How To Measure Damages In Securities Fraud Cases

Wednesday, August 25, 2004

Stephen Younger, Damages In Securities Litigation, http://

Abstracted from: Damages In Securities Litigation
By: Stephen Younger Patterson Belknap Webb & Tyler, New York, NY
Review of Securities & Commodities Regulation - Vol. 37, No. 3, Pgs. 19-25

Overview:
Describes the methods used by courts to calculate damages in Rule 10b-5 actions. Considers the Private Securities Litigation Reform Act of 1995, and summarizes the materiality, reliance, and causation requirements under Rule 10b-5. Covers out-of-pocket damages, the benefit-of-the-bargain theory, and other measures of damages.

Out-of-pocket damages.
Section 10(b) of the 1934 Act and Rule 10b-5 do not set out a methodology for assessing damages, leaving the task to the judiciary. Attorney Stephen Younger reviews several formulations that courts can use to calculate damages in securities-fraud cases. Courts generally attempt to assess out-of-pocket costs when measuring the damages. In determining the out-of-pocket costs, the court must compare the price the plaintiff actually paid or received for the security and the "true value" of the security without the fraud. The plaintiff bears the burden of proving the security's true value, which courts variously have considered as of the date of the fraud, on the date the fraud was or should have been discovered, or on a later date that gives effect to the market's reaction to the fraud. Class actions generally require the use of economic experts for a statistical regression analysis to develop a price line and a value line showing the security's price and value during the class period. The variance represents the effect of the fraud and constitutes approximate damages.

Defrauded out of the benefits.
Proponents of the benefit-of-the-bargain theory urge the court to award plaintiffs the amount they would have earned if the misrepresentation had actually been true. Although courts generally reject this approach as overly speculative, the author notes that in Osofsky v. Zipf (1981), the Second Circuit indicated that the theory could apply if the amount of damages can be calculated to a reasonable certainty. Some courts apply a variation called the cover measure. This variation is based on the notion that the plaintiff would have covered the losses had the fraud been revealed in time. The leading case using the cover measure is Mitchell v. Texas Gulf Sulphur (1971); the Tenth Circuit decided that if stockholders sell shares prematurely, based on misleading information, they are entitled to receive the difference between the price paid and the price of the security a reasonable amount of time after the information is disclosed.

Other methods of assessing damages.
The author points out other bases for assessing damages. Courts may allow recovery of consequential damages, those costs incurred by the plaintiff as a result of the fraud, which may include brokerage fees and capital gains taxes. Generally plaintiffs must prove that the fraud was the proximate cause of the consequential damages and that the damages are not being recovered under any other theory. Under the federal securities laws, punitive damages are not permitted, but a fraudulent transaction could be rescinded under 1933 Act Section 12(2). In enforcement actions, the SEC may require a defendant to disgorge profits that were made through fraud. The Private Securities Litigation Reform Act of 1995 attempts to mitigate damages if the price of the shares rises during the 90 days after a corrective disclosure is made. Damages may not exceed the price paid for the securities and the mean trading price over the 90-day period after the fraud is disclosed.

Requirements of materiality, reliance, and causation.
Under Rule 10b-5, the plaintiff must show that the defendant misrepresented or omitted a material fact and that the plaintiff relied on that misrepresentation or omission. The Supreme Court eased the reliance standard by permitting claims based on the fraud-on-the-market theory. Under this theory, plaintiffs who purchased shares in an efficient market need not prove that they relied on specific information, explains the author. The theory assumes that an efficient market incorporates material information into market prices, raising the rebuttable presumption that the plaintiff in effect relied on the information by paying the market price. To prove loss causation, plaintiffs must show that the loss resulted from the misrepresentation, while transactional causation looks at whether the misrepresentation affected the investor's decision to invest.

Abstracted from Review of Securities & Commodities Regulation, published by Standard & Poor's, 55 Water Street, New York, NY 10041

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