Elements of Damages in Securities Litigation

In the modern age of large publicly traded corporations and automated trading platforms that allow everyday users to engage in securities trading there still remains an entirely complex set of issues that even the most diversified and sophisticated stockholders struggle to control. That is the internal daily workings of the corporation and the non-public information that lays at the foundation of corporate decision making and that at the end of the day dictate the stock price of the company. It is agreed upon that stock related transactions are based on trust and form a specific type of contract and where that trust gives way in the circumstances of less than honest control from the corporate officers or their failure to investigate and make reasonable decisions, the investors must be able to recover for their losses if they can show that a subsequent corrective disclosure made after the initial dishonest statement or conduct was in fact a proximate cause for their losses. Therefore, it is critical for investors to establish said causal nexus between the corrective disclosure and the decline in stock price in order to maintain a compensable claim. This article will focus on various elements of damages that a Plaintiff in securities litigation will be expected to show in order to establish such causal nexus as well as various models of calculating damages and eliminating unrelated “noise” that should not become part of the damages.

I will first summarize an article by Frank H. Easterbrook and Daniel R. Fischel that provides an overview of the underlying framework behind damages in securities cases and specifically addresses several elements of damages that come up most often in the context of securities litigation and methods for their assessment. Second, I will review an article by Allen Ferrell and Atanu Saha that provides a more detailed overview of what constitutes loss causation, corrective disclosure, and collateral types of damages, as well as explains the application of an important tool for assessing damages in liquid markets – the event study. Third, I will briefly summarize an article written by Barbara Black which specifically explores one of the more debated type of damages, reputational damages, and the analytical framework advanced by both proponents of said damages and those who argue against allowing such damages. Finally, I will analyze the above mentioned articles to show that corrective disclosure must produce a compensable claim under the right circumstances.

I.    GENERAL FRAMEWORK BEHIND DAMAGES IN SECURITIES CASES.

I will start my analysis with an overview of the article written by Frank H. Easterbrook and Daniel R. Fischel on optimal damages in securities cases.[1] The authors of this article contend that damages in in situations that involve securities are based on a certain measurable harm to investors. They look at securities as specialized contracts where investors contribute working capital and bear the financial risks in exchange for a share of returns and ability to participate in business decisions.[2] Looking at securities fraud from this contractual perspective allows them to analogize it with a traditional contract breach. In that sense, authors argue, it is extremely important to properly scale damages according to the infraction and steer away from extremes: punishment that is too harsh will force businesses to incur additional expenditures in preventative measures and will make management reluctant to taking risks otherwise warranted by industry standards, while very lenient damages would promote indifference and, arguably, facilitate managers to choose the “fraud” path and pay the low fines. Therefore, the authors argue, it is critical to align breach and subsequent damages in the most efficient manner.[3] 

1.      Liability and Damages Rules.

Because investors would like to obtain the information relevant to the company and value of its securities at the lowest possible cost, it is critically important to establish the legal framework that recognizes the value and significance of nondisclosure on the part of the company.  In order to do that the authors explore the two underlying methods applicable to securities contracts – an increased specification of the substantive law, which considers “materiality”, and the selection of the measure of damages.[4] 

The legal framework in general educates people on the proper standard of care, required amount of investigation, and whether disclosure is required under the circumstances. Although authors agree that both freedom from potential liability and the low amount of damages will induce firms to cut costs and not disclose, they also emphasize that those approaches are not always equivalent and have different ways for the treatment of uncertainty. In support of this argument the authors suggest that it is likely that investors would agree that managers should forego extensive and expensive investigations of every remotely possible outcome and simply take the chance if it significantly lowers their cost. In these situations the legal system will likely allow such omissions and regard to them as “non-material” or material but bearing no damages.[5]

The “materiality” view requires the judicial system to investigate and consider the likelihood of a particular outcome.[6] Because the damages in cases of undisclosed “material” facts can generally be very high, the parties will spend a lot of resources on litigation. The downside to this is the difficulty or reconstructing the probability of event in question after the fact, which makes litigation not only expensive but also uncertain about the outcome. In this sense, setting a threshold for materiality allows sellers to weigh the possible damages versus the cost of investigation and investigate and disclose to the point where an extra dollar spent on investigating will net an extra dollar for the investors. This view also promotes professional efficiency on the seller’s part because the person who is best informed on the issues in question will be able to make the best decision while employing the least amount of investigative resources.[7] 

