why dura’s contextual qualification of loss causation is a generalized holding and is not limited...

Why Dura’s Contextual Qualification of Loss Causation is a Generalized Holding and is Not Limited to Rule 10b-5 Fraud-on-the-Market Cases

David Randall Jenkins, Ph.D.Algorithm-LLC.com

Preliminary Matters

oWhen Securities Laws Apply

oTransaction v. Loss Causation

oRescissory Relief v. Damages Relief

When Securities Laws Apply

• Securities laws apply if the interest is specifically described in the governing statute

• Interests in partnerships and limited liability companies not usually defined as securities, per se

• Securities laws apply if the interest meets the definition of an investment contract

• Interests in partnerships and limited liability companies can be defined as an investment contract

Interests in Investment Contracts

SEC v. W. J. Howey Co., 328 U.S. 293 (1946)

1. Still good law with a slight modification

2. Howey holds an investment contract involves—

a) an investment of money,

b) in a common enterprise,

c) where profits are derived solely by the efforts of others

Investment in MoneyAn investment in money means—

a. Money or cash equivalents contributed to the enterprise

b. Fair market value of property contributed to the enterprise

c. Fair market value of services enterprise

____________International Brotherhood of Teamsters v. Daniel, 439 U.S. 551 (1979)

Common Enterprise• The common enterprise is defined by the venture entity

• General partnership interests are usually endowed with a rebuttable presumption that they do not involve the issuance of securities

• Limited partnership interests are usually endowed with a conclusive presumption that they involve the issuance of securities

• Member-managed limited liability companies are usually endowed with a rebuttable presumption that they do not involve the issuance of securities

• Manager-managed limited liability companies are usually endowed with a rebuttable presumption that they involve the issuance of securities

Substance Controls Over Form

Substance controls over form. Daniel, supra.

A general partnership or joint venture interest can be designated a security if the investor can establish, for example, that— • an agreement among the parties leaves so little power in the

hands of the partner or venturer that the arrangement in fact distributes power as would a limited partnership; or

• the partner or venturer is so inexperienced and unknowledgeable in business affairs that he is incapable of intelligently exercising his partnership or venture powers; or

• the partner or venturer is so dependent on some unique entrepreneurial or managerial ability of the promoter or manager that he cannot replace the manager of the enterprise or otherwise exercise meaningful partnership or venture powers.

Nutek Information Systems, Inc., et al., v. Arizona Corporation Commission, 194 Ariz. 104 (Az.App.Div.1 1998)


• The critical difference between LLCs and general partnerships is that the general partners' personal liability necessarily gives the partner an incentive to be highly informed about the business. At the same time, personal liability discourages involvement by unsophisticated investors. It follows that LLCs may have greater securities law exposure than general partnerships.

• Usually general partners and joint venturers have enough control over their business entities that the third prong of the Howey test does not apply to them. Citing, Williamson v. Tucker, 645 F.2d 404 (5th Cir. 1981).

• The large number of geographically dispersed investors and the extent of LLC diluted partnership power prevented the members from exercising effective control of the business. Citing, S.E.C. v. Telecom Marketing, Inc., 888 F. Supp. 1160, 1166 (N.D. Ga. 1995) (stating the "number of partnership units sold so dilutes each partner's power that in actuality it appears none could exercise any meaningful partnership control").

Nutek, supra.


• Investors must have meaningful knowledge of the specific business being operated. Citing, Long v. Shultz Cattle Co., 881 F.2d 129, 134 n.3 (5th Cir. 1989).

• An investor's knowledge of the business being operated provides one of the most reliable indicators of that investor's ability to exercise control over the investment. When the investor does not possess specialized knowledge of the business, he or she is far more likely to expect profits based on the efforts of the promoter or manager.

• Securities law protection may inure to one investor and not another in the same venture.

Nutek, supra.

