Securities Fraud, Stock Price Valuation, and Loss Causation: Toward a Corporate Finance Based Theory of Loss Causation
Over the last twenty years, the calculation of damages in securities class action litigation has increasingly become based upon principles of corporate finance. Moving from initial, relatively unsophisticated damage ribbons to highly complex event studies, the courts, often spurred by defendants seeking to minimize their exposure to potentially ruinous damages, have sought to require plaintiffs to propound damages theories that accurately reflect the various factors affecting stock price and rely upon only those factors actually related to fraudulent activity as the basis for damages. Some recent decisions in securities cases, however, addressing the concept of "loss causation," have deviated from the basic principles of corporate finance. In particular, certain courts and commentators have concluded that a stock drop following the disclosure of fraudulent activity is essential to establish loss causation and, hence, is a sine qua non for a plaintiff to prevail on the merits and ultimately recover damages.1 Other courts and commentators, although not directly adopting such a rule, have implicitly done so by arguing that any loss causation standard that does not require a direct link between the fraud and the reduction in value in the investment (as opposed to plaintiff's loss) equates loss causation with transaction causation, which, they argue, allows loss causation to be proven merely through a showing that there was "fraud on the market."2 The classic securities fraud case, where the stock price collapses upon disclosure of fraud, typically does not present a difficult loss causation issue. Assume