Despite the well set rules that provide sellers with guidance necessary to choose the best strategy, the outcomes of certain transactions may not always be as clear, especially in private actions where investors often sue sellers when the stock price goes down. There is a plethora of possible situations where stock prices can fall due to outside events that are not related to the firm and, therefore, a bad turnout for the stock price may not always be indicative of bad actions on the part of the seller. As the authors contend, if we were to equate bad outcomes with bad actions and impose harsh damages based on that logic, we would do more to discourage action on behalf of the sellers rather than promote efficient disclosure.[8]

To avoid this false correlation the authors suggest considering several sources for damages. In situations where a particular action can have both costs and benefits, they suggest resorting to the evaluation of net harm that the action imposes on other players in the market divided by the probability that such action will be detected and prosecuted.[9] 

There are four main components to evaluating net harm. First is the net transfer to the offender, which can be calculated as the gross loss minus the benefit established through the transaction. The second one is the total cost of carrying out the offense, disclosing it, taking preventative measures to avoid a similar offense in the future, and litigating those offenses. The third is what can be considered the “cost of doing business” – the cost a firm needs to carry to distinguish themselves from untruthful competitors. The final group of components considers the related reductions in the allocative efficiency of economy and assumes that in cases of inaccurate or untruthful disclosure people will invest in the wrong ventures and will, therefore, spend too much money and resources to produce goods and services as well as receive incorrect information about the underlying risks, which in turn skews the choice between consumption and investment.[10]  

The “net harm” rule, however, is not all inclusive as it may create the proper incentives for those players who decide how much to investigate and disclose, but it does not necessarily give the right information to other players in the market, especially the investors. The “net harm” approach compensates for the entire social or net loss that the class suffers, but it does not differentiate between investors who might be harmed in the process and who might benefit from it and only accounts for overall loss. Unsurprisingly, the authors suggest that investors should be able to protect themselves in these situations. The issue is in striking a perfect balance between lower damages that lead to unnecessary investigative expenditures by investors and high damages in cases of private injuries which induce firms to spend too much on preventative investigation. The authors suggest that for the majority of offenses the transfer of wealth makes the largest element of net harm and is, therefore, a good starting point in evaluating damages.

2.      Economic Harm in Liquid Markets.

Unfortunately, it is not always easy to apply the net harm approach, especially in cases considering market reaction to newly disclosed information. In these situations it is not uncommon to see that a large part of wealth transfer goes to various market players who are not responsible for the nondisclosure and, therefore, such transfers would not be part of net harm. As a rule of thumb, the authors propose that although net harm is a close approximation of total loss, it will not fully exceed it.[11] Additionally, because things do not happen in an instant, there is generally a plethora of various other events that happen in the period between the sale of security and the corrective disclosure. Therefore, authors argue, it is very important to separate the changes that affect the industry as a whole from the firm-specific events. This approach works well in liquid markets and allows analysts to establish expected market trends where any significant deviation of stock price for one firm can be attributed to that firm’s specific events. The authors then conclude that the shorter the period that is covered by the analysis the more precisely analysts can distinguish between the market as a whole fluctuation from the firm-specific stock price-change.[12]

3.      Remedies Absent in Securities Cases.

Notably, several of the popular types of contract remedies are generally not being considered in securities cases. First, there are no benefit-of-the-bargain damages.[13] The authors explain that a simple reason for this is that there are no bargains in liquid security markets since there is no real reason for sellers to provide buyers with bargains because the stock price is presumed to be reflective of its current value and, therefore, the buyer does not suffer any lost opportunities in relation to other stocks he could have purchased instead. Second, there are no consequential damages in securities cases because there is no real nexus between employed assets necessary to continue operations and stock price changes.[14] Simply put, a mere change in price does not prevent buyer from generating required funds elsewhere and continuing production or pursuing alternative endeavors as opposed to contract situations that employ real assets without which the business operations would come to a halt causing the owner to miss out on profits or alternative opportunities. Similarly, the law of securities does not provide for punitive damages, which is understandable considering that they are designed to function as a multiplier of severity of damages and such multipliers are already built into most securities damages models and properly adjust for the severity of infraction.[15]  

4.      Plaintiff’s Loss v. Defendant’s Gain.

The authors then proceed to evaluate two options for awarding damages based on either the loss suffered by the Plaintiff or the gain accumulated by the Defendant and conclude that, despite both options often netting the same result, there are situations where one option should have preference over the other.[16]

