Inflation Methodologies in Securities Fraud Cases: Theory and Practice

Thu Jun 13 16:24:38 EDT 2002
By Dr. Chudozie Okongwu and Dr. David Tabak

One of the key tasks in assessing damages in a securities fraud case is the determination of what portion of the traded stock price is real (the true value) versus the part that is due to alleged misstatements or omissions (the inflation). If liability is established then the calculation of the inflation in the stock price serves as the basis for all damage claims. Surprisingly, there is not a large body of literature on the correct method to employ in estimating stock price inflation.

This working paper by NERA Senior Vice Presidents Dr. David Tabak and Dr. Chudozie Okongwu analyzes both the theoretical justification for applying different inflation methodologies in different situations and the frequency with which various methods are used in practice. There are several methodologies for measuring the true value in a stock before a corrective disclosure of previously omitted or misstated information. Among the most common are the constant dollar inflation, constant percentage inflation and the constant true value methodologies. The authors also examine the interaction of the choice of inflation methodology with the measurement of damages given the loss causation requirements of the securities laws. Finally, they examine settlements of shareholder class actions and find that an extremely large, and likely unreasonable, share of those settlements use the constant true value methodology, which the authors find to be inappropriate in many cases.