Transaction v. Loss Causation

• Proof of transaction causation is a necessary and sufficient condition—

• for rescission under Arizona’s securities laws when tender or substitute tender is feasible. Grand v. Nacchio, 214 Ariz. 9, 27 (Az.Appls.Div.2 2006); citing, A.R.S. §44-2001(A)

• for common law rescission when equitable considerations obviate the need to return both parties to the ex ante status quo relationship (e.g., what was obtained was worthless)

• Proof of transaction causation and loss causation is a necessary and sufficient condition—

• when the plaintiff is seeking damages

• when the plaintiff sues for rescission under Arizona’s securities laws and neither tender nor substitute tender is feasible

• when the plaintiff sues for common law rescission when equitable considerations requires proximate causation (e.g., what was obtained was not worthless and the plaintiff made the unilateral decision to dispose of the investment interest without first seeking rescission)

Grand, supra.

Transaction Causation• Transaction causation is also known as “but for” causation and has

been analogized to the element of reliance. AUSA Life Insurance Company v. Ernst & Young, 206 F.3d 202 (2nd Cir. 2000); citing, Currie v. Cayman Resources Corp., 835 F.2d 780, 785 (11th Cir. 1988).

• Transaction causation means that the violations in question caused the plaintiff to engage in the transaction in question. Id; citing, Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 380-381 (2nd Cir. 1974).

• The relevant test for materiality of a misrepresentation or omission is whether there is a substantial likelihood that a reasonable investor would consider it important in deciding whether to purchase the security. TSC Industries v. Northway, Inc., 426 U.S. 438, 449 (1976).

Pre-Dura Loss Causation

Movitz v. First National Bank of Chicago, 148 F.3d 760 (1998)

• A finding of transaction causation is not a sufficient basis for loss causation

• The requirement of proving loss causation is a general requirement of tort law

• The care a defendant may be contractually required to take in advising plaintiff with regard to the purchase of an investment is not intended to prophesy or avert market fluctuations but to make sure that the property was a sound purchase under current market conditions

• Plaintiff may not have lost this money as a result of the defendant’s misconduct but only as a result of the collapse of the Houston real estate market.

DuraThe Supreme Court of the United States contextually qualified loss

causation for deceit cases, including those arising under SEC Rule 10b-5, in Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005). The now famous Dura “tangle of factors” ascribing loss causation has been subsequently characterized as “disaggregation.” The Supreme Court teaches its perception of the tangle of factors in the following statement, to wit:

When the purchaser subsequently resells such shares, even at a lower price, that lower price may reflect, not the earlier misrepresentation, but changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events, which taken separately or together account for some or all of that lower price. (The same is true in respect to a claim that a share's higher price is lower than it would otherwise have been--a claim we do not consider here.) Other things being equal, the longer the time between purchase and sale, the more likely that this is so, i.e., the more likely that other factors caused the loss.

Dura, at 342-43 (Emphasis added).

Dura’s Progeny

Second circuit law “precludes assigning two different causes to the same quantum of loss.”

In re Flag Telecom Holdings, Ltd. Securities Litigation, 574 F.3d 29, 37 (2nd Cir. 2009)

A plaintiff’s failure to disentangle losses from those caused by general market-wide phenomena subject his claims to dismissal for failure to state a claim upon which relief may be granted.

Williamowsky v. Take-Two Interactive Software, Inc., 818 F.Supp.2d 744, 756-57 (S.D.N.Y. 2011)

Dura: Generalized Loss Causation

Contextual Qualification or Per Se Rule

10b-5 Qualification?

The Dura Court’s generalized loss causation contextual qualification is recognizable within Dura’s script. The Court reversed the Ninth Circuit’s decision (pleading loss was caused by fraudulently inflated purchase price was sufficient notice) by finding the circuit court’s “approach inconsistent with the law’s requirement that a plaintiff prove that the defendant’s misrepresentation (or other fraudulent conduct) proximately caused the plaintiff’s economic loss.” Dura, supra, at p. 346. Specifically, the Court refrained from limiting its generalized disaggregation loss causation contextual qualification when it plainly stated: “We need not, and do not, consider other proximate cause or loss-related questions.” Id (emphasis added).