5.      Fraud in the Issuance of Securities.

The most common loss-based damages situation arises in the fraudulent issuance of stock.[17] Under section 12 of the 1933 Act, when securities are not properly registered or contain a significant misrepresentation, a traditional remedy is the purchase price of the stock minus the actual value of said stock at the time of trial or sale. This is effectively a recessionary loss-based measure that not only compensates the investor for loss suffered but also shifts the risk of market fluctuation on the seller. On the other hand, when the issue lies with the registration of stock or if plaintiff is seeking to recover from a third party, potential defendants - underwriters and accountants - may reserve to a defensible claim under section 11(e) of the 1933 Act which provides that a defendant may claim that the loss was a result of other circumstances than fraud or omission. This defense allows the application of a market analysis that filters out market fluctuations and other “noise”. While it may seem unfair to hold issuers and sellers to a higher standard than the registers of stock, there is a simple reasoning behind this strategy – deterrence. Issuers and sellers are strongly encouraged to conduct proper investigation and have a valuable tool that allows them to check their conformity to the market expectations through SEC’s administrative guidance process.   

II. THE LOSS CAUSTAION REQUIREMENT FOR RULE 10B-5 CAUSES OF ACTION.

The second article under review is written by Allen Ferrell and Atanu Saha on what is likely the most important elements for the Rule 10b-5 cause of action – the loss causation and corrective disclosure.[18] Relying on the decision in Dura Pharma, the authors state that it is a well-established principle that in order to maintain a cause of action under the Rule 10b-5, the plaintiff must establish a fact of actionable misconduct akin to knowingly making a false misrepresentation upon which the plaintiff relied and which was the cause of plaintiff’s loss.[19] This notion is now further codified in the Private Securities Litigation Reform Act of 1995.[20] Furthermore, in one of the most important decisions on the issue, Oscar Private Equity Investments v. Allegiance Telecom, Inc., the Fifth Circuit concluded that loss causation must be properly pleaded “before a class-wide reliance can be presumed under a fraud-on-the-market theory at the class certification stage” of litigation.[21]  

1.      The Event Study Analysis as Analytical Framework of Loss Causation.

The first element in establishing loss causation and significance, or “materiality”, of misstatements that the authors consider is the event study analysis.[22] In simple terms, the event study allows analysts to measure the impact of an alleged misrepresentation and is reviewed as a mathematical formula with various variables that allow for adjustments to achieve the best possible precision, including the selection of an industry index, length of the “event window”, assessment of a post-disclosure “trickle” effect, and the impact of various compounding effects on stock market’s reaction to the corrective disclosure. An element of the outmost importance in this approach is properly choosing the length of the event window, which allows analysts to account for market overreaction and various confounding effects that may have an impact on the change in the stock price.[23] 

2.      When Does Corrective Disclosure Occur: Requirement for Corrective Disclosure and its Substance.

The court in Dura Pharma established that there can be no loss causation without a fall in the stock price “after the truth became known” to the market.[24] Under the term “truth”, the court in Dura implied the disclosure of the actionable misconduct to the market. The court then emphasized that a mere change in stock price is not indicative of an actionable misconduct because it could have been the result of various outside events like a change in economy or new industry related facts. This assumption properly indicates the requirement of corrective disclosure before loss causation may be established.

Alternatively, some scholars argue that under the “market forces operating on the fraud” theory, investors may recover without a distinct act of disclosure when they initially had to pay an inflated price for the stock that later lost some of its value and forced investors to incur a loss upon sale of said stock. In these situations the initial overvaluing of the stock comes from an inadvertently false statement combined with market reliance on such statement. The problem with recovery under such theory lies with the facts that it ignores Dura requirement that the market learn the truth about the initial misrepresentation, that the initial false statement was not necessarily made in bad faith or with intention to conceal harmful information, and that the drop in stock price might be a result of unrelated market and economic changes that do not give rise to recoverable damages. Therefore, if we were to employ the “market forces operating on the fraud” theory, we can then often see instances where investors claim damages bypassing the required corrective disclosure of actionable misconduct. Furthermore, allowing such recovery would provide an unnecessary safety net for investors seeking to gamble on the market changes to score a good deal.

