In Re Williams Securities Litigation-WCG Subclass

FILED
United States Court of Appeals
Tenth Circuit

February 18, 2009
PUBLISH Elisabeth A. Shumaker
Clerk of Court
UNITED STATES COURT OF APPEALS

TENTH CIRCUIT

In re: WILLIAMS SECURITIES No. 07-5119
LITIGATION - WCG SUBCLASS.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE NORTHERN DISTRICT OF OKLAHOMA
(D.C. NO. 02-CV-72-SPF-FHM)

Jonathan E. Bridges, Susman Godfrey LLP, Dallas, TX (William Christopher
Carmody, John W. Turner, and Jeremy J. Brandon, Susman Godfrey LLP, Dallas,
TX; Joshua H. Vinik, Matthew A. Kupillas, and Kent A. Bronson, Milberg Weiss
LLP, New York, NY; and Behram V. Parekh, Yourman Alexander & Parekh LLP,
Los Angeles, CA, with him on the briefs), for Plaintiffs-Appellants.

James L. Kincaid, Crowe & Dunlevy, Tulsa, OK (Michael J. Gibbens, Victor E.
Morgan, Susan E. Huntsman, Crowe & Dunlevy, Tulsa, OK and Mary H. Tolbert,
Crowe & Dunlevy, Oklahoma City, OK, with him on the brief) for Defendants-
Appellees Howard E. Janzen, Scott E. Schubert, Kenneth Kinnear II, Matthew W.
Bross, Bob F. McCoy, Howard S. Kalika, John C. Bumgarner Jr., and Frank M.
Semple.

Theodore J. Boutrous, Jr., Gibson, Dunn & Crutcher LLP, Los Angeles, CA
(Julian W. Poon, Gibson, Dunn & Crutcher LLP, Los Angeles, CA; Timothy K.
Roake and Ethan D. Dettmer, Gibson, Dunn & Crutcher LLP, Palo Alto, CA; and
Graydon Dean Luthey, Jr. and Sarah Jane Gillett, Hall, Estill, Hardwick, Gable,
Golden & Nelson, P.C., Tulsa, OK, with him on the brief), for Defendants-
Appellees The Williams Companies, Inc. and Keith E. Bailey.

Before McCONNELL, ANDERSON, and BALDOCK, Circuit Judges.
McCONNELL, Circuit Judge.

On July 24, 2000, The Williams Companies, Inc. (“WMB”) announced that

it would be spinning off its telecommunications subsidiary, Williams

Communications Group (“WCG”), in a move that it called “the best way to ensure

that both our energy and communications businesses have the efficient and

effective access to the capital necessary to pursue the substantial growth that each

enjoys.” Not two years later, on April 22, 2002, WCG filed for bankruptcy and

its stock hit $0.06. A nationwide class of plaintiffs who purchased stock or notes

issued by WCG between those dates brought fraud claims under § 10(b) and §

20(a) of the Securities Exchange Act and Rule 10b-5. The district court found

genuine issues of material fact as to falsity, materiality, and scienter in

connection with numerous alleged misrepresentations, but granted the defendants’

motion for summary judgment on the issues of loss causation and damages. The

plaintiffs had attempted to prove the latter with the expert testimony of Dr. Blaine

Nye, but the court found his testimony unreliable under Daubert because his

theories of loss causation could not distinguish between loss attributable to the

alleged fraud and loss attributable to non-fraud related news and events. The

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plaintiffs appeal the exclusion of Dr. Nye’s testimony and the grant of summary

judgment. 1 We affirm.

I. BACKGROUND

A. The Rise and Fall of WCG

As an energy company that produces and transports natural gas, WMB

owns a large network of pipelines. In the 1980s, it began running fiber-optic

cable through decommissioned pipelines and formed a telecommunications

subsidiary that built a coast-to-coast network. It sold that subsidiary in 1995 and

entered into a temporary non-compete agreement that prevented it from reentering

the telecommunications industry until 1998. During this interim,

telecommunications stocks continued to rise, with the Telecom Index growing

from 215.71 at the beginning of 1997 to 306.60 by that year’s end, an increase of

42%. When the non-compete agreement expired, WMB formed a new subsidiary,

WCG, that set out to build a nationwide fiber-optic network using the

decommissioned pipeline that WMB still owned. In October, 1999, when the

Telecom Index had reached 616.80, WCG conducted an IPO to raise additional

capital for its network expansion. Over the next few months both WCG’s share

1
Plaintiffs have also appealed the district court’s award of deposition and
copying costs to Defendants under 28 U.S.C. § 1920. See In re Williams
Securities Litigation, Case No. 08-5100. That issue was separately briefed and
will be addressed in a separate opinion.

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price and the Telecom Index climbed even higher, with WCG peaking at $61.81

on March 7, 2000, and the Telecom Index peaking three days later at 1248.06.

