ss MUNI ieaiihchhiciletchateeheiiemiiiha cil 10

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

a es Se rcreienceenneemenennneti 23

Nike, Inc. v. Kasky, 539 U.S. 654 (2003) .......0.....cccccceeee 16

Piper v. Chris-Craft Indus., 430 U.S. 1 (1977).......... 29, 30

Reiter v. Sonotone Corp., 442 U.S. 330 (1979) ............... 24

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

SR a eeir GUE dexinnsertantinsenccmmnemunmanimnemmereinaensinipeamaiae 9

Santa Fe Indus. v. Green, 430 U.S. 462 (1977)............. 5,8

Schreiber v. Burlington Northern, Inc.,472 U.S. |

STE cincnindshieraninniniennemecsnasinneticianindaptmemamnniiasaastieadstestatinasictas 5

vi

TABLE OF AUTHORITIES-Continued

Page

SEC v. First Jersey Sec., Inc., 101 F.3d 1450

PE CE cevereninenincinennanineniicmienaniiapeanenninnnnentes 25

Shearson/American Express Inc. v. McMahon,

SE ane aE ccccnecnrennenaiiecncinintapbinniamennines 28

Szabo v. Bridgeport Machs., Inc., 249 F.3d 672

eT 23

TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438

GED conceerenseneestenitasemmenninmmmetemmenumannetl 5,15

Ultramares Corp. v. Touche, 255 N.Y. 170

SEIU crennsenmssnnenencsennmsininniinsentnigmesmmesmenmensmumtmnannnt 4

Virginia Bankshares, Inc. v. Sandberg,

Se 8

Visa Check/MasterMoney Antitrust Litig., In re,

ee CO ee Be crnsceccsrsncnenesescememssecen 24

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

ee 23, 24

Statutes:

tT a) eee 26

LSE le 26

a 25

vil

TABLE OF AUTHORITIES-Continued

Page

Fa an OF HEN i cccnesinnicesnenenineanionnmaneneiiniemeneiena 26

a Pele etsclisinnianienmmnntmnianesuitenieiniamenimeens 25

i 7, 30

ae Ue SH cccnenecinnesronnitennsmemeninitinetinnnniiennieti 7, 30

IN Ue TUIEE ecacintstentintninereninnsinmmatiiiiniimeieme 26

Fe ine Oe ET eeeceesiessersienntineatcnnininrsiantinstnamnniensiingatianiin 25

Seas it TIE icctarinnsioieianienndensineienesnsmaninnniniiaieitiimtenieeasie 25

a ees OF SAUTEED icrienninteieitonsterarnisiniernennnneintenbiniantinemtbneiitiacciniinias 25

Sa ee Oe Waa iiensisinennrcnentoreniesnnmnsnantndiienininsintsiamuiiiiunians 25

Miscellaneous:

Alexander, Do the Merits Matter? A Study of

Settlements in Securities Class Actions,

43 STAN. L. REV. 497 (1991)..000.. eee ceeeeeeee 5, 6, 14, 17

Backman et al., Forward-Looking Statements

and Cautionary Language After the 1995

Reform Act: An Empirical Study, in PLI,

SAILING IN “SAFE HARBORS” 153 (1997)................0.. 15

vill

TABLE OF AUTHORITIES-Continued

Page

4 BROMBERG & LOWENFELS, SECURITIES FRAUD &

COMMODITIES FRAUD § 7:498 (2d ed. 2004) ............. 11

Coffee, Overcriminalization?, NATL L.J.,

Aang, 16, 2BB4, G0 13 ..nccrcccoccscorcccscesecsscesccososessscssossoess 26

CORNERSTONE RESEARCH, POST-REFORM ACT

SECURITIES LAWSUITS: SETTLEMENTS REPOR-

TED THROUGH DECEMBER 2003 (2004), http://

securities.stanford.edu/Settlements/REVIEW_

1995-2003/2003 Settlements.pdf.................ccccceeeeees 19

DEVITTO, IRRATIONAL MARKETS AND THE ILLUSION

4, . 3 ¢ _. | Ee 13

Dunbar & Heller, Fraud on the Market Meets

Behavioral Finance, COLUM. L. SCH. CENTER FOR

L. & ECON. STUD. (Dec. 1, 2003), http://www.

law.columbia.edu/center_program/law_economics/

wkshops/fall200348 1253 ..........cccccccceeecesseseeneenenennees 22

EASTERBROOK & FISCHEL, THE ECONOMIC STRUCTURE

OF CORPORATE LAW (1991) ..........cccccccceeeeeeeeeeeeees 13, 15

Easterbrook & Fischel, Optimal Damages in

Securities Cases, 52 U. CHI. L. REV. 611 (1985) ....... 21

Eisenberg, Enforcement Issues and Litigation,

21 SEC. REG. L.J. 421 (1994)... ccccesescecseeseereeeenes 26

FRIENDLY, FEDERAL JURISDICTION: A GENERAL

VI CID TR ceccccccesccccccnssccssccescsssssssssenssonstocsssonesess 14,29

ix

TABLE OF AUTHORITIES-Continued

Page

H.R. Conf. Rep. No. 104-369 (1995) ..0.....cccccceeceeee passim

H.R. Rep. No. 104-50 (1995) .0.......cccccccsceseesseeeseeees 7, 14, 16

2 HAZEN, THE LAW OF SECURITIES REGULATION

ERE 23

Hearings before the Subcmte. on Securities of the

Cmte. on Banking, Housing and Urban Affairs,

De TE DUR DU CR ecctccicistcereccvecsccnsern acntncesosoncs 7

KRIPKE, THE SEC AND CORPORATE DISCLOSURE

Sen ITED aiesisanscisicteteiinceniueiaiieiiiaaiiagaiahaniiasaisiiiiiaigiciaaiinges 15, 30

Langevoort, Taming the Animal Spirits of the

Stock Markets, 97 Nw. U.L. REV. 135 (2002)............ 22

Loss & SELIGMAN, FUNDAMENTALS OF SECURITIES

FD nee 4

9 Loss & SELIGMAN, SECURITIES REGULATION

Ss UN UI cheikh i erie 1]

NASD, Dispute Resolution Statistics, http://

www.nasdadr.com/statistics.asp......... Sconseniannsnenssenteese 28

NASD, Five-Year Statistical Review 2000-2004,

http://www.nasdr.com/2380.aSp .............cccecceeeseeeeeees 27

PEEIEE UIEITIIIIED: sccsnicnentinenincncieteitemniemanieatasentapmtepaiganes 28

NERA, RECENT TRENDS IN SECURITIES CLASS ACTION

LITIGATION: 2003 EARLY UPDATE (Feb. 2004).......... 19

xX

TABLE OF AUTHORITIES-Continued

Page

New York Stock Exchange, Regulation: Enforcement

http://www.nyse.com/regulation/p 1020656068

597. .html?displayPage=“%F regulation%2F 10222

2 FRO BING. ccccsnsnssssccenennensenuniiiaaiiauinansmamineaiaian 28

Office of New York State Attorney General,

Press Releases 2004, http://www.oag.state.ny.us/

BECSS/ARBOCNNOS BITTE occccccsscessccesessessensonseeninenmnntnmnintinets 27

Oldham, Taking “Efficient Markets” Out of the

Fraud-on-the-Market Doctrine Afier the Private

Securities Litigation Reform Act, 97 Nw. U.L.

