Counterfactual keys to causation and damages in shareholder class-action lawsuits

Wisconsin Law Review

Volumn 2009, Issue 2, 2009, Pages 199-242

  Dunbar, Frederick C ^a   Sen, Arun ^a  

^a NERA ECONOMIC CONSULTING   (United States)

Author keywords

[No Author keywords available]

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EID: 77951638305     PISSN: 0043650X     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (35)

1. Richard A. Epstein, Two Fallacies in the Law of Joint Torts, 73 GEO. L.J. 1377, 1377 (1985). An interesting issue brought up by Palsgraf is the role of foreseeable causally dependent chains in establishing liability. That is not the subject of this Paper, however.
2. H.L.A. HART & TONY HONORÉ, CAUSATION IN THE LAW 94-96 (2d ed. 1985).
3. See, e.g., DAVID HUME, AN ENQUIRY CONCERNING HUMAN UNDERSTANDING 51 (Tom L. Beauchamp ed., 2000);
4. John Collins et al., Counterfactuals and Causation: History, Problems, and Prospects, in CAUSATION AND COUNTERFACTUALS 1, 1 (John Collins et al. eds., 2004) ("Thirty-odd years ago, so-called regularity analyses (so-called, presumably, because they traced back to Hume's well-known analysis of causation as constant conjunction) ruled the day⋯."). 6.
5. See, e.g., G.H. von Wright, On the Logic and Epistemology of the Causal Relation, in LOGIC, METHODOLOGY AND PHILOSOPHY OF SCIENCE IV 239, 307 (Patrick Suppes et al. eds., 1973) ("The idea which I have been discussing could be termed manipulative or experimentalist causation.").
6. See generally ROBERT W. FOGEL, RAILROADS AND AMERICAN ECONOMIC GROWTH (1964).
7. David Lewis, Causation, 70 J. PHIL. 556 (1973)
8. reprinted in CAUSATION 193, 194 (Ernest Sosa & Michael Tooley eds., 1993). The regularist approach was associated with the first of the following two sentences from Hume: "[W]e may define a cause to be an object, followed by another, and where all the objects, similar to the first, are followed by objects similar to the second. Or in other words, where, if the first object had not been, the second never had existed." HUME, supra note 5, at 60. Hume goes on to relate how we form ideas about causation: "[W]hen many uniform instances appear, and the same object is always followed by the same event; we then begin to entertain the notion of cause and connexion ⋯" Id. at 61.
9. See ERNEST W. ADAMS, A PRIMER OF PROBABILITY LOGIC 281 (1998).
10. See, e.g., STEPHEN L. MORGAN & CHRISTOPHER WINSHIP, COUNTERFACTUALS AND CAUSAL INFERENCE: METHODS AND PRINCIPLES FOR SOCIAL RESEARCH 4-6 (2007).
11. An indication of the general acceptance of the terminology in legal scholarship is given by a 2003 symposium. Symposium, Baselines and Counterfactuals in the Theory of Compensatory Damages: What Do Compensatory Damages Compensate?, 40 SAN DIEGO L. REV. 1091 (2003).
12. Michael Moore, For What Must We Pay?: Causation and Counterfactual Baselines, 40 SAN DIEGO L. REV. 1181, 1184 (2003).
13. Peter Menzies, Difference-making in Context, in CAUSATION AND COUNTERFACTUALS, supra note 5, at 139. One of the key issues is the potential ambiguity of the counterfactual world. The Menzies article addresses this and other concerns.
14. Ronald J. Allen & Michael S. Pardo, The Problematic Value of Mathematical Models of Evidence, 36 J. LEGAL STUD. 107, 109 (2007) ("[T]he application of probability theory to juridicial proof⋯. suffers from a deep conceptual problem that makes ambiguous the lessons that can be drawn from it⋯."); id. at 137 ("Conventional probability approaches are difficult to reconcile with the evidence concerning the structure of trials.").
15. Lawrence H. Tribe, Trial by Mathematics: Precision and Ritual in the Legal Process, 84 HARV. L. REV. 1329, 1330 (1971).
16. Complaints used in one shareholder class-action lawsuit have been known to be recycled with global search-and-replace for the name of the defendant firm. Nell Minow, Time to Wake the Sleeping Bear, LEGAL TIMES, Feb. 13, 1995.
17. Richard Craswell & John E. Calfee, Deterrence & Uncertain Legal Standards, 2 J.L. ECON. & ORG. 279, 299 (1986).
18. Perhaps as a result of the incremental nature of Supreme Court decisions, there has been relatively little commentary on how the traditional overall evidentiary burden in shareholder class-action lawsuits has been restructured. For an exception, see Jill E. Fisch, Cause for Concern: Causation and Federal Securities Fraud 44 (Inst. Law Econ., Research Paper No. 08-19, 2008), available at http://ssrn.com/abstract=1234021 ("If Basic has transformed securities fraud into a statutory claim, with a different scope and objectives, the rationale behind the common-law analogy is not compelling. There is no reason to believe that common-law principles can or should be transferred uncritically to the transactional context of the global-securities markets.").
19. MICHAEL J. KAUFMAN, SECURITIES LITIGATION: DAMAGES § 11A-40 (2006) ("The soundest interpretation of the Court's concept of 'economic loss' is that it permits a showing that the investor suffered a loss by purchasing securities at an artificially inflated price without mitigating that loss by reselling those securities at the same inflated price. Only that definition of 'economic loss' gives any meaning to the Court's opinion. By that refined standard, the plaintiffs who purchase securities at an artificially inflated price of loss per share, cannot show 'economic loss' if they resell those shares the instant after the transaction at $100 per share. Those plaintiffs have fully mitigated their losses. Similarly, a plaintiff who purchases at $100, but resells at $125, may suffer an 'economic loss' in the court's sense if the sale price would have been higher in the absence of the fraud. Loss occurs when the dissemination of the misrepresented or nondisclosed facts causes a movement in the market price of the securities.").