At that point, WCG’s stock price began to decline, and by July 21, 2000

had fallen more than 50% to $29.38. During that same period the Telecom Index

declined 28%. On July 24, 2000—the first day of the class period—WMB

announced that it would spin off WCG, making it a stand-alone company. WCG’s

stock was trading at $28.50 that day.

The plaintiffs allege that WMB, WCG, and various corporate officers

publicly misrepresented the reasons for the spin-off, the prospects for WCG’s

survival as a stand-alone company, and the adequacy of WCG’s capitalization.

Publicly, for instance, WMB issued a press release saying, “Our energy and

communications businesses have tremendous opportunities before them. Creating

the most effective and efficient access to capital will help fuel that growth, and

we believe that can best be achieved by creating two independent businesses.”

Private discussions within the WMB board, however, seem to show that the true

reason for the spin-off was that WCG’s growing capital needs were a drain on

WMB’s balance sheet, and that WMB needed to “heave the junk called WCG

overboard as fast as possible.” WMB’s CEO, Defendant Keith Bailey, told

shareholders that WCG was “strongly positioned for success” with “the financial

resources in place to enable it to deliver on the promise of a very bright future.”

He announced that WCG was “pre-funded for their capital needs . . . to carry

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them to that point of EBITDA positive,” and during the road show, senior

executives said that the spin-off “better enables each company to execute its

respective business plan”; “optimizes access to capital”; and “creates a Win-Win

for WMB and WCG shareholders.” Internally, however, there seems to have been

much more pessimism about the continuing availability of enough capital to

satisfy WCG’s appetite. Officers were warning that WCG was “still

approximately $800 million under-funded through the end of 2001,” and that

WCG did not have “any choice at this point other than going on a rigid, essential

need only capital diet while [it] restore[d] capital capacity through operating

performance and selling non core assets.” In short, Plaintiffs allege that the

Defendants’ public statements painted a rosy view of WCG’s future prospects as

an independent company, when in reality its need for capital and growing debt not

only called future profitability into doubt, but was indeed the motivation for the

spin-off itself.

This gap between the public statements and internal assessments continued

up to and after the spin-off occurred on April 23, 2001. In August 2001, for

instance, WCG publicly announced that it “continues to project . . . becoming free

cash flow positive by year-end 2003,” and its CEO, Howard Janzen, said that,

“With funding that takes us into 2004, a plan to be free cash flow positive by the

end of 2003, and the right team and strategy in place, we are positioned to not

only survive the current shakeout, but thrive in the years to come.” At the same

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time, internal assessments recognized that WCG’s lack of funding was growing

more and more worrisome in light of its large amount of debt. A presentation to

the board in August 2001 said that, “[f]rom a financial standpoint we realize the

cash generated from our business is insufficient to service our debt.” The WCG

board considered a number of options for generating additional cash to service the

company’s debt, but none seemed feasible. WCG’s stock price continued to

decline, and by the end of 2001 it was trading at $2.35 per share. The Telecom

Index had fallen to 236.63.

On January 29, 2002, WMB issued a press release announcing the delay of

its 2001 earnings report pending assessment of WMB’s contingent obligations

with respect to WCG. WCG’s stock fell from $1.63 to $1.34. That same day, one

of WCG’s competitors wrote down $3.2 billion worth of assets, and the day

before another of WCG’s competitors announced bankruptcy. Also that day,

Milberg Weiss filed the first of the lawsuits that would later be consolidated into

the present case. On February 4, 2002, WCG issued a press release announcing

that its lenders had informed WCG that it might be in default, and that WCG was

performing a review of the possible impairment of its long-lived assets. The

stock price fell from $1.42 to $1.00. On February 25, 2002, WCG issued another

press release. This time it announced that it was considering the potential

benefits of a Chapter 11 bankruptcy. The stock price fell to $0.22. After the

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market closed on April 22, 2002, WCG filed for bankruptcy. At the end of the

next day, its stock closed at $0.06.

B. Dr. Nye’s Testimony

The controversy in the present case concerns the Plaintiffs’ ability to

present a theory of loss causation. While the district court agreed that triable

issues of fact existed with regard to whether the defendants made

misrepresentations, whether they knew they were false, and whether those

misrepresentations were material, the Plaintiffs also bore the burden of

demonstrating that the decline in the price of WCG stock and notes was

attributable to a draining of the fraud premium. Their one expert on the subject,

Dr. Nye, presented two basic scenarios. 2

1. Scenario 1

In Scenario 1, Dr. Nye used a “leakage theory” to identify the losses that

could be attributed to the disclosure of the fraud. Under this theory, the fraud

was not revealed to the market by a single corrective disclosure, but instead “the

leakage of WCG’s true financial condition and prospects during the Class Period

2
Dr. Nye actually presented three scenarios to explain the loss causation as
related to the stock—Scenario 1, Scenario 2, and Scenario 2-alternative—and two
similar scenarios to explain loss causation as related to the notes—Notes Scenario
1 and Notes Scenario 2. Scenario 2 and Scenario 2-alternative were both
premised on a “corrective disclosure” theory, but Scenario 2 used a “constant
percentage” method for measuring damages while Scenario 2-alternative used a
“constant dollar” method. The Plaintiffs do not appeal the district court’s
rejection of Scenario 2’s constant percentage method.

