Risk Disclosures and Damages Measurement in Securities Fraud Cases
1 April 2006
By Dr. David Tabak
In securities fraud cases, damages analyses typically begin by estimating the stock's "artificial inflation," which is the amount by which the actual stock price exceeds the true value, or the level that the price would be if defendants corrected any previous misrepresentations or unlawful omissions of information. Because an improper misrepresentation or concealment of a material risk would lead to investors' overpaying for a security, if other elements of a case are satisfied, such a misrepresentation or unlawful omission can create liability on the part of defendants. In this article from Securities Reform Act Litigation Reporter, NERA Senior Vice President Dr. David Tabak examines issues relevant to determining the artificial inflation in a stock price when the ultimate disclosure is only of a risk of an event that is later realized.
Dr. Tabak breaks down his analysis into four steps: (1) determining which risks are required to be disclosed; (2) measuring the price decline on disclosure of the realization of the risk; (3) estimating the probability at earlier dates that the risk would eventually be realized; and (4) using the probability to estimate the artificial inflation in the security's price. He notes that certain risks may not be required to be disclosed by companies because they are immaterial as a matter of law. When other risks are ultimately disclosed, it is often not merely the risk that is disclosed, but the realization of that risk. The disclosure, then, will cause a price decline in excess of what would have occurred had the risk alone been disclosed. To properly calculate the level of artificial inflation in a security's price at earlier points in time, it is necessary to adjust that price decline to reflect only the information that could have been revealed earlier. Thus, if before the disclosure of the realization of a risk defendants could only have disclosed that such a risk existed, but not that it would necessarily come to pass, the price decline measured upon realization and disclosure of the risk must be adjusted for the prior probability that the risk would have eventually been realized.
This article, from the April 2006 issue of Securities Reform Act Litigation Reporter, is reproduced with permission from Law Reporters. All rights reserved.
