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An issuer makes a positive, material misstatement in violation of Rule 10b-5. What must an investor who purchases the issuer's shares on the open market show to establish causation in a "fraud-on-the-market" action for damages? After years of confusion in the lower courts, the Supreme Court recently granted certiorari on the question in the case of Broudo v. Dura Pharmaceuticals.

This Article argues that the confusion in the lower courts has arisen because they have analyzed the issue in terms of the twin concepts of "transaction causation" and "loss causation." They initially developed this bifurcated framework as a way of deciding causation in actions based on a showing of traditional reliance, which involve the plaintiff establishing that the defendant's misstatement caused the plaintiff to engage in what has turned out to be a losing transaction. Fraud-on-the-market actions involve a fundamentally different kind of causal connection between the defendant's misstatement and the plaintiff's injury. The plaintiff must instead establish that the defendant's misstatement caused her to pay a higher price for her purchase, not that it caused her to make the purchase. This difference in causal connection was recognized by the Court when it originally approved fraud-on-the-market actions in Basic v. Levinson more than fifteen years ago. Because of this fundamental difference in causal connection, the twin concepts of transaction causation and loss causation simply do not make sense in fraud-on-the-market actions.

The Court in its upcoming decision in Broudo concerning fraud-on-the-market actions should, consistent with the causal link it recognized in Basic, avoid the use of this inappropriate transaction causation/loss causation framework. Its focus instead should be on developing standards for what the plaintiff must plead and prove in order to establish that the defendant's misstatement inflated the price at the time of purchase.


Law | Securities Law


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