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revealed the risks that had been concealed by the prior misrepresentations.” Nye

Rpt. ¶ 110. The losses “were caused by the materialization of the concealed risks,

specifically that WCG’s assets were overstated, that WCG was in default of its

debt covenants, and that there was significant uncertainty about WCG’s ability to

continue as a going concern.” Id. Scenario 1 posited that WCG’s true value, had

the defendants not made their rosy statements about WCG’s prospects, was its

value upon declaring bankruptcy. Dr. Nye therefore began with the $0.06 at

which WCG was trading upon filing for bankruptcy, and then incorporated the

movements of the market and industry back to July 24, 2000, the first day of the

class period. Doing this, he concluded that WCG’s true value on the day WMB

announced the spin-off was not $28.50, but $0.56. Id. at ¶ 108. Under Scenario

1, Dr. Nye attributed almost all of WCG’s value—ninety-eight percent—to the

fraud, and assumed that almost the entire decline in price was the result of the

truth gradually leaking into the market, despite the fact that the decline in WCG

share price closely correlated with the overall decline in the telecommunications

industry as a whole.

The district court found Scenario 1 an unreliable method for identifying the

loss attributable to the alleged fraud. For one thing, while Dr. Nye claimed to

remove the market and industry effects on the value of WCG stock and notes, he

“[did] not even purport, in Scenario 1, to have removed the effects of ‘[n]onfraud

company-specific information.’” Dist. Op. at 113. Instead, Scenario 1 attributed

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any decline in WCG’s value that was independent of market and industry effects

to the exposure of the fraud. This “fail[ed] to differentiate between losses rooted

in causes cognizable under loss causation doctrine, on one hand, and, on the other

hand, losses attributable to industry-specific stresses, the meltdown in the

telecommunications sector, and other negative developments unrelated to the

alleged fraud.” Id. at 114. The district court’s second objection to Scenario 1

was that Dr. Nye had not identified any public disclosures before January 29,

2002 that even arguably alerted the market to the fraud, other than to say that

disclosures occurred “every day.” Id. at 113. “Thus, remarkably, he has not

identified either fraud or non-fraud related news (much less parsed the effects of

the two) for the class period through January 28, 2002,” even though loss

causation requires proof that a market decline was the result of the revelation of a

misrepresentation or omission. Id. at 114.

2. Scenario 2-alternative

Scenario 2-alternative (and the corresponding Notes Scenario 2) was based

upon a “corrective disclosure” theory. Here, Dr. Nye focused on the price

declines after four specific public disclosures: WMB’s delay of its earnings report

on January 29; WCG’s February 4 announcement that it might be in default;

WCG’s February 25 announcement that it was considering bankruptcy; and

WCG’s actual filing for bankruptcy on April 25, 2002. Dr. Nye calls these four

announcements “partial disclosures,” as they did not precisely mirror the alleged

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misrepresentations but nonetheless “revealed the risks that had been concealed by

the prior misrepresentations and omissions,” and therefore “Plaintiffs’ losses were

caused by the materialization of the concealed risks.” Nye Rpt. at ¶ 121. Dr. Nye

attributed the decline in value after each corrective disclosure, net of market and

industry effects that he purported to isolate through a regression analysis, 3 to the

revelation of fraud.

The district court found Scenario 2-alternative unreliable because “it is not

supported by a showing of material, new, company-specific and fraud-related

information that became available to the efficient market on January 29, 2002 or

on the three subsequent corrective disclosure dates proposed by plaintiffs.” Dist.

Op. at 121. The “new” was in reference to the fact that Milberg Weiss had filed

the Cali complaint on that day, alleging the very fraud that was allegedly

exposed. The district court believed that if the information had been sufficiently

exposed such that Milberg Weiss was able to file its detailed allegations of fraud,

then Dr. Nye’s claim that “new” information was being revealed to the market

was dubious—especially considering that the share price did not significantly

drop. Id. at 116–18. Furthermore, Scenario 2-alternative suffered from the same

flaws as Scenario 1: Dr. Nye did not distinguish between declines attributable to

3
One distinction between the second scenario as applied to the notes and the
stock is that Dr. Nye did not apply this regression analysis to the notes and
therefore did not attempt to remove market and industry effects. See Nye Rpt. ¶
138.

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disclosures of fraud and declines attributable to non-fraud-related company-

specific information.