PREV. FES CA Pececccenccccsssssccinnssemninsiaiamminammmnnae 18

PERKINS & PERKINS, THE INTERNET BUBBLE

( 1D PPP axcacnceccvsnisesesesunanesemscapeesessivenmmmmmennuianiansieiiiiiian 13

POSNER, ECONOMIC ANALYSIS OF LAW

CFby B.. SGD ecesetvcvesecscersesossesssennnctnninnenemminmenninivhdia 13

Romano, The Shareholder Suit: Litigation without

Foundation?, 7 J. L. ECON. & ORG. 55 (1991)............. 6

S. Rep. No. 106-90 (1995) ....ccccccccssvocsvscscocssevevssonsoees passim

Scannell & Pacelle, Wall Street Gets Sticker Shock

from Citigroup, WALL ST. J., May, 12, 2004,

8 C7... rcevesccesoosensonsscscveossmunsneunzannibesimetiibesssitiaidiatasminiainle 20

SEC, 1993 ANNUAL REPORT, http://www.sec.gov/pdf/

annrep03/ar03enforce.pdf.............cccccccceeceereeeseesereeeees 26

XI

TABLE OF AUTHORITIES-Continued

Page

SEC, Additional Form 8-K Disclosure Requirements

and Acceleration of Filing Date, Securities Act

Release No. 33-8400, 69 Fed. Reg. 15594 (2004) ..... 25

SEC, DAY TRADING: YOUR DOLLARS AT RISK

(Mar. 2, 2001), http://www.sec.gov/investor/

Rakai ctaciiacean ahaa aaa 13

SEC Press Releases:

No. 2002-14 (Jan. 22, 2002), http://www.sec.gov/

| __ n e 27

No. 2002-179 (Dec. 20, 2002), http://www.sec.gov/

mews/ press) 2002-179. BAM ......ceccccccccsseccccssecseseeess 27

No. 2003-176 (Dec. 18, 2003), http://www.sec.gov/

news/press/2003-176. htm .............cccccceececeeeeeeeeeeees 27

No. 2004-14 (Feb. 5, 2004), http://www.sec.gov/

news/press/2004-14.Ftm ..............cceeeeeeceeeeeeeeeeeees 27

No. 2004-42 (Mar. 30, 2004), http://www.sec.gov/

news/press/2004-42 Atm .............::cccceeeeeeeeeeseeeeeeees 27

SEC, Selective Disclosure and Insider Trading,

Securities Act Release No. 33-7881,

a ee es Sr I iinaieitnircticictnaciaeitiaiiaiecainieaiit 15

SEC, SPECIAL STUDY: REPORT OF EXAMINATIONS OF

DAY-TRADING BROKER-DEALERS (Feb. 25, 2000),

http://www.sec.gov/news/studies/daytrading.htm...... 13

Smith, /PO Investors Get Assurance on Settlement,

WALL, ST. 5., FURS Zio Bees BOC cecccecccccesocscccccosccesses 20

XU

TABLE OF AUTHORITIES-Continued

Stanford Law School Securities Class Action

Clearinghouse, http://securities.stanfora.edu ............. 26

United States Dep’t of Justice, Office of the Deputy

Attorney General, The President’s Corporate Fraud

Task Force, http://www.usdoj.gov/dag/cftf................ 27

Winter, On ‘Protecting the Ordinary Investor’, .

63 WASH. L. REV. 881 (1988) .........-:cceeeeeeeseeeeeereeeeees i3

Winter, Paying Lawyers, Empowering Prosecutors,

and Protecting Managers: Raising the Cost of

Capital in America, 42 DUKE L.J. 945 (1993) ..... 14, 25

INTEREST OF THE AMICUS CURIAE

Merrill Lynch & Co., Inc. (“Merrill Lynch”) is a

diversified financial services company with 48,000

employees worldwide.' Merrill Lynch provides corpor-

ations, financial institutions, and governments with

investment banking and advisory services, including

underwriting new securities offerings. It also provides

wealth management services, including retail brokerage, to

more than a million clients. Merrill Lynch furnishes

research and analysis concerning individual securities,

prepared both by employee analysts and by third parties.

Like other financial services companies, Merrill Lynch

is subject to federal class action suits brought by investors

whose investments have not performed as they had hoped.

Such suits, which mushroomed prior to passage of the

Private Securities Litigation Reform Act in 1995, dipped

temporarily thereafter. In 2000, however, a huge stock

market “bubble” burst, causing trillions of dollars in

market losses within a matter of months. The events that

precipitated the collapse of the bubble also bankrupted or

slashed the value of many issuers of securities, particularly

internet and technology companies, diminishing prospects

for recovering damages from them. Investors therefore

turned their sights on the securities industry. They filed

hundreds of class action securities fraud suits against firms

that served as underwriters for issuers’ stock offerings and

that employed research analysts who offered opinions on

the securities. Plaintiffs magnified the threat these suits

posed by seeking certification of long class periods and

' Pursuant to Rule 37.6, Merrill Lynch states that no counsel for a

party authored this brief in whole or in part and that no person or

entity other than Merrill Lynch made a monetary contribution to its

preparation. The consents of the parties to the submission of this

brief have been filed with the Clerk.

2

classes encompassing anyone anywhere in the world who

purchased the stock.

Merrill Lynch is a defendant in a number of these suits.

It is vitally interested in the question presented in this case,

which affects how easily Section 10(b) suits can survive

motions to dismiss or be certified as class actions and what

must be proved at trial to establish liability. A permissive

loss causation standard like that adopted by the Ninth

Circuit threatens to make issuers and their advisers, and

even the analysts who opine on a company’s prospects,

insurers against market fluctuations attributable to other

events, including seismic shifts across broad markets like

the bursting of the 1998-2000 stock market bubble. In an

area where the threat of huge liabilities exerts so powerful

a pressure to settle that few cases ever reach trial it is

particularly important that the loss causation standard be

rigorous enough to weed out meritless suits at the early

stages of litigation.

Merrill Lynch believes that its experience with post-

bubble suits and as a leading financial services company

gives it a perspective that will be useful to the Court in

considering the meaning of the loss causation requirement.

SUMMARY OF ARGUMENT

The Ninth Circuit’s lax causation standard invites the

abusive litigation and coerced windfall settlements that

Congress in the Private Securities Litigation Reform Act

sought to forestall. Weak causation rules arbitrarily reward

speculators instead of compensating those truly injured by

fraud, harm investors by increasing costs, create perverse

disclosure incentives, and undermine the efficient

operation of capital markets. To effectuate the goals of the

Securities Exchange Act and PSLRA, this Court should

insist on a more rigorous standard that screens out

3

speculative theories of causation and requires a plaintiff to

show that defendant’s misconduct actually and directly

caused plaintiff's loss. In this case, that would require that

plaintiffs plead and prove not only that Dura’s allegedly

misleading statements inflated the price of Dura’s stock,

but also that revelation of the truth resulted in a decline in

price that can reliably be traced to the misstatement to the

exclusion of other factors.

That standard serves the goals of the securities laws. It

enables investors to obtain compensation for injuries

caused by fraud, allows innocent defendants to dispose of

meritless suits prior to trial and resist unwarranted class

certification, and removes a serious impediment to the free

flow of information in securities markets.

The hundreds of Section 10(b) class actions filed since

the stock market bubble burst in 2000 demonstrate the

need for this Court to adopt a rigorous loss causation

standard. These suits seek to hold issuers, underwriters,

and research analysts responsible for losses that investors

incurred on risky stocks of unproven internet and high

technology companies, which reached unprecedented

highs on a wave of investor enthusiasm before losing most

of their value within a few months. The Exchange Act and

PSLRA require plaintiffs in these actions to trace their

losses back to fraud by defendants and exclude both the

effect of other forces driving the inflation and bursting of

the bubble and company-specific factors that caused many

investments to fail. Absent a rigorous loss causation

standard, these class action suits threaten to seriously

burden the federal district courts while chilling speech on

subjects of importance to public investors.

The existence of numerous other civil, criminal,

administrative and arbitral remedies, as well as practical

incentives to truthful disclosure, ensure that a rigorous

4

causation standard will not detract from the deterrent and

compensatory goals of the securities laws. The Solicitor

General and SEC properly recognize that the Ninth

Circuit’s lax causation standard is not an appropriate

means to supplement government enforcement.

