WASHINGTON – The U.S. Supreme Court (search) declined to loosen the standard for proving securities fraud, ruling Tuesday that investors must show a clear link between the alleged fraud and a drop in stock price to proceed with their lawsuits.
In a unanimous decision, justices sided with Dura Pharmaceuticals Inc. (search) , which was sued for fraud following its November 1998 disclosure that its asthma drug dispenser didn't receive federal approval as expected. As a result, investors suing major corporations such as Enron Corp. could have a tougher case in court.
Dura investors said they should recover for losses from a precipitous stock drop, arguing that the company knowingly made false statements about the device's prospects.
But Justice Stephen G. Breyer (search), writing for the court, said that ruling by the San Francisco-based 9th U.S. Circuit Court of Appeals runs counter to the basic principle that a corporate wrong must cause a loss.
"We consider a Ninth Circuit holding that a plaintiff can satisfy this requirement simply by alleging in the complaint and subsequently establishing that the price of the security on the date of purchase was inflated," Breyer wrote. "In our view, the Ninth Circuit is wrong."
The appeals court had allowed investors to proceed with their lawsuit under the corporate fraud theory of "loss causation." The 9th Circuit reasoned that investors need not show the disclosure of fraud caused a stock drop, so long as they can point to share prices that were artificially high at the time of purchase because of misleading statements.
But in the Supreme Court ruling, Breyer wrote that normally in fraud cases "an inflated purchase price will not itself constitute or proximately cause the relevant economic loss."
"We find the Ninth Circuit's approach inconsistent with the law's requirement that a plaintiff prove that the defendant's misrepresentation ... caused the plaintiff's economic loss," he said.
The ruling has high-stakes implications for lawsuits from investors seeking to recoup billions in damages after the collapse of major companies such as Enron Corp. (search). Backing Dura were the Bush administration, the Chamber of Commerce and the Securities Industry Association (search), which feared a wave of fraud claims from investors who bought shares "too high."
About 190 class-action lawsuits alleging securities fraud are filed each year. Because companies fear large judgments, many are forced to settle such suits before trial, the groups said in friend-of-the-court filings.
But public pension funds, AARP, the National Association of Shareholder Consumer Attorneys and the University of California — the lead plaintiff in a class-action suit against Enron — countered that the 9th Circuit's standard is needed to deter a repeat of recent corporate scandals.
In the Dura case, investors said they bought shares from April 1997 to February 1998 at inflated prices, following false statements from the company about sales of its products and the multimillion-dollar potential of a new drug delivery device.
Investors were seeking to recover in part for a 47 percent stock drop on Feb. 24, 1998 — nine months before its disclosure that the delivery device wouldn't receive federal approval — on unrelated news of an earnings shortfall due to weak sales of an antibiotic.
The case is Dura Pharmaceuticals v. Broudo, 03-932.