C. Summary Judgment

After excluding Dr. Nye’s expert testimony as unreliable under Daubert,

the district court determined that the Plaintiffs had “failed to present evidence

sufficient to raise a triable issue as to loss causation.” Id. at 162. For largely the

same reasons that it excluded Dr. Nye’s testimony, the court found that the

Plaintiffs had failed to present evidence of a causal connection between the

decline in value and the exposure of the misrepresentations, and had failed to

separate fraud-related losses from losses attributable to other factors. It therefore

granted the Defendants’ motion for summary judgment. Id. at 163. The Plaintiffs

now appeal both the court’s Daubert ruling and the grant of summary judgment.

II. DISCUSSION

A. Loss Causation Under Dura

In a private securities fraud action the plaintiff must prove that the

defendants (1) made a material misrepresentation or omission; (2) with scienter;

(3) in connection with the purchase or sale of a security; (4) upon which the

plaintiff relied; (5) that the plaintiff suffered an economic loss; and (6) that the

material misrepresentation was the cause of that loss. See Stoneridge Inv.

Partners, LLC v. Scientific-Atlanta, 128 S.Ct. 761, 768 (2008). The sixth element

is commonly referred to as “loss causation.” See Emergent Capital Inv. Mgmt.,

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LLC v. Stonepath Group, Inc., 343 F.3d 189, 197 (2d Cir. 2003) (“Loss causation

. . . is the causal link between the alleged misconduct and the economic harm

ultimately suffered by the plaintiff.”); cf. Pasley v. Freeman, 100 Eng. Rep. 450,

457 (1789) (“If, indeed, no injury is occasioned by the lie, it is not actionable: but

if it be attended with a damage, it then becomes the subject of an action.”).

Before 2005, there was some confusion amongst the courts as to what

exactly plaintiffs had to show in order to prove loss causation, with the Ninth

Circuit holding that a plaintiff need only show “that the price on the date of

purchase was inflated because of the misrepresentation,” Knapp v. Ernst &

Whinney, 90 F.3d 1431, 1438 (9th Cir. 1996), and other circuits holding that an

“allegation of a purchase-time value disparity, standing alone, cannot satisfy the

loss causation pleading requirement.” Emergent Capital, 343 F.3d at 198. The

Supreme Court resolved the confusion in Dura Pharmaceuticals, Inc. v. Broudo

by rejecting the Ninth Circuit approach and holding that “an inflated purchase

price will not itself constitute or proximately cause the relevant economic loss.”

544 U.S. 336, 342 (2005). Alleging that price has been inflated as a result of a

misrepresentation is not enough—even if the plaintiff has suffered a loss—unless

the plaintiff can identify a “causal connection” between the loss and the

misrepresentation. Id. at 347.

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 Even if the truth has made its way into the marketplace, Dura requires that

a plaintiff show that it was this revelation that caused the loss and not one of the

“tangle of factors” that affect price. Id. at 343.

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.

Id. at 342–43. The securities laws are not meant to “provide investors with broad

insurance against market losses, but to protect them against those economic losses

that misrepresentations actually cause.” Id. at 345. The plaintiff bears the burden

of showing that his losses were attributable to the revelation of the fraud and not

the myriad other factors that affect a company’s stock price. Without showing a

causal connection that specifically links losses to misrepresentations, he cannot

succeed.

B. Dr. Nye’s Testimony

Before expert testimony can be admitted, Federal Rule of Evidence 702

requires the district court to “ensure that any and all scientific testimony or

evidence admitted is not only relevant, but reliable.” Daubert v. Merrell Dow

Pharmaceuticals, Inc., 509 U.S. 579, 589 (1993). “In performing this gatekeeper

role, the judge must assess the reasoning and methodology underlying the expert’s

opinion, then determine whether it is scientifically valid and applicable to a

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particular set of facts.” Burlington Northern and Santa Fe Ry. Co. v. Grant, 505

F.3d 1013, 1030 (10th Cir. 2007). See also Daubert, 509 U.S. at 591 (instructing

district courts to consider the relevance, or “fit,” of the testimony in resolving the

factual dispute). The question before us is whether either of Dr. Nye’s methods

could reliably link the class’s losses to the revelation of the alleged

misrepresentations, as Dura requires. We review the district court’s decision to

admit or deny testimony for abuse of discretion. Gen. Elec. Co. v. Joiner, 522

U.S. 136, 143 (1997); Burlington Northern, 505 F.3d at 1030.