ARGUMENT

I. PLAINTIFFS IN PRIVATE SECTION § 10(b)

DAMAGES SUITS MUST PLEAD AND PROVE

IN A NON-SPECULATIVE MANNER THAT

DEFENDANT’S FRAUD CAUSED PLAINTIFFS’

INJURIES.

During an “‘ebullient’ stage” in the development of

implied causes of action, this Court found an implied cause

of action under Section 10(b) even though there is no

indication Congress “considered the question of private

civil remedies” when it enacted this antifraud provision.

Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723,

729-730 (1975); Loss & SELIGMAN, FUNDAMENTALS OF

SECURITIES REGULATION 1025 (3d ed. 1995). To prevent

that judicially implied right of action from resulting in

“liability in an indeterminate amount for an indeterminate

time to an indeterminate class’” (Blue Chip Stamps, 421

U.S. at 748, quoting Ultramares Corp. v. Touche, 255

N.Y. 170, 174 (1931)), this Court has repeatedly

“narrow[ed] Rule 10b-5 as a matter of substantive

coverage.” LOSS & SELIGMAN, supra, at 1036, 1050.

As the Court explained in Blue Chip Stamps, it has

pruned this “judicial oak” grown from a “legislative acorn”

“as a matter of policy.” 421 U.S. at 735, 737-739. It has

rejected “expansive imposition of civil liability” under

Section 10(b) because the implied cause of action

“presents a danger of vexatiousness different in degree and

in kind from that which accompanies litigation in general.”

5

Id. at 739-740. In particular, the Court has recognized that,

because of the risk of a jury verdict holding defendant

liable for huge market losses, “even a complaint which by

objective standards may have very little chance of success

at trial has a settlement value to the plaintiff out of any

proportion to its prospect of success” if the plaintiff is able

to “prevent the suit from being resolved against him by

dismissal or summary judgment.” And the threat of costly

and disruptive discovery adds a further “in terrorem

increment” to the settlement value of a suit. /d. at 740-741.

This Court has therefore repeatedly limited the scope

of private securities damages actions to curtail their

coercive potential and make meritless claims easier “‘to

dispose of before trial.”” Blue Chip Stamps, 421 U.S. at

742-743. See Ernst & Ernst v. Hochfelder, 425 U.S. 185

(1976) (requiring proof of scienter, not mere negligence);

TSC Indus. v. Northway, Inc., 426 U.S. 438 (1976)

(rejecting lax definition of materiality); Santa Fe Indus. v.

Green, 430 U.S. 462 (1977) (limiting Section 10(b) to

manipulative or deceptive conduct); Schreiber v. Burling-

ton Northern, Inc., 472 U.S. 1 (1985) (confining Section

14(e) to manipulative acts that involve misrepresentation

or nondisclosure); Central Bank v. First Interstate Bank,

511 U.S. 164, 189 (1994) (rejecting aiding and abetting

claims under Section 10(b) because they would engender

“uncertainty and excessive litigation’’).

Despite these and other judicially imposed limitations,

empirical studies showed that “(flor practical purposes, the

merits do not matter” in Section 10(b) class actions.

Alexander, Do the Merits Matter? A Study of Settlements

in Securities Class Actions, 43 STAN. L. REV. 497, 501

(1991) (Section 10(b) became “a grotesquely inefficient

form of insurance against large stock market losses” that

“encourages the filing of more and weaker suits”). Bet-the-

6

company damages claims and huge litigation costs forced

defendants into settlements that were neither “voluntary,”

because the risks mean that trial was not “a practically

available alternative,” mor “accurate,” because “the

strength of the case on the merits has little or nothing to do

with determining the amount of the settlement.” /d. at 499;

accord Romano, The Shareholder Suit: Litigation without

Foundation?, 7 J. L. ECON. & ORG. 55 (1991).

Responding to “significant evidence of abuse” that

undermined “American capital markets” and caused

“serious injuries to innocent parties” who were “forced to

pay exorbitant ‘settlements,’” Congress passed the Private

Securities Litigation Reform Act (“PSLRA”) “to protect

investors, issuers, and all who are associated with our

capital markets from abusive securities litigation.” H.R.

Conf. Rep. No. 104-369, at 31-32 (1995) (“H.R. Conf.

Rep.”). The PSLRA prescribes an express “loss causation”

standard, stays costly discovery pending ruling on motions

to dismiss, establishes a safe harbor for forward-looking

statements, and imposes other procedural and substantive

limits to curtail abusive Section 10(b) class suits.

Nevertheless, respondents urge and the Ninth Circuit

adopted a causation standard that moves headlong in the

opposite direction, significantly easing plaintiffs’ burden

and encouraging abusive strike suits. Both Congress in the

PSLRA and this Court have identified such lax causation

rules as a particular concern and have insisted that

plaintiffs show in a _ non-speculative manner that

defendant’s misconduct actually caused plaintiffs’ losses.

7

A. Section 10(b) Claimants May Not Rely On

Speculative Theories Of Causation But Must

Plead And Prove That Defendant’s Misconduct

Actually Caused Them Injury.

Congress in the Exchange Act established the general

principle that an investor may not recover an “amount in

excess of his actual damages on account of” a violation of

the securities laws. 15 U.S.C. § 78bb(a) (emphasis added).

After years of experience with abusive Section 10(b)

damages actions based on speculative causation theories,

Congress expressly provided in the PSLRA that a private

Section 10(b) “plaintiff shall have the burden of proving

that the act or omission of the defendant * * * caused the

loss for which the plaintiff seeks to recover damages.” 15

U.S.C. § 78u-4(b)(4) (emphasis added). The language of

these provisions on its face requires a plaintiff “to plead

and then to prove,” without speculation, that defendant’s

act Or omission caused a loss to plaintiff. H.R. Conf. Rep.

at 41. This standard is not satisfied by mere allegation or

evidence that defendant’s conduct inflated the price of a

security when plaintiff purchased it, for such inflation may

or may not eventually result in actual injury directly

traceable to defendant’s illegal act or omission.

In adopting the PSLRA Congress recognized that Sec-

tion 10(b) class actions are filed and settlements coerced

whenever “a company’s stock moves significantly, up or

down.” H.R. Rep. No. 104-50, at 16 (1995) (“H.R. Rep.”).

Such movements occur for many reasons. They do not by

themselves show that a plaintiffs loss is due to

defendant’s misconduct. Accordingly, Congress sought to

ensure “that plaintiffs prove that the loss in the value of

their stock was caused by the Section 10(b) violation and

not by other factors.” S. Rep. No. 104-98, at 7 (1995) (“S.

Rep.”); see Hearings before the Subcmte. on Securities of

8

the Cmte. on Banking, Housing and Urban Affairs, S. Hrg.

No. 103-431, at 568 (1993) (“market loss” difference

between “purchase price” and “sale price” of stock does

not identify “losses caused by fraud”) (testimony of

Patricia Reilly). Simply proving inflation at the time of

plaintiff's purchase does not establish that defendant’s

wrongful conduct resulted in plaintiff's loss.

Congress’s refusal to allow damages actions to proceed

on the basis of speculative and indeterminate damages

theories reflects principles previously announced by this

Court. A series of decisions insisted on rules that avoid

“throw[ing] open to the trier of fact * * * hazy issues of

historical fact” about causation, and that “permi{t]

exclusion prior to trial” of a Section 10(b) plaintiff who

cannot prove “in a readily demonstrable manner” that an

alleged fraud “damaged him.” Blue Chip Stamps, 421 U.S.

at 742-743, 746. See also id. at 734-735 (limiting Section

10(b) action to purchasers and sellers of securities because

causation of injury to others would be “conjectural and

speculative”); Virginia Bankshares v. Sandberg, 501 U.S.