A lawsuit is not a “downside insurance policy” against losses attributable to general market declines.” Dura, at pp. 347-48

Formal information content Dura’s holding implicates generalized loss causation contextual qualification:




Dura’s generalized loss causation contextual qualification is made more clear considering the mandate in light of the Court’s earlier decisions, such as Basic Incorporated v. Levinson, 485 U.S. 224 (1988). In Basic, the Court anointed the Efficient Market Hypothesis as a Daubert competent fraud-on-the-market methodology. See, Basic, at p. 246. The Court had the opportunity to tie its Dura disaggregation loss causation holding to the Efficient Market Hypothesis. Had it done so, foreseeably emerging post-Dura loss causation jurisprudence may have constrained disaggregation to fraud-on-the-market pleadings and proof.

Formal Supreme Court information content the holding implicates generalized loss causation contextual qualification:




The first section of the opinion deals with what securities-fraud plaintiffs ultimately must prove in order to establish loss causation, concluding “that a plaintiff must prove that the defendant’s misrepresentation (or other fraudulent conduct) proximately caused the plaintiff’s economic loss.” (Citation omitted). While this proof may take a variety of forms, the Supreme Court declined to define either its substantive or temporal parameters with much precision.

Coughlin, P. J., Isaacson, E. A., and Daley, J. D., “What’s Brewing in Dura v. Broudo? A Review of the Supreme Court’s Opinion and Its Import for Securities-Fraud Litigation,” Loyola University Chicago Law Journal, Vol. 37, 2005, pp. 1-42, at 15.

Anecdotal evidence the Dura Court generalized its holding:




The Court was asked to consider how investors could plead and prove causation. More specifically, the issue was whether it is sufficient to plead that an investor paid an inflated price for a stock on the day of purchase, and nothing more, in alleging that fraud caused such loss? The Court held that such a statement, standing alone, was not enough to plead (or prove) “loss causation” in these cases. Beyond that, the Court left the doors wide open: to plead causation in a securities fraud case, it said, a plaintiff should “provide a defendant with some indication of the loss and the causal connection that the plaintiff has in mind.” The Court explicitly stated that it was making no other ruling on proximate cause.

Thorsen, M. S., Kaplan, R. A., and Hakala, S., “Rediscovering the Economics of Loss Causation,” 6 J.

Bus. & Sec. L. 93, at p. 94 (2006).

Anecdotal evidence the Dura Court generalized its holding:




United States v. Vogel Fertilizer Co., 455 U.S. 16 (1982)

The Supreme Court’s historic use of informal information signals supports the argument it generalized Dura’s, to wit:

On the eve of the passage of the Tax Equities and Fiscal Responsibilities Act of 1982, the Supreme Court decided a surtax exemption case involving brother-sister corporations as defined in 26 U.S.C. §1561. The Court’s decision was pro-taxpayer to the point where it might have been considered an aberration against its typically conservative tax fabric.

TEFRA included a provision that targeted use of newly formed corporations to receive stock in existing corporations having material earnings and profits in a section 351 tax-free exchange for the new corporation’s stock and securities.

In 1989, Congress changed section 351 to provide only stock from the new corporation could be received. In 2004, Congress changed the section 1561 80% threshold relevant in Vogel to 50%.




Rowan Cos., Inc. v. United States, 452 U.S. 247 (1981).


Congress initially enacted Section 530 of the Revenue Act of 1978 as a temporary measure. It later made the provision permanent in the Tax Equities and Fiscal Responsibilities Act of 1982.

In 1981, the Court issued its Rowan decision. It held subtitle A’s section 119 defined wages for subtitle C’s FICA and FUTA purposes, as well as for FIT purposes which the Treasury had already recognized in regulations. The Court declared regulations to the contrary invalid. In 1983 Congress, first, excluded meals and lodging for the convenience of the employer for FICA and FUTA purposes and then, second, “decoupled” exclusions in chapter 24 (FIT) from exclusions in chapter 21 (FICA) and chapter 23 (FUTA).

