The U.S. Supreme Court Tuesday gave stock investors a stern but necessary warning: don't look to litigation as an easy path to recoup losses.
By upholding a high standard to prove securities fraud, the nation's top court signaled that "buyer beware" is still a vital motto for equity investors.
In a litigious society that favors placing responsibility for negative outcomes on anyone but ourselves, this is a refreshing if sobering message.
While likely to allow some corporate sleight of hand to slip below the standards for viable lawsuits, the Tuesday decision achieves a greater good by making sure that class-action lawsuits that claim securities fraud are substantial in their assertions.
The decision also gives public companies some breathing room in public statements and actions. This is probably quite welcome just about now in corporate suites because of the perception in many corner offices that executives are under siege from the Sarbanes-Oxley reform Act. That law demands, among other things, that chief executives personally sign off on financial statements and that companies prove their internal control systems are worthy of the name.
The facts of the case, Dura Pharmaceuticals Inc. v. Broudo, include the following, as recounted in Wednesday's Wall Street Journal: shareholders claimed the stock price of Dura purchased in the 1997-1998 period was inflated by company misrepresentations about two products. Those statements were reversed during a period in which the company stock price fell.
In 2000, Dura Pharmaceuticals was acquired by Elan Corp.
A more detailed set of facts led the Ninth U.S. Circuit Court of Appeals in San Francisco to reverse a lower court decision and allow the lawsuit to proceed.
The Supreme Court disagreed with that decision, essentially saying the suit hadn't specifically linked the misrepresentations to the actual losses.
Securities laws aren't designed "to provide investors with broad insurance against market losses, but to protect them against those economic losses that misrepresentations actually cause," wrote Justice Stephen Breyer, the Journal reported. The high court opinion was unanimous.
The justices are aware a lot of things affect stock prices and they want a tight fit between the alleged misrepresentations and the change in share price. It makes it tough on those bringing suit, but to do otherwise would create an investment world dominated by courts rather than by markets.
A lower stock price might reflect "not the earlier misrepresentation, but changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions or other events," wrote Breyer, as cited by the Journal.
In a very different case a few years ago, the late Federal Judge Milton Pollack in his own way made clear the high standard that needed to be met for a successful securities fraud suit.
In July 2003, Pollack, at the time in his mid-90s, dismissed a class action suit against Merrill Lynch and its former star Internet analyst, Henry Blodget.
The plaintiffs claimed in that case, in essence, that Merrill provided bad investment advice on two Internet stocks in an alleged attempt in the late 1990s to win investment banking business from the companies it evaluated.
Pollack focused on the investors who brought that suit, calling them "high-risk speculators" who took big chances during the technology bubble years and then hoped "to twist the federal securities law into a scheme of cost-free speculator's insurance."
Pollack wrote federal securities laws at issue in the case "only fault those who, with intent to defraud, make a material misrepresentation or omission of fact (not opinion) in connection with the purchase or sale of securities that causes a plaintiff's losses."
Lipschutz is senior editor, Americas, Dow Jones Newswires.