1083, 1105-1106 (1991) (refusing to extend Section 14(a)

private damages action to shareholders whose proxy was

unnecessary to approval of a transaction to avoid

“speculative claims” in which “[c]ausation would turn on

inferences” that would be “hazy” and “unreliable”); Dirks

v. SEC, 463 U.S. 646, 667 n.27 (1983) (declining to give

weight to claims of “shareholder ‘losses,’ ‘injury,’ and

‘damages’” where there was “no clear causal connection

between inside trading and outsiders’ losses”); Santa Fe,

430 U.S. at 474 n.14 (non-disclosure not actionable where

plaintiffs “do not indicate how they might have acted

differently had they had prior notice of the merger”).

These precedents preclude recovery of losses that are

“indirec[t],” “too remote,” or speculative. Holmes v. SIPC,

503 U.S. 258, 268-269 (1992).

9

Consistent with these precedents, courts of appeals

typically require proof that a defendant’s misconduct

determined the security’s ultimate performance (“loss

causation”)}—not merely that it induced plaintiff's

purchase or sale of the security (“transaction causation”).

E.g., Emergent Capital Inv. Mgmt. v. Stonepath Group,

343 F.3d 189, 198 (2d Cir. 2003) (allegation that

defendant’s misconduct inflated the price of a stock is “a

paraphrased allegation of transaction causation,” which

“may explain why plaintiff purchased” the stock but not

“why it lost money on the purchase”); First Nationwide

Bank v. Gelt Funding Corp., 27 F.3d 763, 769 (2d Cir.

1994) (properly dismissed complaint did not allege that

misstatements were “the reason the transaction turned out

to be a losing one”); Robbins v. Koger Properties, Inc.,

116 F.3d 1441, 1448 (11th Cir. 1997).

Without these limitations, Section 10(b) would be an

uncompensated insurance mechanism covering losses

attributable to events other than defendant’s fraud. See

Bastian v. Petren Resources Corp., 892 F.2d 680, 685 (7th

Cir. 1990) (Posner, J.) (“Defrauders are a bad lot and

should be punished, but Rule 10b-5 does not make them

insurers against national economic calamities” or

“industry-wide phenomena”). Speculators in a _ risky

market could effectively transfer the risk of bad invest-

ments to issuers and market professionals, even though, if

those losses would have occurred regardless of any fraud,

“any award of damages to them would be a windfall.” Jd.

at 684-685.

“No social purpose would be served by encouraging

everyone who suffers an investment loss because of an

unanticipated change in market conditions to pick through

offering memoranda,” press releases, and analyst reports

“in the hope of uncovering a misrepresentation.” /d. at

10

685. Section 10(b) plaintiffs must plead and prove that the

value of their securities fell “because of the misrepresented

financial condition,” not “as a result of some subsequent

event.” Citibank v. K-H Corp., 968 F.2d 1489, 1496 (2d

Cir. 1992). See Moore v. PaineWebber, 189 F.3d 165, 172

(2d Cir. 1999) (no liability for losses attributable to

“intervening” or “extraneous” causes); id. at 177

(Calabresi, J., concurring) (purchase “as a result of fraud

-does not suffice to show loss causation when the whole

market collapses”); First Nationwide, 27 F.3d at 769-770

(“when factors other than the defendant’s fraud are an

intervening direct cause of a plaintiff's injury, that same

injury cannot be said to have occurred by reason of the

defendant's actions”); Bastian, 892 F.2d at 684 (securities

lost value because of market collapse, not risks concealed

by defendant); H.R. Conf. Rep. at 42 (Section 10(b)

damages limited to “losses caused by the fraud and not by

other market factors”).

In a case like this one, in which Dura is alleged to have

made misleading statements concerning its business, these

principles require that the plaintiff allege and prove a

distinct inflation in stock price caused by defendant’s

conduct, and then a distinct deflation in price upon

revelation of the truth that is directly linked to the

defendant’s false statements and is not explained by other

events. Plaintiffs concededly have not so pled. In a

manipulation case, the same principles require the plaintiff

to show distinct inflation in a security’s price caused by

market manipulation, foilowed by a decline when the

manipulation ceased that can be directly traced to cessation

of defendant’s misconduct rather than some other event. A

less objective causation standard would be too easy to ~

circumvent, thereby subverting Congress’s goal of

disposing of meritless Section 10(b) cases at the dismissal

stage. S. Rep. at 7.

ll

Any lesser showing would prove not that defendant’s

wrong caused plaintiff's loss, only that it migfxt have done

so. In particular, the “foreseeability” test used by some

courts to address issues of proximate cause is poorly

adapted to transactions in modern securities markets in

which “[s]o many forces operate in the market for an

active security that there is little certainty in identifying

causes or measuring their separate effects.” 4 BROMBERG

& LOWENFELS, SECURITIES FRAUD & COMMODITIE?

FRAUD § 7:498, at 7-985 to 7-986 (2d ed. 2004); see also 9

Loss & SELIGMAN, SECURITIES REGULATION 4280-4281

(rev. 3d ed. 2004) (“With all the factors that determine

stock market prices,” any “lingering effects” of a fraud

soon “become intermingled with many other market

determinants’”’).

A requirement that a Section 10(b) damages plaintiff

allege and prove merely that its loss was “foreseeable” —

rather than that it was directly caused by defendant’s

conduct—would encourage suits based on uncabined

speculation, make impossible the early disposal of merit-

less suits, and give rise to the very abuses identified in

Blue Chip Stamps and by Congress in adopting the

PSLRA. See Fogarazzo v. Lehman Bros., 2004 WL

1151542, at *11, *14 (S.D.N.Y. 2004) (refusing to dismiss

Section 10(b) claim that analyst reports caused plaintiffs’

losses after bubble burst on ground that it was

“foreseeable” that market would ignore publicly known

fects about issuer’s dire financial condition because

analysts were “optimistic”). Mere speculation that

defendants may have caused investment losses is not

enough to warrant giving plaintiffs the tools to extract

massive settlements that, we show in the next section,

undermine the investor-protective goals of federal

securities legislation.

12

B. Permitting Section 10(b) Class Actions To

Proceed On The Basis Of Speculative Theories

Of Causation Would Do “More Harm Than

Good.”

““(CJjourts must look to the underlying policies or

legislative intent in order to draw a manageable line

between those causal changes that may make an actor

responsible for an effect and those that do not.’” Dep't of

Transp. v. Public Citizen, 124 S. Ct. 2204, 2215 (2004);

see Blue Chip Stamps, 421 U.S. at 735. Given Congress’s

aim in the PSLRA to enable “defrauded investors [to]

recover their losses,” while simultaneously preventing

“abusive and meritless suits” that result in “serious injuries

to innocent parties,” “the investing public and the entire

U.S. economy,” the proper causation rule should require

plaintiff to trace a measurable loss to defendant’s wrongful

conduct and allow defendants to obtain dismissal of claims

that rest on speculative theories that cannot reliably

support that showing. H.R. Conf. Rep. at 31.

Permissive causation rules requiring merely a causal

link to price inflation but not to a plaintiff's loss would

turn Section 10(b) into an uncompensated insurance

scheme for speculators in high-risk stocks (and a rich

harvest of fees for their lawyers), and would do “‘more

harm than good.’” Hochfelder, 425 U.S. at 214 n.33,

quoting Blue Chip Stamps, 421 U.S. at 747-748. Because

such rules result in compensation for market losses that are

not reliably tied back to a defendant’s misleading

Statement, they do not serve Congress’s goal of

compensating an investor for no more than his “actual

damages” “caused” by the wrong.

Every delayed announcement of accurate firm

information produces both winners (who sold during the

period of inflation) and losers (who bought then and sold

il

13

after disclosure of the truth). POSNER, ECONOMIC

ANALYSIS OF LAW 489 (Sth ed. 1998). “Over the long run,

any reasonably diversified investor will be a buyer half the

time and a seller half the time” and will not benefit from “a

legal rule that forces his winning self to compensate his

losing self over and over.” EASTERBROOK & FISCHEL, THE

ECONOMIC STRUCTURE OF CORPORATE LAW 340 (1991);

see Winter, On ‘Protecting the Ordinary Investor’, 63

WASH. L. REV. 881, 884 (1988) (describing ways in which

diversification reduces risks to ordinary investors).