Next, the authors turn to establishing what constitutes corrective disclosure.[25] In their analysis they suggest a hypothetical where a company makes a false statement in their financial statements followed by a downward revision of its projected earnings and a subsequent decision to restate their financials. The question then turns to when the corrective disclosure occurred: did the truth about false statements become known at the time of a downward adjustment of projected earnings or at the time of decision to restate financials. In their analysis of the hypothetical, the authors rely on the Fifth Circuit opinion in Greenberg v. Crossroads Sys., Inc., where in a similar situation the court found no loss causation.[26] In support of their decision, the Circuit court stated that the downward earnings projection itself did “not report any concern that [the company’s earlier statements] may be incorrect.”[27] Finding the point of corrective disclosure becomes critical in situations like Greenberg. Authors suggest that one of the more common approaches to establishing corrective disclosure is to consider whether said disclosure reveals the “true financial condition” of the firm that was so far hidden by the false statements. According to this theory, it is unimportant whether misstatement or misconduct has been identified because the market will react to the company’s “true” performance.[28] The “true financial condition” theory has its flaws and the major one is that it does not account for the fact of wrongdoing and effectively establishes fault based on the mere fact of downgraded earnings projections which can otherwise be attributed to unrelated market or firm-specific conditions.

Notably, the “true financial condition” theory is sometimes employed in the context of the “zone of risk” test for loss causation established by the Second Circuit in Lentell v. Merill Lynch, where the court explained that is establishing loss causation one must consider whether “the loss was within the zone of the risk concealed by the misrepresentation or omission.”[29] The authors of this article suggest that a proper interpretation of the “true financial condition” in the context of the “zone of risk” assessment that squares with Dura, is to establish a requirement for a corrective disclosure that would indicate that new information unveil prior actionable misconduct and without such disclosure the negative information as well as subsequent losses should not fall within the “zone of risk.” Otherwise, authors argue, the loss causation would be satisfied by the negative news independently from the existence of an earlier misconduct which is the underlying basis for liability. 

Another interesting issue in estimating damages in securities transactions turns to the assessment of stock price fluctuations where one can often see the firm’s stock price recover, at least in part, in the period following the initial corrective disclosure date identified in the complaint. These fluctuations over a time can be interpreted as a series of subsequent mini-disclosures of the truth to the market. There are several situations where these mini-disclosures can become important in assessing damages. First of all, we can look at these fluctuations in light of market overreaction to the initial disclosure. In these situations, the original disclosure may suggest other significant issues with firm’s financials triggering a significant initial drop in price that will over time recover when those other concerns prove to be ungrounded. Therefore, a non-disclosure of additional issues is in itself a form of disclosure that brings new information to the market and should be evaluated in assessing damages. Alternatively, the initial corrective disclosure may not show the full extent of the underlying issues and the subsequent mini-disclosures may cause the stock price to decline even further.

3.      Collateral Damage.

“Collateral damage” in the context of loss causation is particularly noteworthy because it can show that a corrective disclosure itself triggered a negative trend on the stock price without an assumption that the misstatement caused an artificial inflation of stock price.[30]  There are two major types of “collateral damage”: reassessment of the quality of firm’s management and/or internal control; and a possible disruptive legal action.

The first type is employed when the investors revalue the company from the point of view of how it is being run in light of initially false statements followed by the corrective disclosure.[31] Simply put, investors may infer that because the firm issued false statements about their financials that required a subsequent correction, it is not being run according to the market expectations and the stock price will therefore take a nose dive due to loss of trust in management and additional risk of future misconduct. The downside of this view, the authors contend, lies with its lack of actionable misconduct since there was no initial misstatement related to firm’s management but rather said misstatement was related only to firm’s financials.  Furthermore, there is no duty to disclose that the firm’s management or the quality of firm’s internal controls are not up to par with market expectations. This critique is grounded in the Supreme Court’s statement that “[s]ilence, absent duty to disclose, is not misleading under Rule 10b-5.”[32] 

The second type of “collateral damage”, the disruptive legal action, turns to consider whether the fall in the firm’s stock price is attributed to investor’s expectations of catastrophic law suits, government sanctions and SEC enforcement proceedings resulting from the accounting restatement.[33] The authors suggest that in these situations a decline in stock price is attributable to the new and firm-specific information instead of revaluing of the firm based on the market learning the “true financial conditions” about the firm’s financials that were the focus of the initial misstatement.