The second circuit viewed this action as invalidating Rowan. However, that conclusion is misplaced. Rowan stands for the notion exogenous legislation contextually qualifies the endogenous infrastructure.




McNally v. United States, 483 U.S. 350 (1987).


Following the passage of the Tax Reform Act of 1986, the real estate market collapsed nationwide. Values plummeted. The culprit was the act’s provision eliminating the ability to offset active income with passive losses. Foreseeably, criminal and civil litigation would be mounted to blame others for the resulting losses.

The Court took a bold step and decided an issue it had historically refused to address: whether the federal mail and wire fraud statutes criminalized the wrongful deprivation of an intangible right. This is known as the “Intangible Rights Doctrine.” In McNally, the Court held the mail and wire fraud statutes never intended to prosecute the wrongful taking of intangible rights.





The Court decided Dura on April 19, 2005. There is an appearance the courts often use a decision date to communicate an informal information signal. Assuming the appearance is true, what significance is the date? How does the date’s informal information content weigh in on this issue?

Arrovian ImpossibilityPlaying “Economics Jeopardy”—

“I’ll take “Dura Disaggregation Loss Causation for $2,000, Alex.”

“The Answer is: Arrovian Impossibility.”

“The question is: What makes Dura Disaggregation Loss Causation Daubert incompetent in non-Fraud-on-the-Market cases?”

Arrovian ImpossibilityProfessor Kenneth J. Arrow

Stanford University Professor Emeritus Kenneth J. Arrow’s famous 1951 doctoral dissertation, Social Choice and Individual Values used a paradigm of two individuals ranking respective preferences over three social states to prove it is generally impossible to aggregate preferences in the (individual: societal) migration. Arrow shared the 1972 Nobel Memorial Prize in Economics with Sir John Hicks for his work in social welfare.

See, Arrow, K. J. Social Choice and Individual Values. Monograph No. 12. Cowles Commission for Research in Economics. New York: Wiley (1951, 1963).

Arrovian ImpossibilityProfessor Amartya K. Sen

In his 1998 Nobel Memorial Prize in Economics acceptance speech, Professor Amartya K. Sen coined the term “Arrovian Impossibility” and claimed the proof filled the academic economics discipline with pessimism. Sen won the prize for his work in social choice theory.

Sen’s Nobel acceptance speech is also published in an academic journal, to wit: See, Sen, A. K. "The Possibility of Social Choice." The American Economic Review, 89(3), June 1999, pp. 349-378.

Arrovian ImpossibilityArrovian Impossibility End-Run Academic Research

Arrovian impossibility’s immediate consequence for academic research in the interrelated disciplines of economics, finance, and accounting led to the emergence of empiricism in search of theory. That is, Arrovian impossibility shut down the (theory: empiricism) migration. Ergo, academics strove to validate (empiricism: theory) migrations as an end-run around Arrovian impossibility. In furtherance of such academic efforts, a University of Rochester managerial accounting professor concludes rich empirical settings stimulate theory just as theories stimulate empirical work.

See, Zimmerman, J. L. "Conjectures Regarding Empirical Managerial Accounting Research." Journal of Accounting & Economics. Vol. 32 (2001), pp. 411-427.

Arrovian Impossibility

Harry M. Markowitz

In his seminal post-Arrovian impossibility (empiricism: theory) treatise, Portfolio Selection, Markowitz declares the process of selecting a portfolio is a two-stage process beginning with observation. Markowitz explicitly recognizes Arrow's impossibility constraint:

Care must be used in using and interpreting relations among aggregates. We cannot deal here with the problems and pitfalls of aggregation.

See, Markowitz, H., "Portfolio Selection," The Journal of Finance, 7(1), March 1952, pp. 77-91. Markowitz was recognized for his work in financial economics (portfolio theory) when he was awarded a 1/3 share of the 1990 Nobel Memorial Prize in Economics.