1. Scenario 1

Loss causation is easiest to show when a corrective disclosure reveals the

fraud to the public and the price subsequently drops—assuming, of course, that

the plaintiff could isolate the effects from any other intervening causes that could

have contributed to the decline. See, e.g., In re Winstar Commc’ns, 2006 WL

473885, at *15 (S.D.N.Y. Feb. 27, 2006). Dura did not suggest that this was the

only or even the preferred method of showing loss causation, though; it

acknowledged that the relevant truth can “leak out,” Dura, 544 U.S. at 342, which

would argue against a strict rule requiring revelation by a single disclosure. See

In re Seitel, Inc. Sec. Litig., 447 F. Supp.2d 693, 711 (S.D. Tex. 2006) (“[T]he

Supreme Court did not adopt the argument that a plaintiff must show that the

stock price declined due to a specific corrective disclosure or financial

restatement.”); In re Bradley Pharm., Inc. Sec. Litig., 421 F. Supp.2d 822, 828

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(D.N.J. 2006) (rejecting argument that Dura mandates a corrective disclosure

method for proving loss causation); In re Enron Corp. Sec., Derivative &

“ERISA” Litig., 439 F. Supp.2d 692, 701 (S.D. Tex. 2006). By premising

Scenario 1 on a leakage theory rather than a corrective disclosure theory,

therefore, Dr. Nye’s methodology does not automatically run afoul of Dura.

To satisfy the requirements of Dura, however, any theory—even a leakage

theory that posits a gradual exposure of the fraud rather than a full and immediate

disclosure—will have to show some mechanism for how the truth was revealed.

See In re Worldcom, Inc. Sec. Litig., 2005 WL 2319118, at *23 (S.D.N.Y. Sept.

21, 2005) (“[Plaintiff must] establish that his losses were attributable to some

form of revelation to the market of the wrongfully concealed information”)

(emphasis added). A plaintiff cannot simply state that the market had learned the

truth by a certain date and, because the learning was a gradual process, attribute

all prior losses to the revelation of the fraud. The inability to point to a single

corrective disclosure does not relieve the plaintiff of showing how the truth was

revealed; he cannot say, “Well, the market must have known.”

It was precisely this failure to describe how the market was alerted to the

fraud between July 24, 2000 (the first day of the class period) and January 29,

2002 (the day of the first potential corrective disclosure) that led the district court

to reject Scenario 1 as unreliable. At one point Dr. Nye argued that a number of

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tiny corrective disclosures occurred each and every day of the class period, which

had the cumulative effect of gradually disclosing the fraud.

A [Dr. Nye]: I think under Scenario 1 I say that corrective
disclosures are throughout the Class Period on the beginning of the
Class Period.
Q: Okay. And on what days were there corrective disclosures under
Scenario 1?
A: Scenario 1, every day. In other words, the whole thing is a
manipulated period.

Nye Dep. 51. He even submitted a 1300-page compendium of news articles,

reports, and SEC filings that was supposed to show “numerous instances of

leakage of corrective information concerning WCG’s true financial condition.”

Dist. Op. 99 The majority of these allegedly corrective disclosures, however,

were actually either news that was generally applicable to the telecommunications

industry as a whole, or was an upbeat rather than negative statement about WCG.

Dist. Op. 99–100. As it would be difficult to characterize an announcement that

contained no negative information about WCG as revelatory of the truth about

WCG’s grim prospects, we cannot say that the district court abused its discretion

in rejecting the theory that these disclosures leaked the truth to the market.

The primary justification for Scenario 1, however, was not that any specific

disclosure alerted the market to the fraud, but that the fraud was revealed once the

previously concealed risks materialized. According to Dr. Nye, “Plaintiffs’ losses

were caused by the materialization of the concealed risks, specifically that

WCG’s assets were overstated, that WCG was in default of its debt covenants,

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and that there was significant uncertainty about WCG’s ability to continue as a

going concern.” Nye. Rpt. ¶ 110. The problem is that Dr. Nye identifies no point

between July 24, 2000 and January 29, 2002 when these concealed risks did

materialize. While the truth could be revealed by the actual materialization of the

concealed risk rather than by a public disclosure that the risk exists, see Lentell v.

Merrill Lynch & Co., Inc., 396 F.3d 161, 173 (2d Cir. 2005) (loss can be caused

by “materialization of the concealed risk”), any theory of loss causation would

still have to identify when the materialization occurred and link it to a

corresponding loss.

Plaintiffs argue that Scenario 1 was “reasonable in light of Nye’s premise

that WCG’s true, non-inflated share price on each day of the class period was

very low.” Aplt. Br. 60. In other words, because Dr. Nye opined that WCG’s

true value was at the level the company was trading on the day it declared

bankruptcy, any decline in price before bankruptcy must have resulted from the

draining of the fraud premium. While an expert’s testimony that a security’s

value has been inflated by fraud throughout the class period could be relevant for

showing transaction causation, it does not show loss causation. See Lentell, 396

F.3d at 175 (allegations that “market price of [the] securities was artificially

inflated” and that “securities were acquired at ‘artificially inflated prices’” may

establish transaction causation, but do not establish loss causation). Loss

causation requires a showing of more than an artificially inflated price and

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subsequent decline. Dura, 544 U.S. at 342. Until the fraud is revealed the

purchasers actually benefit from the inflation and therefore have no legally

compensable injury.