III. REPUTATIONAL DAMAGES IN SECURITIES LITIGATION.

The final article under review elaborates further on the specific type of “collateral damage” discussed above – reputational damages, and considers whether plaintiffs can recover damages resulting from a stock price fall related to the market reevaluation of the quality of firm’s management and internal controls.[34] In her comment Professor Black proposes that damages resulting from the revaluation of the firm’s management and internal controls following the initial misstatements may bear a higher impact on the company stock than the misstatement or omission itself and if plaintiffs can establish a scienter showing that the misstatement was a result of a willful and deliberate action on behalf of the firm’s management and weed out the other post-disclosure “noise” through use of an event study, then plaintiffs should be allowed to recover for such reputational damages.

1.      How Many Misstatements are there?

In her analysis Professor Black considers Ferrell and Saha’s argument against reputational damages, which is based on presumption that the initial misstatement should be considered as an independent statement about the firm’s financials and an unrelated “silent” statement about management controls and with addition of a “no duty to disclose” consideration should give no rise to recoverable damages, and suggests a different approach.[35] She first proposes that the double-statement argument made by Ferrell and Saha should instead be construed as a misstatement about company’s financials and a misstatement about the integrity of company’s management and quality of its internal controls.[36] She further argues that unless investors can safely rely on the information that managers distribute to the market, investors will be forced to spend additional amounts of investigative resources, as discussed in the first article under review, and therefore, participation in the market will be unduly costly for investors and will decrease the overall market efficiency.

In support of her argument, Professor Black relies on decision in Virginia Bankshares, which established that statements of opinions that the speaker does not believe to be true and opinions that are not well-grounded may be actionable.[37]  The court in Virginia Bankshares explained that managers’ statements are material in both the substance of the actual subject matter of the opinion as well as the fact that the managers believe in the rightfulness of the said opinion and prepared it in good faith.[38] This proposition makes sense – investors are inclined to trust managers who presumably know more about the internal state and inner workings of the company they are entrusted with and said trust gives greater weight to the statements made about the financial side of things. Professor Black further strengthens her argument by invoking provisions of the Sarbanes-Oxley Act of 2002, which was enacted in response to catastrophic accounting scandals in Enron and Worldcom litigations to boost accounting controls and investor confidence and codifies that the false statements about financial information necessarily implies a misrepresentation about company management and internal controls.[39] A key provision to this discussion is the Section 302, which requires both the CEO and CFO of the reporting to company to certify that: “(1) they have reviewed the annual report on Form 10-K and the quarterly financial reports on Form 10-Q; (2) based on their knowledge, the reports do not contain any materially misleading statements, and (3) based on their knowledge, the financial information in the report fairly presents the company's financial condition, results of operations and cash flows.”[40] Furthermore, they must certify that they are responsible for overseeing the disclosure controls procedures, financial reporting and that they disclosed any significant issues related to company’s controls to the auditors and the auditing committee.[41] We can then rightfully assume that any willful and material misstatements in said certification could not occur without some sort of misconduct on behalf of the certifying managers. This assumption is further supported by the SEC’s conclusion that "an officer providing a false certification potentially could be subject to … both Commission and private actions for violating § 10(b) and Rule 10b-5.”[42] Therefore, a deliberate misrepresentation of company’s financials necessarily involves a false representation of the integrity of firm’s management and controls. Simply put, if the market knew that the managers were dishonest, it would adjust the firm’s stock price accordingly. Thus, the decline in stock price can be directly linked to the initial misrepresentation and not the new “firm-specific” information unrelated to fraud.

Although no circuit courts have expressly allowed a false 302 certification made with required scienter to serve as an independent basis for Rule 10b-5 liability, they have acknowledged that said certification is probative of the scienter if certifying managers act recklessly and deliberately. The author further contends that the lack of specific guidance from the courts on this issue is in itself probative of the close interrelation between false financial statements and misstatements about quality of managerial and internal controls. Accordingly, it is reasonable to infer that reputational damages are directly linked to the initial misstatements about company’s financial and should be recoverable by the affected investors.

Professor Black then quickly dismisses the second argument advanced by Ferrell and Saha against reputational damages – the “no duty to disclose” theory.  In her view, the interpretation and reasoning behind the “no duty” argument is irrelevant in situations in which defendants acted intentionally and recklessly in their certification or statement regarding the integrity of firm’s management and its internal controls.