This balance of benefits and harms was pronounced

during the bubble, when a high proportion of those buying

and selling technology stocks were short term day-traders

interested solely in movement in a stock’s price over a few

minutes or hours and not in the accuracy of information

about a company or the integrity of its stock price as a

reflection of the company’s value. See SEC, DAy

TRADING: YOUR DOLLARS AT RISK (Mar. 2, 2001); SEC,

SPECIAL STUDY: REPORT OF EXAMINATIONS OF DAyY-

TRADING BROKER-DEALERS (Feb. 25, 2000); PERKINS &

PERKINS, THE INTERNET BUBBLE 25 (1999). Momentum

traders, though they might hold a stock longer than day-

traders, similarly sought to take advantage of fluctuating

price movements, aiming to sell before upward momentum

ran out. See DEVITTO, IRRATIONAL MARKETS AND THE

ILLUSION OF PROSPERITY 108 (2001) (“Momentum”

investors “simply identify stocks with the greatest upward

momentum and buy them”; “value or worth of a company

is not a consideration”). These speculators traded the stock

of a single company many times. Sometimes they

benefited from delays in the dissemination of truthful

information; sometimes they lost. Obviously, it would be

unavailing to try to demonstrate loss causation simply by

pointing te “price inflation” at the time such traders

purchased stock.

14

The arbitrary provision of compensation. to some

i,vestors for market losses that may or may not have been

aused by defendant’s conduct results in the very problem

ct abusive litigation and coerced settlements that Congress

identified in the PSLRA. See, e.g., Winter, Paying

Lawyers, Empowering Prosecutors, and _ Protecting

Managers: Raising the Cost of Capital in America, 42

DUKE L.J. 945, 949-950 (1993) (stock transactions result

in “litigation whenever investors have lost an amount

sufficient to support an award of attorney’s fees”; in one

industry, a class action was filed to challenge every IPO

where the stock traded below the IPO price after 15

months). This may be beneficial for lawyers and expert

witnesses, but it is manifestly injurious to investors.

These suits “extract a deadweight loss from investors.”

Id. at 952. Continuing stockholders are harmed when the

issuer incurs litigation costs and pays a massive settlement

compensating some shareholders and their lawyers. See

H.R. Conf. Rep. at 32 (“Investors always are the ultimate

losers when extortionate ‘settlements’ are extracted from

issuers’); S. Rep. at 9 (“long-term investors ultimately end

up paying the costs associated with the lawsuits”);

FRIENDLY, FEDERAL JURISDICTION 120 (1973). They are

harmed too when investment banks and other professionals

that are essential to raising capital and the efficient

working of the market are subjected to open-ended Section

10(b) damages suits. Defending those suits drives up the

cost of professional services and makes professionals

unwilling to serve newer and smaller companies. Central

Bank, 511 U.S. at 189, citing Winter, supra; see H.R. Rep.

at 20 (“Fear of litigation keeps companies out of the

capital markets,” and “businesses suffer as auditors and

directors decline engagements and board positions”);

Alexander, supra, 43 STAN. L. REV. at 570-573.

ES

15

Lax causation rules also disserve the core goal of the

securities laws to ensure the free flow of information that

is Critical to investors and to market efficiency. H.R. Conf.

Rep. at 42 (“Abusive litigation severely affects the

willingness of corporate managers to disclose information

to the marketplace”). A firm that discloses information

“inevitably takes the risk of excessive optimism and

excessive pessimism.” EASTERBROOK & FISCHEL, supra, at

339. A “rule penalizing excesses in either direction would

lead to silence” about a company’s prospects. /bid.

Investors particularly “want the issuer’s own view of

its future.” KRIPKE, THE SEC AND CORPORATE DISCLO-

SURE 25 (1979). Broad causation theories bring the threat

of massive liabilities for such prognostications (see Asher

v. Baxter Int'l, 377 F.3d 727 (7th Cir. 2004)), creating a

potent disincentive to discuss the company’s future. See

Backman, Forward-Looking Statements and Cautionary

Language After the 1995 Reform Act, in PLI, SAILING IN

“SAFE HARBORS” 153, 158-159, 208-209 (1997). Corpo-

rate managers’ communications with analysts, which are

“necessary to the preservation of a healthy market,” are

also muzzled by the risk of Section 10(b) suits based on

weak causal links. Dirks, 463 U.S. at 658-659; see SEC,

Release No. 33-7881, 65 Fed. Reg. 51716, 51718 n.19

(2000) (“fear of legal liability” “chill[s]” communications

with analysts). When SEC disclosure requirements do not

make silence an option, issuers may respond to the threat

of unconstrained liability with defensive disclosure that

“bur[ies] the shareholders in an avalanche of trivial

information.” TSC, 426 U.S. at 448; see Basic Inc. v.

Levinson, 485 U.S. 224, 231 (1988).

Allowing Section 10(b) suits to proceed on the basis of

speculative causation theories thus detracts from the

quantity and quality of information received by investors.

16

Congress’s goal in adopting more stringent limits on

private damages actions in the PSLRA was to address the

concern that Section 10(b) suits had “‘chillfed]” the

“robustness and candor of disclosure.’” H.R. Conf. Rep. at

43; see H.R. Rep. at 19 (“abuse of the 10b-5 system * * *

deters the voluntary disclosure of information that the

Federal securities laws were designed to promote”); S.

Rep. at 5. This Court has refused to interpret the Exchange

Act in ways that undermine the free flow of information,

and it should do so once again here. Dirks, 463 U.S. at

658-659.

Open-ended liabilities based on speculative causation

theories also burden constitutionally protected speech.

This Court should not expand implied private rights of

action in a way that infringes on the First Amendment,

especially with regard to expression in which there is such

a strong public interest. See Lowe v. SEC, 472 U.S. 181,

210 & n.58 (1985) (there is “no doubt about the protected

character” of “the expression of an opinion about a

marketable security,” “factual information about * * *

market trends,’ and “commentary” on “market

conditions”); Nike, Inc. v. Kasky, 539 U.S. 654, 664 (2003)

(Stevens, J., concurring); id. at 676-678 (Breyer &

O’Connor, JJ., dissenting). As the United States explained

in its brief in Nike, the “First Amendment does not

tolerate” a “private cause of action” for monetary relief

against a company for “false statements respecting its

products”—whether those statements “constitute ‘com-

mercial’ or ‘noncommercial’” or hybrid speech—because

such “unconstrained” actions pose “a serious threat of

unjustifiable chill to legitimate speech on matters of public

interest” and to “the free flow of useful information.” 2003

WL 899100, at *7-*8, *12, *20, *25. The United States

pointed to the necessity of “constraining features” like

rigorous standards of “actual” reliance and causation to

17

avoid an unconstitutional burden on speech. /d. at *20-

*21, *23.

Furthermore, lax causation standards lead _ to

“procedural intractibility” that imposes a considerable

burden on the courts. Jn re Merrill Lynch & Co., 273 F.

Supp. 2d 351, 366 n.28 (S.D.N.Y. 2003) (Pollack, J.).

Dissatisfied investors “would be able (with the benefit of

hindsight) to point to any allegedly misleading positive

statement issued by anyone (not just the issuer) and couple

that with an allegation that the price of the security was

inflated as a result to satisfy loss causation,” which invites

“self-serving testimony, strike suits and _ protracted

discovery.” bid. Because the “issues would be hazy,” the

“litigation protracted,” and the “resolution unreliable,”

these class actions would be especially burdensome. /bid.

(quoting Grace v. Rosenstock, 228 F.3d 40, 48 (2d Cir.