20. The use of the but-for-world concept is common in estimating damages. See Robert Hall & Victoria Lazur, Reference Guide on Estimation of Economic Losses in Damages Awards, in REFERENCE MANUAL ON SCIENTIFIC EVIDENCE 277, 284 (2d ed. 2000) ("In cases where damages are calculated under the restitution-reliance principle, the 'but for' analysis posits that the harmful event did not occur."). Restitution-reliance-principle cases include securities-fraud actions. Id. at 325-26.
21. See, e.g., Janet C. Alexander, The Value of Bad News in Securities Class Actions, 41 UCLA L. REV. 1421, 1426-27 (1994); (Pubitemid 24818386)
22. Daniel R. Fischel, Use of Modern Finance Theory in Securities Fraud Cases Involving Actively Traded Securities, 38 BUS. LAW. 1, 1-2 (1982);
23. Jonathan R. Macey et al., Lessons from Financial Economics: Materiality, Reliance, and Extending the Reach of Basic v. Levinson, 77 VA. L. REV. 1017, 1028-43 (1991);
24. A. Craig MacKinlay, Event Studies in Economics and Finance, 35 J. ECON. LITERATURE 13, 13 (1997);
25. Mark L. Mitchell & Jeffry M. Netter, The Role of Financial Economics in Securities Fraud Cases: Applications at the Securities and Exchange Commission, 49 BUS. LAW. 545, 545 (1994). (Pubitemid 24782008)
26. Robert J. Shiller, From Efficient Markets Theory to Behavioral Finance, 17 J. ECON. PERSP. 83, 84-85 (2003).
27. These steps are amplified as follows in David Tabak & Frederick Dunbar, Materiality and Magnitude: Event Studies in the Courtroom 3-4 (Nat'l Econ. Research Ass'n, Working Paper No. 34, 1999): The procedure for performing an event study has several well-defined steps: First, one estimates a predicted stock price return, or percentage change, from the day before the news reaches the market to the day the stock price assimilates the news. In doing this estimation, one uses a model that takes into account market and industry effects on stock price returns. Next, the predicted return is subtracted from the actual return to compute what is called the excess return. If the excess return is calculated as the sum of individual excess returns over a number of periods (usually individual trading days), the difference between the actual and predicted returns summed over all these periods is called the cumulative excess return (or "CAR"). Typically, the predicted return does not exactly equal the actual return even when no event has occurred. To determine whether the difference between the actual and the predicted return, the CAR, is just due to chance, the CAR is tested for statistical significance⋯. The final step, if necessary, involves computing the relevant magnitude of the event. To do this, one calculates the change in stock price or capitalized value of the firm implied by the estimated CAR and thus attributable to the event in question. Id.
28. See JUDEA PEARL, CAUSALITY: MODELS, REASONING AND INFERENCE 12-21 (2000).
29. Janet C. Alexander, Rethinking Damages in Securities Class Actions, 48 STAN. L. REV. 1487, 1504 n.68 (1996); (Pubitemid 126407557)
30. see also Bradford Cornell & James C. Rutten, Market Efficiency, Crashes, and Securities Litigation, 81 TULANE L. REV. 443, 467-08 (2006);
31. Richard A. Booth, Who Should Recover What in a Securities Fraud Class Action? 4, 7 (University of Md. Legal Studies, Research Paper No. 2005-32, 2005), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=683197.
32. TODD FOSTER ET AL., RECENT TRENDS IN SHAREHOLDER CLASS ACTION LITIGATION: FILINGS STAY LOW AND AVERAGE SETTLEMENTS STAY HIGH - BUT ARE THESE TRENDS REVERSING? 15 (2007), available at http://www.nera.com/publication.asp?p-ID= 3267.
33. Allen Ferrell & Atanu Saha, Loss Causation Requirement for Rule 10b-5 Causes of Action: The Implications of Dura Pharmaceuticals, Inc. v. Broudo, 63 BUS. LAW. 163, 181 (2007).
34. This example may seem stylized, but it is uncannily similar to what occurred to Refco, Inc. On October 10, 2005, a press release from the company stated the following: Refco Inc. (NYSE: RFX) today announced that it had discovered through an internal review a receivable owed to the Company by an entity controlled by Phillip R. Bennett, Chief Executive Officer and Chairman of the Board of Directors, in the amount of approximately $430 million. Mr. Bennett today repaid the receivable in cash, including all accrued interest⋯. This receivable from the entity controlled by Mr. Bennett was reflected on the Company's prior period financials, as well as on the Company's May 31, 2005 balance sheet. The receivable was not shown as a related party transaction in any such financials. Press Release, Refco, Inc., Refco Announces Undisclosed Affiliate Transaction (Oct. 10, 2005), available at http://www.secinfo.com/d11MXs.z1eVu.d.htm. Although revealing an accounting violation by not showing the debt as a related-party transaction, Refco was in a financially stronger position after the press release having exchanged, dollar for dollar, a finance receivable for cash. Yet, the stock price fell 45 percent on the announcement. See Peter A. McKay et al., Refco CEO Takes Leave Over Debt, WALL ST. J., Oct. 11, 2005, at C1.
35. DAVID TABAK, MAKING ASSESSMENTS ABOUT MATERIALITY LESS SUBJECTIVE THROUGH THE USE OF CONTENT ANALYSIS 1 (2007), available at http://www.nera.com/image/ PUB-Tabak-Content-Analysis-SEC1646-FINAL.pdf.