2. Are Reputational Damages an Over-Recovery That Should Be Prohibited?

The author then turns to discuss whether reputational damages should be denied to limit plaintiffs’ recovery in order to preclude putting too much pressure on the company forcing it to settle questionable claims to avoid the risk of getting hit with enormous damages.  She recognized the Supreme Court’s concern about broadening the scope of private action under Rule 10b-5, but emphasized that, despite the complexity of the nature of damages under Rule 10b-5, the Congress purposefully left the specific methods of calculation of damages open to interpretation based on assumption that said damages are already capped because plaintiffs cannot recover more than the difference between the initial purchase price and the mean trading price of the stock over a 90-day period from the date of corrective disclosure.[43]  The requirement of said 90-day period effectively allows analysts to differentiate damages caused by the fraudulent statements from the surrounding “noise” that is unrelated to the issue and should not give rise to recoverable damages and an event study proves to be an accurate tool in assessing said damages. Therefore, establishing an additional cap on recoverable damages is unnecessary and would amount to unwarranted judicial activism.

IV. BRINGING IT ALL TOGETHER.

1. Where Do We Start When Trying To Calculate Damages?

Considering the vast majority of approaches to calculating damages in security cases that often have significant benefits and issues as well as specific situations where they apply, it becomes rather confusing where to start and how to establish that causal nexus between the corrective disclosure following the initial misconduct and a subsequent decline in stock price in order to maintain a compensable claim.

I agree with the authors of the first article in their conclusion that in situations that involve both cost and benefit decision making that would otherwise require an extensive and often costly judicial inquiry, it is safe to start with the net harm approach in order to, at least, approximate the maximum possible efficiency that would incentivize managers to make business decisions that would generate a maximum possible return for their investors and disclose all the material information on one hand, while protecting investors from having to conduct an extensive and costly research into the firms financials to protect themselves, thus, increasing their cost of participating in securities market on the other hand. As the authors of Optimal Damages rightfully suggest, the net harm approach is hard to apply in liquid markets due to an abundance of additional information and events that can affect the stock price fluctuations.

In these situations using the event study, which is extensively discussed in Allen Ferrell’s article, can prove very useful because it allows analysts to carefully tailor it to the issue at hand and, therefore, eliminate what is considered the “noise” – events and actions that bear no significance on the outcome or events that do have an impact on the stock price but do not give rise to a compensable claim. As authors of all three articles state, choosing the proper event window is critical. I tend to agree with the authors suggesting that using a shorter window is preferable because there are less extraneous factors to account for. In my view, not only are there less factors to consider, but the financial and time investments required for “considering” those factors are also significantly lower.  Furthermore, extending event window and, hence, allowing more “noise” to come in would open the floodgates of expert testimony battles as to the relevancy and significance of particular “noise” factors, which again will significantly increase costs and reduce efficiency in claims’ resolution. Although a longer event window might produce a more accurate “true financial condition” following the corrective disclosure, as well as allowing the market to adjust for what it could have overreacted to – expectations of subsequent lawsuits, significant changes in management, SEC enforcements etc., the entailed costs of a longer event window analysis seem to offset the benefit derived from such analysis, therefore, making the shorter event window analysis more efficient and preferable.

Turning to the discussion of “fraud-on-the-market” theory as opposed to the “true financial condition“ theory, I agree with Allen Ferrell in that both have significant issues. The “fraud-on-the-market” theory, however, is in my view more problematic and should be abandoned due to its blind reliance on the misstatement itself to establish loss causation and because it also provides an unwarranted safety net for market gamblers. Although, some might argue that “market gamblers” are in fact just “well-informed investors” who should be protected because they stimulate market efficiency, I disagree with this approach. In my opinion, the benefits towards market efficiency advanced by the proponents of “informed investor” definition are negated by the judicial clutter and litigation costs that would increase if were to allow recovery under the relatively low pleading standards of the “fraud-on-the-market” theory. Furthermore, we would then need to develop a way to differentiate between the investors who are indeed “well-informed” and investors who are blindly betting on a good deal hoping for a favorable outcome.