2000)); Alexander, supra, 43 STAN. L. REV. at 572

(describing “cost to the public in judicial resources”).

Given all these considerations, it is important in

devising rules governing Section 10(b) damages actions to

“reconcile the conflicting interests of investors in a manner

designed to best protect the interests of a// investors—

those who are plaintiffs in a particular case, those who are

investors in the defendant company, and those who invest

in other companies” whose access to capital markets and

professional advice would be curtailed by excessive

liability risks. S. Rep. at 22. The lax causation rule

plaintiffs advocate would skew the securities laws in favor

of Section 10(b) plaintiffs, who may or may not have been

injured by defendant’s wrongful conduct, at the expense of

investors in general. It also would undermine the efficient

operation of capital markets and create perverse incentives

that contradict the securities laws’ goal of ensuring robust

communication concerning issuers of securities. Plaintiffs’

18

causation standard, in short, has nothing to recommend it.

See Central Bank, 511 U.S. at 188 (“Extending the 10b-5

cause of action * * * makes the civil remedy more far

reaching, but it does not follow that the objectives of the

statute are better served”).’

A standard requiring particularized pleading and a

reliable showing that defendant’s wrong actually and

directly caused a plaintiff's loss suffers from none of these

defects. It achieves what Congress intended by “reduc[ing]

significantly the filing of meritless securities lawsuits

without hindering the ability of victims of fraud to pursue

legitimate claims.” H.R. Conf. Rep. at 39.

C. Hundreds Of Post-Bubble Section 10(b)

Damages Actions Illustrate The Need For

Rigorous Loss Causation Standards That Weed

Out Meritless Cases At The Dismissal Or Class

Certification Stages.

The federal courts today are congested with cases that

clearly illustrate the danger of lax causation standards and

the need to uphold the more rigorous pleading and proof

requirements that Congress mandated in the PSLRA.

Investors have filed hundreds of Section 10(b) damages

suits in the aftermath of the stock market bubble to recover

losses incurred on speculative investments in unproven

internet and technology companies. A record 503 private

> These problems are compounded by the willingness of lower

courts to ease plaintiffs’ burden of proof by expanding the Basic

presumption of causation and reliance to situations ever more

remote from the issuer misstatements addressed in that case. See

pp. 19-21, infra; see generally Oldham, Taking “Efficient

Markets" Out of the Fraud-on-the-Market Doctrine After the

Private Securities Litigation Reform Act, 97 NW. U. L. REV. 995

(2003).

19

federal securities law class action suits were filed in 2001,

the year after the bubble burst. NERA, RECENT TRENDS IN

SECURITIES CLASS ACTION LITIGATION: 2003 EARLY

UPDATE 2 (Feb. 2004). These class actions exert

irresistible pressure to settle. Securities fraud settlements

totaled $6.6 billion in 2001-2003. CORNERSTONE, POST-

REFORM ACT SECURITIES LAWSUITS | (2004).

These suits reach beyond issuers of securities.

Congress recognized in adopting the PSLRA that

“fujnderwriters” and “other professionals are prime targets

of abusive securities lawsuits. The deeper the pocket, the

greater the likelihood that a marginal party will be named

as a defendant.” S. Rep. at 9. When these “peripheral

defendants are sued, the pressure to settle is overwhelming

—tregardless of the defendant’s culpability.” /d. at 21.

Securities firms, which are perceived to have deep pockets

and which inevitably are involved in some capacity in

securities transactions, have been “prime targets” of post-

bubble suits.

Plaintiffs, for example, have sued the underwriters of

309 bubble-era IPOs in class actions alleging that they

misled investors about IPO allocation practices, principally

alleged agreements that persons receiving IPO shares

would purchase additional shares in the aftermarket. Those

purchases supposedly inflated the price of the stock, in a

gradually diminishing amount, throughout lengthy class

periods that typically span the inflation and bursting of the

bubble. /n re IPO Sec. Litig., No. 21 MC 92 (S.D.N.Y.). In

addition, many suits have been filed against research

analysts and their employers, alleging that analysts issued

optimistic opinions they did not believe in order to protect

their firms’ investment banking work for the issuer, and

that their opinions inflated the price of the stock during

a

20

some extended period. E.g., In re Merrill Lynch Research

Reports Sec. Litig., No. 02 MDL 1484 (£.D.N.Y.).

The cost to settle such suits threatens to be enormous.

One securities firm, which already has agreed to a multi-

billion dollar settlement, has set aside reserves of nearly

$10 billion to cover bubble-era securities fraud suits.

Scannell & Pacelle, Wall Street Gets Sticker Shock from

Citigroup, WALL ST. J., May 12, 2004, at Cl. The issuers

in the IPO suits, which are not plaintiffs’ main target, have

agreed to settle claims against them for $1 billion. Smith,

IPO Investors Get Assurance on Settlement, WALL ST. J.,

June 27, 2003, at C1.

The causal assertions made in these cases are

incredibly speculative and stretch beyond the breaking

point the fraud-on-the-market theory adopted by a 4-2

plurality of this Court in Basic. Plaintiffs claim that a small

number of open market “tie in” purchases of a security,

made a few days after an IPO, inflated the price of the

security and injured every purchaser throughout class

periods of many months or years. They also contend that

third party opinions, which are not alleged to have

misstated facts about the issuer and which were circulated

in a volatile market full of competing opinions, inflated the

price of a security for long periods. But it is not a matter of

“common sense and probability” to presume that limited

aftermarket stock purchases or analyst opinions cause a

lasting impact on stock price. No presumption of causation

or reliance is justified in circumstances so far removed

from those addressed in Basic. See Hevesi v. Citigroup,

Inc., 366 F.3d 70, 78-80 (2d Cir. 2004); DeMarco v.

Lehman Bros., 222 F.R.D. 243 (S.D.N.Y. 2004).

Congress understood that security prices “rise or fall

for reasons unrelated to the alleged fraud” and insisted that

plaintiffs may recover only for “losses caused by the fraud

21

and not by other market conditions.” H.R. Conf. Rep. at

42. Plaintiffs may not simply “presume” that market prices

were affected for lengthy periods but should have to

disentangle any price effects of “tie in” purchases and

analyst opinions from effects of other events. That task is

“complex and uncertain” (ibid.), and not ordinarily

possible in a class proceeding. Econometric tools for

segregating the price effects of particular events are largely

useless over long class periods. See Elkind v. Liggett &

Myers, 635 F.2d 156, 171 (2d Cir. 1980) (it is “difficult if

not impossible” to prove over more than a “short period”

“the time when and extent to which the integrity of the

market was affected” by alleged misconduct not involving

issuer statements; “unrelated factors affecting the market

price” make it “impossible as a practical matter to isolate”

any “rise or decline in market price * * * caused by” that

conduct); Greenberg v. Crossroads Sys., 364 F.3d 657,

665 (Sth Cir. 2004) (plaintiffs must show “stock’s price

was actually affected” by fraud, segregating effect of other

factors, otherwise presumption of reliance and causation

“would be based solely on speculation”); Basic, 485 U.S.

at 253-255 (White & O’Connor, JJ., concurring in part and

dissenting in part) (fraud-on-the-market approach is

subject to limits of economic theory).’

> See also Easterbrook & Fischel, Optimal Damages in Securities

Cases, 52 U. CHI. L. REV. 611, 627-628 (1985) (the longer the

period examined the poorer “our ability to match particular pieces

of news with the effects attributable to them”). Index comparisons

cannot account for firm-specific factors. See Akerman v. Oryx

Communications, 810 F.2d 336, 342-343 (2d Cir. 1987) (expert's

“statistical analys[e]s” purporting to show that stock had gone

down more than an index and had underperformed 82 of 100 new

issues “lack[ed] credibility because they fail[ed] to reflect any of

the countless variables that might affect the stock price

performance of a single company”).

