Tenth Circuit Affirms Summary Judgment on Loss Causation Grounds, Emphasizes Strict Loss Causation Requirements in Securities Fraud Actions
On February 18, 2009, in In re Williams Securities Litigation – WCG Subclass, No. 07-5119 (10th Cir.), the United States Court of Appeals for the Tenth Circuit upheld an order granting summary judgment to securities fraud defendants on loss causation grounds.
On July 24, 2000, the Williams Companies, Inc. (“WCI”), a natural gas and pipeline enterprise, announced its plan to spin off its telecommunications subsidiary, Williams Communications Group (“WCG”). Through press releases and other communications, WCI touted the move as the best way to ensure both firms’ continued financial health, and as a means to help WCG access the “tremendous opportunities” available to it. WCI informed shareholders that WCG was “strongly positioned for success” and had “a very bright future.” Privately, however, WCI’s board of directors allegedly offered another reason for the spin-off – namely, that WCI needed to “heave the junk called WCG overboard as fast as possible.” Indeed, several months before the spin-off announcement, WCG’s stock price had begun to decline. By the time the spin-off was announced, WCG’s stock traded at $28.50, having lost more than half its value over the prior four months. Thereafter, WCG’s stock price continued to fall. On April 22, 2002, WCG filed for bankruptcy, and its share price closed at $0.06 the following day.
A nationwide class of shareholders who had purchased WCG securities between the spin-off announcement and the bankruptcy brought various securities fraud claims under Sections 10(b) and 20(a) of the Securities Exchange Act against WCI, WCG and various corporate officers. At the summary judgment stage, the plaintiffs attempted to introduce testimony from a loss causation expert, Dr. Blaine Nye. The United States District Court for the Northern District of Oklahoma rejected the proposed testimony as unreliable under Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993) because Dr. Nye’s theories could not distinguish between loss attributable to the alleged fraud and loss attributable to non-fraud related news and events. Accordingly, the District Court awarded the defendants summary judgment, and the plaintiffs appealed.
The Tenth Circuit affirmed, holding that the plaintiffs’ proposed expert testimony “failed to identify a causal nexus between the revelation of the previously-concealed truth [about WCG’s financial problems] and the decline in value of WCG securities.” As the Court explained, “loss causation” is the requirement that securities fraud plaintiffs prove “that the material misrepresentation was the cause of th[e] loss.” The Tenth Circuit applied the Supreme Court’s decision in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005), which held that “an inflated purchase price will not itself constitute or proximately cause the relevant economic loss.” Rather, under Dura, plaintiffs must show “a causal connection that specifically links losses to misrepresentations[.]”
The Tenth Circuit examined Dr. Nye’s proposed expert testimony in detail. Dr. Nye advanced two different theories pursuant to which he purported to link the alleged misrepresentations with the stock price decline. Initially, he articulated a “leakage theory,” meaning that the fraud was gradually exposed (i.e., “leaked out”) during the relevant period rather than by means of a single complete disclosure. Dr. Nye “opined that WCG’s true value was at the level the company was trading on the day it declared bankruptcy,” which led Dr. Nye to conclude that “any decline in price before bankruptcy must have resulted from the draining of the fraud premium.”
The Tenth Circuit noted, however, that this approach “fails . . . to identify any causal link between the revelation of the truth and the decline in price[.]” Establishing such a causal connection requires an expert “to identify when the materialization [of the concealed risk] occurred and link it to a corresponding loss.” Dr. Nye’s leakage theory did not “explain how the truth was revealed to the market,” which meant that he could not connect any specific revelation to any particular loss. This, in turn, made it impossible to conclude that the alleged misrepresentations caused the stock price decline, rather than a “tangle” of other contemporaneous factors, including “a decline in the telecommunications industry as a whole, and the overall market declines that followed the 9/11 terrorist attacks.” Accordingly, the Tenth Circuit agreed with the District Court’s conclusion that Dr. Nye’s first theory was unreliable.
Dr. Nye’s second theory identified four supposedly partial “corrective” disclosures and claimed that each disclosure caused the stock price to drop. The Tenth Circuit concluded, however, that the truth each disclosure revealed was not sufficiently within the “zone of risk” such that Dr. Nye could show that it was the revelation of the fraud, and not other factors, that caused the subsequent stock price declines. Again, the Court pointed to factors that Dr. Nye had not considered, but that may have contributed to the price drops. Some of the corrective disclosures, for example, accompanied other negative information about WCG unrelated to any alleged fraud. The Court also noted “the total meltdown in the telecommunications industry” that caused several competitors to declare bankruptcy during the same period. The Court explained that “Dr. Nye’s attribution of all of [a particular] day’s losses to the revelation of fraud without considering other factors is unreliable, especially when there were clear indicators that other factors were at play.” The Court cautioned: “[W]e must…be careful not to connect each and every bit of negative information about a company to an initial misrepresentation that overstated that company’s chances for success.”
Additionally, the Court observed, “[l]ike his leakage theory, Dr. Nye’s corrective disclosure theory fail[ed] to identify the mechanism by which fraud was revealed to the market.” Indeed, the first securities fraud action was filed the same day as the first supposedly “corrective” disclosure was issued, thus suggesting that the market knew about the alleged misrepresentations before the string of identified disclosures began. Because Dr. Nye’s corrective disclosure analysis failed to establish that the alleged misrepresentations caused the plaintiffs’ loss, the Tenth Circuit accepted the District Court’s decision that the corrective disclosure theory was unreliable as well.
The Tenth Circuit underscored that both Dr. Nye’s leakage theory and his corrective disclosure theory suffered from the same “fatal flaw”: neither approach “separate[d] fraud-related from non-fraud-related losses.” For this reason, the Court held that the plaintiffs had failed to offer sufficient evidence to support their loss causation arguments.