Saturday, April 11, 2015
In Dura Pharmaceuticals, Inc. v. Broudo, 544 US 336 (2005), the Supreme Court held that to bring a fraud-on-the-market action under Section 10(b), shareholders would have to plead and prove the element of “loss causation,” namely, that disclosure of the fraud caused the company's stock price to drop, resulting in plaintiffs’ losses.
Since Dura was decided, there has been concern that companies might try to avoid liability by strategically disclosing information in a manner that would make it more difficult for plaintiffs to establish stock price effects.
In their new paper, Disclosure Strategies and Shareholder Litigation Risk, Michael Furchtgott and Frank Partnoy take significant steps toward establishing that these fears are well-grounded.
[More under the cut]Furchtgott and Parnoy compare restatements issued prior to Dura, and after Dura. They make several significant findings.
First, after Dura, large firms (i.e., those most likely to be the targets of fraud on the market class actions) became more likely to “bundle” additional information with restatement announcements; presumably, this is because the firms recognized that bundling may make it more difficult for plaintiffs to show that the restatement, rather than unrelated news, affected the company’s stock price.
Second, to the extent these efforts were intended to thwart shareholder litigation, they were successful. Bundling not only mitigated the stock price impact of restatements, but also reduced the likelihood that a lawsuit would be filed.
Third, and perhaps most disturbingly, after Dura, firms were more likely to experience abnormal stock price returns prior to the announcement of a restatement, suggesting that firms began intentionally leaking information in order to condition the market so that the eventual restatement announcement would not have as great an effect. The reason this is disturbing is because to accomplish this, firms may have violated Regulation FD, which forbids selective, private disclosure of information.
It is certainly no secret that managers have long managed their disclosure strategies. Feng Li, for example, found that managers use more obscure and difficult-to-parse language when disclosing negative, rather than positive, information.
It has also been found that managers may “bundle” takeover bid announcements with negative information, apparently to divert attention from the unfavorable performance.
Nonetheless, Furchtgott’s and Parnoy’s study, I think, contributes to our understanding of how managers manipulate disclosure in order to thwart litigation. As a result, as the authors point out, a strategy that presumably was adopted to mitigate litigation risk may have the side effect of “decreas[ing] the timeliness and clarity of information that investors receive from firms.”