Dr. Nye’s Scenario 1 bootstraps from the conclusion that WCG was

essentially valueless from the start to a scenario where any decline was a

“recognition” of this truth and therefore a draining of the fraud premium. He

fails, however, to identify any causal link between the revelation of the truth and

the decline in price from July 24, 2000 to January 28, 2002. WCG’s share price

fell from $28.50 to $1.63 during that period, and while Dr. Nye could not explain

how the market learned of the fraud over that year-and-a-half, he claimed that the

decline must have resulted from its revelation and not from the “tangle of factors”

that affect a company’s stock price—despite the fact that the same period

witnessed the bankruptcies of WCG competitors, a decline in the

telecommunications industry as a whole, and the overall market declines that

followed the 9/11 terrorist attacks. See Dura, 544 U.S. at 343 (“Other things

being equal, the longer the time between the purchase and sale, the more likely

that . . . other factors caused the loss.”). This failure to show a causal connection

between the fraud and the loss would turn the securities laws into just the sort of

“broad insurance against market losses” that Dura rejected. Id. at 345. We

cannot say that the district court abused its discretion in finding that Dr. Nye’s

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failure to explain how the truth was revealed to the market and failure to then link

the revelation of truth to a corresponding loss made his theory unreliable.

2. Scenario 2-Alternative

While Plaintiffs preferred Scenario 1 because it would allow them to

recover for the entire decline in WCG stock price, including the year-and-a-half

decline from $28.50 to $1.63, Dr. Nye also provided a more modest method for

demonstrating loss causation that would identify specific corrective disclosures

rather than conclusively assert a leakage of the relevant information. He

identified four such disclosures that occurred in the early months of 2002:

WMB’s January 29 announcement that it was assessing its contingent obligations

related to WCG; WCG’s February 4 announcement that its lenders had informed

WCG that it might be in default; WCG’s February 25 announcement that it was

considering Chapter 11; and WCG’s April 22 filing for said bankruptcy. The

district court found Dr. Nye’s attempt at identifying corrective disclosures

inadequate, however, because Scenario 2-alternative was “not supported by a

showing of material, new, company-specific and fraud-related information that

became available to the efficient market on January 29, 2002 or on the three

subsequent corrective disclosure dates proposed by the plaintiffs.” Dist. Op. at

121. In other words, Dr. Nye had not shown why these disclosures should be

considered “corrective” such that corresponding losses could be reliably

attributed to the revelation of fraud rather than other factors.

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 Any reliable theory of loss causation that uses corrective disclosures will

have to show both that corrective information was revealed and that this

revelation caused the resulting decline in price. To be corrective, the disclosure

need not precisely mirror the earlier misrepresentation, but it must at least relate

back to the misrepresentation and not to some other negative information about

the company. See Caremark, Inc. v. Coram Healthcare Corp., 113 F.3d 645, 649

(7th Cir. 1997) (stating that loss causation can be proved by showing defendant

“made a fraudulent misstatement and that this misstatement was responsible for

its damage”) (emphasis added). Dr. Nye himself, however, could not tie these

four particular disclosures to any of the alleged misrepresentations or describe

why they should be considered “corrective.” In his deposition, he admitted, “I

have not tied those four things specifically to allege[d] misrepresentations.” Nye

Dep. at 140. Plaintiffs offer an explanation for his failure: that these four

disclosures revealed the same relevant truth, which was that “WCG likely would

not be able to repay its debt as scheduled and, therefore, its assets likely would

not provide a return to equity investors.” Aplt. 47.

At its heart, Scenario 2-alternative suffers from the same defect as Scenario

1: because Dr. Nye begins with the assumption that WCG was virtually valueless

and that any decline in value drained the fraud premium, he labels any negative

information about WCG a corrective disclosure and attributes all resulting losses

to the revelation of fraud rather than other possible factors. As with Scenario 1,

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we must again be careful not to connect each and every bit of negative

information about a company to an initial misrepresentation that overstated that

company’s chances for success. See In re Motorola Sec. Litig., 505 F. Supp.2d

501, 546 (N.D. Ill. 2007) (“[T]he standard cannot be so lax that every

announcement of negative news becomes a potential ‘corrective disclosure.’”).

At the same time, if we are too exacting in our demands for a connection between

the initial misrepresentation and subsequent revelation—for instance, by imposing

a mirror image requirement, or insisting that the sources of the two disclosures be

the same—then we would eliminate the possibility of 10b-5 claims altogether.