Returning to the first article, I agree with Frank Easterbrook that certain traditional contract remedies should not apply in securities context. His analysis of the three types of such damages makes perfect sense to me. First, I agree that there should be no benefit-of-the-bargain damages because the securities market is simply not designed to produce bargains but should rather portray as accurate of a picture of the firm’s performance as possible. In my opinion, if a company’s stock is trending significantly below industry standard then a reasonable investor should become aware that there is likely some catch to it and, therefore, should not be able to recover if he decides to gamble on said stock. This notion certainly requires some quantifiable measure of stock price’s deviation from the industry standard. When we say “reasonable investor”, we mean an investor who is somewhat familiar with market trends within the industry he is investing in, specifically stock prices and their fluctuations. This knowledge can be based on monitoring historical stock trends or on advice of market analysts. Although such inquiry might trigger higher cost of participation in the securities market for potential investors via increased information costs, the benefits derived from adopting this approach, like the reduction of judicial clutter and decrease in cost of doing business for firms that will not have to litigate as many “gambling” cases, are significant enough to warrant such perspective.

Similarly, I would not award consequential damages because I agree with the author that securities are liquid assets as opposed to non-liquid assets in contract law where consequential damages are used and a downfall in the stock price will not preclude a prudent investor from raising resources from alternative sources to support his business or pursue a lucrative business alternative if his business or said alternative indeed warrant the use of extra resources. Finally, I agree that there is simply no reason to enlist punitive damages in securities litigation because the underlying policy behind punitive damages – punishment for wrongdoing and subsequent deterrence, is already fulfilled through the use of various multipliers that account for severity of misconduct. Furthermore, allowing punitive damages is securities cases would, in my opinion, only make managers more reluctant to make aggressive business decisions as well as further promote non-disclosure in attempt to conceal punishable misconduct.       

2.      Should We Allow Reputational Damages?

Now I would like to turn to the argument of whether we should allow investors to recover for reputational damages. I find that we should. When considering the two approaches advanced by Ferrell and Black, I tend to lean towards the method of valuating initial false statement in the same sense as Professor Black – the initial misstatement is in fact a double statement, where one part is a false statement about the financial condition of the company and the other, “silent”, false statement about the integrity of firm’s management and controls. First of all, it is the main framework behind securities law to protect investors and the trust of investors in management should be carefully considered in light of such policy. That is why the Sarbanes-Oxley Act came to be enacted – to promote investor confidence in management. Furthermore, I agree with Professor Black that if investors cannot rely on their firm’s management’s honesty, they will be forced to incur unnecessary losses to employ investigative resources to make up for the knowledge that managers possess and investors generally rely on in their investment decisions. I also find the legal backing of this theory more credible and better established through author’s use of Virginia Bankshares and various provisions in the Sarbanes-Oxley Act that provide for establishing of the required causal nexus between the initial false statement, the subsequent corrective disclosure and the fall in stock price to give rise to a compensable claim. Furthermore, I agree with Professor Black that dismissing reputational damages claim on the basis of capping recovery is unwarranted because, first of all, if Congress wanted to impose a hard cap on recovery it would have explicitly done so by providing us with an exact formula and, second, the requirement for a 90-day period following corrective disclosure allows analysts to carefully analyze the firm’s condition through use of an event study and weed out all the necessary noise. Finally, I believe that investors might have grounds for bringing a derivative action on behalf of the corporation against dishonest management because reputational harm arising from managerial dishonesty certainly harms the corporation as well as investors.

Although, authors of all three articles do not touch on this issue, I believe that damages in securities cases should not be limited to just situations of lower expected return. I believe that knowingly disseminating false statements may just as well affect the cost of company’s capital, whether it is funded through debt or equity or a combination of both. When the market finds out about managers dishonesty or incapacity, it is fair to assume that said companies cost of raising required capital will go up proportionately to the risk that will be implied because of management’s actions. Similarly, draining of cash assets to mitigate the wrongdoings attributable to managers’ dishonesty should also become part of recoverable reputational damages. I understand that this approach, especially, the part pertinent to cost of capital is not critique-proof and one might argue that firm’s cost of capital may go up due to outside forces that affect the entire industry that would preclude recovery. It is a valid point, but this argument of industry “noise” can, again, be accounted for through the use of a carefully crafted event study to show that change in capital cost is attributed to the new “firm-specific” information arising from managerial misconduct and subsequent disclosure that takes away from the market trust in the company.

V. CONCLUSION.

In conclusion I would like to reemphasize that although there are various elements and methods to establishing damages in securities litigation, there always must be a direct causal nexus between the corrective disclosure and the decline in stock price in order to maintain a compensable claim.