Post-Arrovian Impossibility Academic Research


Eugene F. Fama

Fama’s early work in the study of securities prices in completing his University of Chicago doctoral dissertation in the early 1960s led to the formalization of the Efficient Market Hypothesis (EMH). The EMH asserts capital markets are informationally efficient. The weak form of the hypothesis holds extant security prices impound all past publicly available information. The semi-strong form contends security prices impound all past publicly available information and instantly revise on receipt of new publicly available information. The strong form of the hypothesis incrementally contends securities price revisions impound even inside information.

See, Fama, E., "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, 25(2), May 1, 1970, pp. 383–417. Fama was recognized for his empirical analysis of asset prices when he was awarded a 1/3 share of the 2013 Nobel Memorial Prize in Economics.



William F. Sharpe

The Capital Asset Pricing Model (CAPM) is generally regarded as having been developed by Sharpe, among others. The capital asset pricing model is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk.

See, Sharpe, W. F., "Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk," The Journal of Finance, 19(3), September 1964, pp.425-442. Sharpe was recognized for his work in financial economics in 1990 when he, too, was awarded a 1/3 share of the Nobel Memorial Prize in Economics.



Accounting Academic ResearchersWilliam H. Beaver

Accounting researchers likewise pessimistically reflected on Arrovian impossibility. Beaver recognized a problem arises in attempting to make comparisons or trade-offs among the welfare of different individuals. Arrovian impossibility ensures any complete and transitive ordering of information alternatives at the social level will violate one or more of his conditions.

See, Beaver, W. H., "Implications of Security Price Research for Accounting: A Reply to Bierman," The Accounting Review, 49(3), July 1974, pp. 563-571, at 565.



Accounting Academic ResearchersJoel S. Demski

Demski examined the consequence of Arrow's impossibility theorem on the formulation of normative accounting standards and concluded:There is no way of moving from complete and transitive preferences at the individual level to a group level complete and transitive notion of preferences that satisfies Arrow's conditions.

See, Demski, J. S., "The General Impossibility of Normative Accounting Standards," The Accounting Review, 48(4), October 1973, pp. 718-723; citing, Arrow (1963). Also, see, Beaver, W. H. and Demski, J. S., "The Nature of Financial Accounting Objectives: A Summary and Synthesis," Supplement to Journal of Accounting Research Vol. 12, Studies on Financial Accounting Objectives: 1974, pp. 170-187.



Accounting Academic ResearchersArrovian Impossibility End-Run Research

Anyone exploring the literature would be forced to conclude social choice theory, itself, offers no hope that there is a solution to the issue of public choice among financial reporting alternatives.* As a result, accounting research, at best, is among the disciplines attempting the (empiricism: theory) end-run around Arrovian impossibility.

*Walker, M., "Risk Attitudes, Value-Restricted Preferences, and Public Choice Over Lotteries and Information Systems," The Accounting Review, 59(2), April 1984, pp. 278-286; citing, Cushing, B. E., "On the Possibility of Optimal Accounting Principles," The Accounting Review, 52(2), April 1977, pp. 308-321.


Daubert IssuesDaubert* imposes the task of “gatekeeping,” or assuring

expert testimony proceeds from “scientific knowledge” rests on the trial judge. The gatekeeping function’s purpose has been distilled to excluding junk science that does not meet the reliability standard.** In its gatekeeping function, the trial court must consider the following Daubert list of non-exhaustive factors: (1) whether the scientific theory or technique can be (and has been) tested, (2) whether the theory or technique has been subjected to peer review and publication, (3) whether there is a known or potential error rate, and (4) whether the theory or technique is generally accepted in the relevant scientific community.***

*Daubert v. Merrill Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993).

**See, Ellis v. Costco Wholesale Corporation, 657 F.3d 970 (9th Cir. 2011); citing, Kumho Tire Co. v. Carmichael, 526 U.S. 137 (1999).