The Second Circuit has described the balancing act as asking whether “the risk

that caused the loss was within the zone of risk concealed by the

misrepresentations and omissions alleged by a disappointed investor.” Lentell,

396 F.3d at 173 (italics omitted).

Scenario 2-alternative alleges that the fraud was revealed by four public

announcements that gradually unveiled the truth that WCG was virtually

worthless. While the scenario depends upon the cumulative effect of all four

disclosures, we will discuss each of them individually. A close inspection of each

allegedly corrective disclosure shows that the district court did not abuse its

discretion in finding that the truth they revealed was not sufficiently within the

zone of risk such that Dr. Nye could show that it was the revelation of the fraud,

and not other factors, that caused the subsequent declines in price.

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 a. January 29, 2009 Disclosure

Dr. Nye’s first corrective disclosure is a press release in which WMB

announced it would delay the reporting of its fourth-quarter and year-end

financial statements while it re-evaluated the status of certain contingent

liabilities it had with respect to WCG. The share price fell 17.8% that day, from

$1.63 to $1.34, though Dr. Nye acknowledges that “it was not a significant

[negative] return as the market fell 2.5% that day, and the industry was down that

day.” Nye Rpt. 43. That same day, Milberg Weiss filed its Cali complaint, the

first suit in the present case, which, as the district court said, “read together with

the Milberg, Weiss press release of the same date, leaves very little to the

imagination.” Dist. Op. 116. The coincidence of the Cali complaint with Dr.

Nye’s first identified corrective disclosure calls into question whether that day’s

drop in price can reliably be attributed to the revelation that WMB and WCG had

misrepresented WCG’s financial viability and not some other factor.

While an announcement that WCG could be in default on its debt

obligations might fall within the zone of risk obfuscated by the alleged

misrepresentations, the district court questioned whether Dr. Nye had any basis

for saying that the January 29 announcement revealed new information to the

market such that the disclosure can be said to have caused that day’s loss. The

fact that Milberg Weiss was able to assemble a complaint that very day and

identify the very misrepresentations in question would suggest that the market

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already had at least some knowledge of the fraud. Dr. Nye himself admits as

much in his deposition:

Q: . . . Did you ever consider whether the clients who have hired you
in this case if they were able to make those allegations on January
29th, 2002, whether the rest of the market had information that they
could have reached the same conclusions on that date?

A [Dr. Nye]: Did I ever think that?

Q: Yes.

A: Well, to the extent that Milberg Weiss came to that conclusion
based on public information, then I – then I suppose the market
could, too. Is that what the question was?

Q: Yes.

A: Seems like it, yeah. If indeed these are based on public
information, then it’s public information.

Q: And under your definition of an efficient market, [the Cali]
lawsuit and the factual allegations of that lawsuit would have been
factored into the market price of WCG’s securities, correct?

A: I think my definition of efficiency is the same pretty much as the
definition of efficiency, and that is that the price – the market price
reflects all publicly available information. So by definition, if it’s
publicly available information, it would be reflected in the market
price.

Nye Dep. 38–39. Dr. Nye’s acknowledgment that the market already knew of the

alleged misrepresentations on the very day of the first corrective disclosure is in

some tension with his claim that the market’s movements that day were a reaction

to the disclosure and not something else.

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 There is of course a difference between public speculation of potential

misrepresentation and insider confirmation. WMB’s acknowledgment that WCG

might be in default would likely affect the market more than the hunches of

investors. That being said, this expert admittedly believed that the market did

know this information prior to the January 29 disclosure, and the fact that the

market seems already to have had at least some knowledge of the true condition

of WCG’s debt does suggest that an analysis of the January 29 drop should

carefully consider whether other factors might have been at play. In fact, we

know of at least one factor that was certainly at play—the filing of this lawsuit.

Cf. Teachers’ Retirement Sys. of La. v. Hunter, 477 F.3d 162, 187–88 (4th Cir.

2007) (holding that the losses following the filing of a lawsuit were not a result of

the facts disclosed in that suit but “more logically occurred because the market

feared that a lawsuit” would independently harm the corporation). Scenario 2-

alternative, however, makes no allowance for other non-fraud related causes for

the January 29 losses. Thus, despite the fact that Dr. Nye believed that the

market already had at least some knowledge of the fraud and the fact that he knew

of other non-fraud related negative events that day, he made no attempt to show

why those losses were entirely attributable to the revelation of fraud and nothing

else. This is another manifestation of his belief that all negative information

about WCG was a revelation of the fraud—he saw no need to separate fraud-

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related from non-fraud-related losses, because he assumed any and all losses were

of the former variety.

b. February 4, 2002 Corrective Disclosure

Dr. Nye’s second corrective disclosure was a WCG press release that

contained two announcements: 1) that WCG’s lenders had informed the company

that it might be in default under its credit arrangements, and 2) that WCG was

performing a review of the possible impairment of its long-lived assets. Again, as

with the January 29 announcement, Dr. Nye’s attribution of all of that day’s

losses to the revelation of fraud without considering other factors is unreliable,

especially when there were clear indicators that other factors were at play. While