[1] Easterbrook & Fischel, Optimal Damages in Securities Cases, 52 U. Chi. L. Rev. 611 (1985). 

[2] Id. at 614.

[3] Id. at 615.

[4] Id.

[5] Id. at 616; see also Miller v. Asensio & Co., Inc., 364 F.3d 223 (4th Cir. 2004) (finding of liability under Rule 10b-5 in a private securities case does not require an award of damages).

[6] TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 445 (1976) (materiality is an objective standard, involving the significance of an omitted or misrepresented fact to a reasonable investor and how certain it must be that the fact would affect a reasonable investor's judgment); see also Amgen Inc. v. Connecticut Ret. Plans & Trust Funds, 133 S. Ct. 1184 (2013) (proof of materiality of alleged misrepresentations is not a prerequisite to class certification in a securities fraud action based on a fraud on the market theory).

[7] See Easterbrook & Fischel, Antitrust Suits by Targets of Tender Offers, 80 MICH. L. REV. 1155, 1157-59 (1982); Landes, Optimal Sanctions for Antitrust Violations, 50 U. CHI. L. REV. 652 (1983).

[8] Easterbrook & Fischel, Optimal Damages in Securities Cases, 52 U. Chi. L. Rev. at 617.

[9] Id. at 618.

[10] Id. at 622-623.

[11] Id. at 626.

[12] Id. at 627.

[13] Levine v. Seilon, Inc., 439 F.2d 328 (2d Cir. 1971) (no benefit-of-bargain damages in securities cases).

[14] Easterbrook & Fischel, Optimal Damages in Securities Cases, 52 U. Chi. L. Rev. at 633.

[15] See, e.g., Byrnes v. Faulkner, Dawkins & Sullivan, 550 F.2d 1303, 1313 (2d Cir. 1977); Gould v. American-Hawaiian S.S. Co., 535 F.2d 761, 781 (3d Cir. 1976).

[16] Easterbrook & Fischel, Optimal Damages in Securities Cases, 52 U. Chi. L. Rev. at 634.

[17] Id. at 635.

[18] Ferrell & Saha, The Loss Causation Requirement for Rule 10B-5 Causes of Action: The Implications of Dura Pharmaceuticals v. Broudo, 63 Bus. Law. 163 (2007).

[19] Dura Pharmaceuticals v. Broudo, 544 U.S. 336, 344 (2005).

[20] 15 U.S.C. §78u-4(b)(4).

[21] Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007).

[22] Ferrell & Saha, The Loss Causation Requirement, 63 Bus. Law. at 166.

[23] Id. at 170.

[24] 544 U.S. at 342.

[25] Ferrell & Saha, The Loss Causation Requirement, 63 Bus. Law. at 172.

[26] Greenberg v. Crossroads Sys., Inc., 364 F.3d. 657 (5th Cir. 2004).

[27] 364 F.3d at 668.

[28] Thorsen, Kaplan, and Hakala, Rediscovering the Economics of Loss Causation, 6 Bus. & Sec. L. 93, 102-103 (2005). 

[29] Lentell v. Merill Lynch, 396 F.3d 161, 173 (2d Cir. 2005).

[30] Ferrell & Saha, The Loss Causation Requirement, 63 Bus. Law. at 181.

[31] Id.

[32] Basic, Inc. v. Levinson, 485 U.S. 224, 239 n.17 (1988).

[33] Ferrell & Saha, The Loss Causation Requirement, 63 Bus. Law. at 184.

[34] Black, Reputational Damages in Securities Litigation, 35 J. Corp. L. 169 (2005).

[35] Ferrell & Saha, The Loss Causation Requirement, 63 Bus. Law. at 181-185.

[36] Black, Reputational Damages in Securities Litigation, 35 J. Corp. L. at 176.

[37] Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991).

[38] Id. at 1092.

[39] P.L. 107-204/205, 116 Stat. 745 (2002).

[40] 18 U.S.C. § 1350; see also Rule 13a-14(a)/15d-14(a).

[41] Rule 13a-14/15d-14(a).

[42] SEC, Certification of Disclosure in Companies' Quarterly and Audit Reports, Rel. 33-8124, 2002 WL

31720215, *9(Aug. 29, 2002) ("Certification of Disclosure").

[43] See Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, 128 S. Ct. 761, 772 (2008); 15 U.S.C. § 21D(e)(1).