***See, Barabin v. Asten-Johnson, Inc., 700 F.3d 428 (9th Cir. 2012); citing, Mukhtar v. Cal. State Univ., 299 F.3d 1053, 1064 (9th Cir. 2002).

Fraud-on-the-Market Cases

The advantage fraud-on-the-market cases have is the plethora of peer-reviewed security price accounting research papers. The seminal such event study was conducted by Beaver.* My own dissertation employed this Beaver-esque framework.** The basic approach in such security price studies is to establish a security’s relation to market movement in a control period. Then, using such proportional relationship, evaluate statistically significant outliers in the event period. This is the pattern o

*Beaver, W. H., “The Information Content of Annual Earnings Announcements,” Journal of Accounting Research, 1968 Supplement, 6(3), pp. 67-92.

**Jenkins, D. R.; Vickrey, D. W.; and Foster III, T. W., "Additional Evidence on the Incremental Information Content of the 10-K,” The Journal of Business, Finance and Accounting, Spring 1983, pp. 57-66; Jenkins, D. R.; Vickrey, D. W.; and Foster III, T. W., “The Incremental Information Content of the Annual Report,” Accounting and Business Research, Spring 1986, pp. 15-21.

Fraud-on-the-Market Cases

In the post-Dura era, common fraud-on-the-market event study methodologies and techniques are supported by Fama’s Efficient Market Hypothesis, Sharpe’s Capital Asset Pricing Model, and Beaver’s security price research. As a result, legal commentators characterize disaggregation loss causation event studies as including: 1. Identify the event, 2. Establish an event window, 3. Control for Market and Industry Effects to Get an Estimated

Relationship between the Company and the Market, and, 4. Estimate the Effects of the Event.*

*See, Erdlen, A. M., “Timing Is Everything: Markets, Loss, and Proving Causation in Fraud on the Market Actions,” Fordham Law Review, 80:2, Article 15, at pp. 877-922, at 904; Kaufman, M. J. and Wunderlich, J. M., “Regressing: The Troubling Dispositive Role of Event Studies in Securities Fraud Litigation,” 15 Stan. J.L. Bus. & Fin. 183 (2009).

Event Studies in Non-Market Cases

Both Movitz and Dura’s generalized disaggregation loss causation contextual qualification holding implicate proximate cause in non-market cases must likewise distill losses attributable to changes in market-wide and industry economic conditions, and other non-fraud factors in arriving at statistically significant fraud event outliers. The key is to utilize Daubert competent methodologies and techniques.

Randall’s ResearchMy research in fulfilling Dura generalized

contextually qualified loss causation disaggregation begins with my paper, “Ordered Conflict Resolution.” The paper was published in a peer-reviewed online French economics journal in 2010.* The journal’s editorial committee is both international and substantial. Ergo, the paper’s tenets ought to pass muster under Daubert.

The paper demonstrates Professor Arrow’s paradigm is indeed generally impossible for the reason it is flawed with ordered subjective references. The key is the threshold or unordered (subjective: objective) reference transition. The paper explains Ordered Relation Theory’s two ordered conflict enabling axioms.

*The paper is available on the journal’s website here: http://ethique-economique.net/Volume-7-Issue-1.html.

Randall’s ResearchMy current paper, “Axiomatic Social

Choice Theory” is now in peer review at the same online French economics journal.* It explains further axioms central in the impossibility-resolved (individual: societal) well-being aggregation migration.

My initial research also concludes disaggregation is empirical in relation to theory of aggregation. That’s why Arrovian impossibility may be viewed as foreclosing non-market disaggregation loss causation event studies. My goal is to formulate a generalized disaggregation loss causation model whether the event study is set in a non-market case or in a fraud-on-the-market case.

*The paper in its current form is available here: http://works.bepress.com/perfect_and_beautiful_woman/34/.

why dura’s contextual qualification of loss causation is a generalized holding and is not limited...

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