22

The difficulty of disentangling effects of fraud and

extraneous market factors over months or years is

exacerbated in the tumultuous stock bubble market. See

Langevoort, Taming the Animal Spirits of the Stock

Markets, 97 Nw. U.L. REv. 135, 177-178 (2002) (“noise

and the presence of other information” render calculations

of price effect of events “imprecise,” “unusable,” and

“increasingly doubtful” as the time period under

consideration lengthens); Dunbar & Heller, Fraud on the

Market Meets Behavioral Finance, COLUM. L. SCH.

CENTER FOR L. & ECON. STUD. (Dec. 1, 2003), http://

www.law.columbia.edu/center_program/law_ economics/w

kshops/fall2003#81253.* ~

Determining whether plaintiffs have a viable loss

causation claim cannot be deferred until trial. “If a

defendant cannot win an early dismissal of the case, ‘the

economics of litigation may dictate a settlement even if the

defendant is relatively confident that it would prevail at

trial.’” S. Rep. at 7 (1995), quoting SEC Chairman Arthur

Levitt. Accord Blue Chip Stamps; 421 U.S. at 740-741.

The PSLRA’s heightened pleading requirement and overt

mandate that plaintiff must “plead” and then “prove” loss

causation (H.R. Conf. Rep. at 41), along with the coercive

a

Economists broadly agree that markets during the bubble were

not “efficient,” which is a necessary predicate for presuming under

Basic that information is impounded in a security’s market price.

See Gariety v. Grant Thornton, 368 F.3d 356, 365-366 (4th Cir.

2004). The factors routinely used by courts to determine market

efficiency—which focus on the existence of an active and

developed market—are ill-adapted to assess whether the price of

stocks trading in a bubble environment efficiently reflects

economic value and are therefore apt to result in a finding of

efficiency where economists agree there is none, and thus to an

unwartranted extension of Basic. See Dunbar & Heller, supra;

Cammer v. Bloom, 711 F. Supp. 1264, 1286-1287 (D.N.J. 1989).

- —_— ee rw ——

23

consequences of postponing consideration of loss

causation, make dismissal an appropriate remedy to

address defects in loss causation allegations.

The most powerful coercive effect of a Section 10(b)

damages action derives from a willingness by the trial

court to certify the suit as a class action. See Blair v.

Equifax Check Servs., 181 F.3d 832, 834 (7th Cir. 1999)

(“Many corporate executives are unwilling to bet their

company that they are in the right in big-stakes litigation,

and a grant of class status can propel the stakes of a case

into the stratosophere,” giving plaintiffs and “even some

district judges” a “device to wring settlements from

defendants”). It is therefore incumbent on a _ court

considering a motion to certify a class action to make an

independent determination whether plaintiffs have met

their burden of establishing that loss causation can reliably

be proved across the entire proposed class using a fraud-

on-the-market presumption or some trustworthy expert

formula, or whether proof of causation must instead turn

on time- or transaction-specific inquiries incompatible

with class adjudication. E.g., Gariety, 368 F.3d at 365-366;

West v. Prudential Sec., 282 F.3d 935, 938 (7th Cir. 2002);

Newton v. Merrill Lynch, 259 F.3d 154, 166 (3d Cir.

2001); Szabo v. Bridgeport Machs., 249 F.3d 672, 675

(7th Cir. 2001); see 2 HAZEN, THE LAW OF SECURITIES

REGULATION § 12.12[3], at 539 (4th ed. 2002) (“the

difficulty in discounting extrinsic market factors” in

determining whether plaintiffs have been damaged

“necessitate[s] complex analysis”; “the proof may vary

from plaintiff to plaintiff and may thus require severing a

class action”).

Whether defendant’s defenses to loss causation will

require trade-by-trade or other time-specific inquiry is a

key part of this inquiry. E.g., Amchem Prods., Inc. v.

24

Windsor, 521 U.S. 591, 625 (1997); Visa Check Antitrust

Litig., 280 F.3d 124, 138 (2d Cir. 2001). The court “may

not duck hard questions by observing that each side has

some support” from experts. West, 282 F.3d at 938-940

(decertifying securities fraud class where “reputable

financial economist” failed “to test for and exclude other

potential sources of price movement”); DeMarco, 222

F.R.D. at 247-249 (refusing to certify class where

plaintiffs’ expert failed to demonstrate that analyst reports

“materially impacted the market price [of the security] in a

reasonably quantifiable respect” independent of the

plethora of other information, opinion, and “confounding

news” entering the market”); Gariety, 368 F.3d at 365-

366. It would be far too easy an end run around the

PSLRA to allow a plaintiff at the class certification stage

to show that causation is an issue common to the class by

offering speculative expert testimony. See Reiter v.

Sonotone Corp., 442 U.S. 330, 345 (1979) (courts must be

“especially alert” to “administrative chaos” and “class-

action harassment” at the class certification stage).

Il. A RIGOROUS LOSS CAUSATION STANDARD

THAT GUARDS AGAINST BLACKMAIL SETTLE-

MENTS AND WINDFALL RECOVERIES WILL

NOT UNDERMINE THE DETERRENCE AND

COMPENSATION POLICIES OF THE SECUR-

ITIES LAWS.

This Court need have no fear that requiring Section

10(b) plaintiffs to satisfy a rigorous, non-speculative loss

causation standard, as Congress intended, will undermine

the deterrence and compensation policies of the securities

laws or hobble their enforcement. The SEC disagrees with

plaintiffs that a diluted loss causation standard is necessary

to effective operation of the securities laws, and for good

reason. “[{T]}he deterrent effect is weak” when “the merits

of claims” are “irrelevant to their initiation or settlement

25

values,” as is the case with many Section 10(b) damages

suits. Winter, supra, 42 DUKE L.J. at 952. Meritorious

securities fraud suits, of course, will satisfy a rigorous

causation standard. And a plethora of other judicial and

administrative remedies targeted at truly wrongful conduct

by expert regulators and prosecutors also ensure that a

rigorous causation standard will not have adverse effects.

SEC regulations impose stringent reporting obligations

on corporations, subject to SEC enforcement proceedings.

Corporations must file quarterly and annual financial

statements, which executives now must certify under threat

of criminal penalty and disgorgement of their compen-

sation and stock trading profits. 15 U.S.C. §§ 7241, 7243;

18 U.S.C. § 1349. Issuers also must file, within four

business days, Form 8-K reports on any of a host of

material corporate events, including agreements, acquisi-

tions, disposition of assets, off-balance-sheet financial

obligations, and changes in officers or directors. SEC,

Release No. 33-8400, 69 Fed. Reg. 15594 (2004).

The powers of the SEC and Department of Justice to

enforce corporate disclosure obligations are substantial and

do not depend on proving loss causation. The Commission

may obtain injunctive relief, cease-and-desist orders,

orders barring or suspending individuals from serving as

an officer or director of an issuer of securities, and large

civil penalties, including disgorgement of any gain. 15

U.S.C. §§ 78u, 78u-3; see SEC v. First Jersey Sec., 101

F.3d 1450 (2d Cir. 1996) (requiring disgorgement of $75

million). Under the Sarbanes-Oxley Act, the SEC may

earmark penalties and amounts disgorged “for the benefit

of the victims” of the violation. 15 U.S.C. § 7246(a).

A person who willfully and knowingly makes a false or

misleading statement of material fact may also be

criminally liable and is subject to imprisonment for 20

26

years and multi-million deliar fines. /d. § 78ff. The recent

indictment of Enron CEO Kenneth Lay, for example, rests

in part on statements he made about the company in an

online employee forum and in calls with research analysts.

See Coffee, Overcriminalization?, NAT’L L.J., Aug. 16,

2004, at 13. Insiders who trade with knowledge of material

information that has not been disclosed to the public face

civil penalties of three times the profit gained or loss

avoided. 15 U.S.C. § 78u-1. The Securities Act authorizes

many similar remedies for misstatements made in

connection with the registration of securities, for which

liability may be established without proof of scienter. /d.

