The Evolution of Securities Class Action Law: Dura Pharmaceuticals v. Broudo (2005)

Before Basic v. Levinson, the most challenging part of Rule 10b-5 class actions was establishing reliance—showing that members of a class had relied on a material misrepresentation when buying or selling a security. After Basic, establishing reliance was much less of an obstacle, as the fraud on the market theory usually allowed a presumption that investors had relied on a misrepresentation simply by relying on the integrity of the market price. However, reliance alone was not enough to establish liability.

Plaintiffs also had to establish that members of the class had suffered an economic loss. In practice, loss causation is quite challenging to prove. The stock market is often volatile and rapidly incorporates information from many sources at the same time, so it can be difficult to isolate how much a specific event affected a stock price.

After Basic, many plaintiffs began to recruit economists to help prove loss causation. Economists used a statistical tool called an event study, which can estimate the degree to which a specific event had changed a stock price by comparing the subsequent change in the stock price to normal fluctuations of that stock price and trends in the stock market as a whole. Defendants also began to recruit economists in an effort to rebut the arguments of plaintiffs. This led to an arms race in who could provide the best expert testimony on very technical questions.

By the late 1990s and early 2000s, the question of loss causation was causing confusion and inconsistent opinions among courts. A conceptual question began to dominate the dialogue: did loss causation mean that a misleading statement had caused the price of the security to rise and fall, or was it enough for a misleading statement to cause the price of the security to rise and then for something else to cause it to fall?

Read the full article to understand the role Dura Pharmaceuticals v. Broudo (2005) played in reining in some of the more speculative claims in securities class actions. Specifically, now plaintiffs must both show that they lost money and point out how the misrepresentations were linked to the loss.