Dr. Nye believed that by February 4 the market had at least some knowledge of

the misrepresentations, and while the February 4 announcement included a

significant piece of information that was unrelated to the fraud—that WCG was

reviewing the possible impairment of its long-lived assets—he nonetheless drew a

causal link between that day’s decline in price and the market’s learning of the

fraud. He offered no explanation for why one would allot all of the February 4

decline to the revelation of fraud and not to another significant piece of negative

information that was released that day. Cf. Lattanzio v. Deloitte & Touche LLP,

476 F.3d 147, 158 (2d Cir. 2007) (“Plainitffs have not alleged facts to show that

[Defendant’s] misstatements, among others . . . that were much more

consequential and numerous, were the proximate cause of plaintiffs’ loss; nor

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have they alleged facts that would allow a factfinder to ascribe some rough

proportion of the whole loss to [Defendant’s] misstatements.”); In re Omnicom,

Inc. Sec. Litig., 541 F. Supp.2d 546, 553 (S.D.N.Y. 2007) (“Plaintiffs

nevertheless cannot demonstrate that the market reacted negatively to the

disclosures, rather than to other information simultaneously released to the

market.”). Dr. Nye’s failure to show why the February 4 losses should be

attributed to the revelation of fraud and not other non-fraud related news renders

his methodology unreliable.

c. February 25 and April 22 Corrective Disclosures

Dr. Nye’s final two corrective disclosures were WCG’s February 25

announcement that it was considering bankruptcy and its April 22 decision to

actually file for Chapter 11. Plaintiffs argue that WCG’s bankruptcy was within

the zone of risk concealed by its earlier misrepresentations and that the losses that

followed the bankruptcy can therefore be attributed to the revelation of the fraud.

The risks had not fully materialized, they contend, until WCG actually filed for

bankruptcy.

The zone of risk, however, is not infinite in size. The causal connection

between false statements about a company’s prospects and that same company’s

eventual bankruptcy years later is too remote to constitute a corrective disclosure.

Cf. D.E.&J. Ltd. P’ship v. Conaway, 133 Fed. App’x 994, 1000 (6th Cir. 2005)

(“[T]he filing of a bankruptcy petition by itself does not a security fraud

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allegation make.”). Bankruptcy might have been a possibility from the moment

of the spinoff, and might even have been a likely possibility, but there are simply

too many potential intervening causes to say that bankruptcy was WCG’s legally

foreseeable destiny such that its trading price at bankruptcy equaled its true value

on the day the spinoff was announced. The alleged misstatements involved the

risks of defaulting on debt and the true reasons that WCG was spun off from

WMB; they did not involve the certainty of a bankruptcy. There are too many

intervening factors at play—including the total meltdown of the

telecommunications industry—to allow Dr. Nye to reliably equate bankruptcy

with the risks that the original misstatements concealed. To do so would

transform the securities laws into the kind of downside insurance policy that Dura

warned against.

Like his leakage theory, Dr. Nye’s corrective disclosure theory fails to

identify the mechanism by which fraud was revealed to the market. Though he

points to four disclosures, he simultaneously concedes that the market knew of

the misrepresentations even before those disclosures, and also makes no account

for the fact that these disclosures contained non-fraud related information that

would have also affected WCG’s value. The district court did not abuse its

discretion in finding Scenario 2-alternative an unreliable method for proving loss

causation.

C. Summary Judgment

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 Plaintiffs argue that even if the district court did not abuse its discretion in

excluding Dr. Nye’s expert testimony, there was still a genuine issue of material

fact as to loss causation such that the case should have proceeded to the jury.

They contend that the jury could have reasonably drawn the very conclusions that

Dr. Nye did and found that the losses were a result of either the leakage of the

truth or the revelations made in the four corrective disclosures. These

conclusions, however, would be no less speculative and unreliable if reached by

jurors than when reached by Dr. Nye. The fatal flaw still remains, which is that

Plaintiffs have failed to present evidence suggesting that the declines in price

were the result of the revelation of the truth and not some other factor. Given the

evidence that the parties have presented, there is “simply no way for a juror to

determine whether the alleged fraud caused any portion of Plaintiffs’ loss.” In re

Omnicrom, 541 F. Supp.2d at 554 (granting summary judgment). As Plaintiffs

are unable to meet their burden under Dura Pharmaceuticals, we find that the

district court appropriately granted the defendants summary judgment on the issue

of loss causation.

III. CONCLUSION

The scenarios that Plaintiffs offered to explain loss causation failed to

identify a causal nexus between the revelation of the previously-concealed truth

and the decline in value of WCG securities. Because loss causation demands that

plaintiffs show that their losses were caused by a revelation of the fraud and not

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some non-compensable cause, these scenarios do not adequately address the issue

of loss causation. We therefore AFFIRM the district court’s exclusion of Dr.

Nye’s expert testimony which employed these scenarios, and AFFIRM the grant

of summary judgment for Defendants.

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