§§ 77t, 77y. Underwriters and broker-dealers are subject to

equivalent deterrent and remedial sanctions, as well as a

host of specialized standards applicable to their operations.

The SEC is not reluctant to use these powers. The goal

of SEC enforcers has been described by former Chairman

Richard Breeden as leaving securities law violators

“naked, homeless, and without wheels.” Eisenberg,

Enforcement Issues and Litigation, 21 SEC. REG. L.J. 421,

421 (1994). In the aftermath of the bubble and recent

corporate scandals the Commission’s 900-strong

enforcement staff has shown extraordinary vigor. During

fiscal year 2003 alone the SEC brought 271 injunctive

actions and 365 administrative proceedings against issuers

and financial services providers—far more than the 216

private securities class actions filed in federal court in

2003 (see http://securities.stanford.edu)—and obtained

orders requiring the disgorgement of $900 million and the

payment of $1.1 billion in penalties. SEC 1993 Annual

Report 15, http://www.sec.gov/pdf/annrep03/ar03enforce.

pdf. Recently, the SEC and other regulators obtained a

$1.4 billion settlement from ten securities firms accused of

issuing research opinions tainted by conflicts of interest,

and well over a billion dollars in settlements with mutual

27

fund companies accused of market-timing violations,

specialist firms accused of “front running,” and

underwriters accused of IPO allocation violations.’ The

Department of Justice’s Corporate Fraud Task Force has

charged hundreds of defendants since it was formed in

July 2001, including senior officers and managers of

securities issuers and employees of financial services

companies, obtaining many guilty pleas and convictions.

http://www.usdoj.gov/dag/cftf.

State prosecutors and blue-sky officials bring their own

overlapping civil and criminal enforcement actions.

Among state securities law enforcers, for example, the

New York Attorney General alone has_ reported

substantially more than $1 billion in settlements with

financial services companies already in 2004. http://www.

oag.state.ny.us/press/agpress04.html.

Financial services industry Self Regulating Organiza-

tions (“SROs”) actively enforce their regulations, which

implement and supplement the securiti>s laws. In 2003 the

National Association of Securities Dealers (“NASD”)

barred 494 individuals from the securities business,

suspended 333 others, and expelled 30 firms. http://www.

nasdr.com/2380.asp. The New York Stock Exchange

brought 231 cases of rules violations against members that

. E.g., http://www.sec.gov/news/press/2002-179.htm ($1.4 billion

global settlement in analyst conflict of interest cases); id. at 2004-

14.htm ($225 million settlement in case alleging market timing

trading in mutual funds); id. at 2003-176.htm ($250 million market

timing settlement); id. at 2004-42.htm ($240 million settlement in

case against five specialist firms for executing orders for dealer

accounts ahead of executable public customer orders); id. at 2002-

14.txt ($100 million settlement for alleged practices relating to

allocations of stock in IPOs).

28

year. http://www.nyse.com/regulation/p 1020656068597.ht

ml?displayPage=%oF regulation%o2F 1022221394131.html.

Furthermore, agreements between broker-dealers and

their customers invariably include arbitration provisions.

NASD arbitration, which this Court has strongly endorsed

as a means to resolve securities fraud claims, is thus

readily available to investors. NASD MANUAL § 10101;

see Shearson/American Express v. McMahon, 482 U.S.

220, 232 (1987) (describing the “suitability of arbitration

as a means of enforcing Exchange Act rights” and “com-

petence of arbitral tribunals to resolve § 10(b) claims”).

Arbitration jocuses directly on the central issues in

dispute, such as whether a client has been directed to

unsuitable investments or a broker made a material

misstatement to the customer. Arbitration—in which legal

representation and discovery are available and experienced

decisionmakers consider the facts and circumstances of

each case—is less costly and quicker than litigation and

increases the share of recovery that an investor retains. See

Howsam v. Dean Witter, 537 U.S. 79, 85 (2002) (NASD

arbitrators’ “comparative expertise” helps “to secure a fair

and expeditious resolution of the underlying controversy”).

Smaller claims are channeled into a simpler procedure for

even faster and more economic resolution. NASD

MANUAL §§ 10302, 10316, 10321-10322.

Since the stock market bubble burst, thousands of

investors have discovered that arbitration provides a fair

and efficient forum for resolution of claims against broker-

dealers. Nearly 9000 arbitration cases were filed with

—-NASD in 2003. Customers received awards in more than

half of the 7300 NASD arbitration cases closed that year.

See http://www.nasdadr.com/statistics.asp.

Securities market participants are thus hemmed in by

an array of federal and state government powers, both civil

29

and criminal, SRO sanctions, and arbitral remedies, which

effectively curb unlawful practices and compensate non-

speculative injuries. As Judge Friendly observed, “([tJhe

important thing is to stop the evil conduct” and “an

injunction,” “fines,” or other sanctions imposed at the

behest of expert government and SRO regulators achieve

that purpose without the risk attendant on civil damages

actions of “ruin{ing] innocent stockholders,” “produc[ing]

blackmail settlements,” or deterring desirable conduct.

FRIENDLY, supra, at 120. Given the availability of these

fact-specific remedies, which deter and punish misconduct

and compensate those who truly are its victims, there is no

reason why this Court should recognize, in a judicially

implied cause of action, a class-wide liability that rests on

speculative inferences of causation.

Indeed, even against the background of a far more

rudimentary enforcement system than exists today, this

Court refused in Piper v. Chris-Craft Indus., 430 U.S. 1

(1977), to imply a cause of action for damages for

violation of Section 14(e) of the Exchange Act—

prohibiting fraud in connection with a tender offer—

because the threat of damages was not necessary to deter

fraudulent conduct. “[I]njunctive relief” is more effective

than “a damages award” that also “may well be inconsis-

tent with the interests of many members of the protected

class.” Jd. at 42. Reversing a court of appeals’ ruling that

implied a damages cause of action and invoked a

“presumption of reliance and causation” in the name of

deterrence and “effective” remedies (id. at 17-18), this

Court observed that “uncertainties” about whether

particular conduct amounts to a legal violation and “caused

injury” “call into question whether ‘deterrence’ of § 14(e)

violations is a meaningful goal” except for “the most

flagrant sort of violations which no reasonable person

could consider lawful.” /d. at 40 n.26. And for those

30

“obvious and serious” violations, “injunctive relief” is “apt

to be the most efficacious form of remedy.” /bid.°

Congress has limited recovery to “actual damages on

account of the act complained of” (15 U.S.C. § 78bb(a))

and required plaintiffs to plead and prove that the

misrepresentation or omission “caused the loss for which

the plaintiff seeks to recover.” Jd. § 78u-4(b)(4). Partic-

ularly in light of the alternative remedies and sanctions,

“any extension of [the securities] laws, to approach

something closer to [the] investor insurance scheme” that

plaintiffs seek “should come from Congress, and not from

the courts.” Basic, 485 U.S. at 256-257 (White &

O’Connor, JJ., concurring in part and dissenting in part).

CONCLUSION

The judgment of the Ninth Circuit should be reversed.

Respectfully submitted.

ANDREW L. FREY STEPHEN M. SHAPIRO

KENNETH S. GELLER Counsel of Record

Mayer, Brown, Rowe & TIMOTHY S. BISHOP

Maw LLP JOSHUA YOUNT

1909 K Street, N.W. Mayer, Brown, Rowe &

Washington, D.C. 20006 Maw LLP

(202) 263-3000 190 South LaSalle Street

Chicago, Illinois 60603

(312) 782-0600

SEPTEMBER 2004

° Quite apart from the panoply of available legal remedies, self-

interest provides a powerful incentive to timely and truthful

disclosure. “{T]he market provides strong incentives for anyone

who desires continued access to the market to keep the signals

honest.” KRIPKE, supra, at 126; see Piper, 430 U.S. at 40 n.26,-——