Estimating Aggregate Damages in Class-Action Litigation Under Rule 10b-5 for Purposes of Settlement

Fordham Law Review Volume 59 Issue 5 Article 5 1991 Estimating Aggregate Damages in Class-Action Litigation Under Rule 10b-5 for Purposes of Settlement Jon Koslow Follow this and additional works at: https://ir.lawnet.fordham.edu/flr Part of the Law Commons Recommended Citation Jon Koslow, Estimating Aggregate Damages in Class-Action Litigation Under Rule 10b-5 for Purposes of Settlement, 59 Fordham L. Rev. 811 (1991). Available at: https://ir.lawnet.fordham.edu/flr/vol59/iss5/5 This Article is brought to you for free and open access by FLASH: The Fordham Law Archive of Scholarship and History. It has been accepted for inclusion in Fordham Law Review by an authorized editor of FLASH: The Fordham Law Archive of Scholarship and History. For more information, please contact . NOTES ESTIMATING AGGREGATE DAMAGES IN CLASS-ACTION LITIGATION UNDER RULE 10b-5 FOR PURPOSES OF SETTLEMENT INTRODUCTION Courts and commentators have increasingly accepted the application of financial theory to damages calculations' in litigation2 brought by shareholders under Rule lOb-5. 3 A small body of legal and financial literature describes and advocates the use of damages computation models and procedures. The damages models are designed to estimate the "per-share damages" for each day in which purchases or sales of a security are affected by a fraud. These models, however, generally fail to confront the problems posed in estimating "aggregate damages" for a class. An accurate estimation of aggregate damages for class actions is particularly important for purposes of settlement because few Rule lOb-5 cases go to judgment.4 1. See, e.g., Basic Inc. v. Levinson, 485 U.S. 224, 246-47 nn.24-26 (1988)(citing articles and cases supporting application of financial theory and fraud-on-the-market theory); Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 49 & n.22 (2d Cir.)(technical computations "may be used in" computing damages)(citing cases), cert. denied 439 U.S. 1039 (1978); Mills v. Electric Auto-Lite Co., 552 F.2d 1239, 1248-49 (7th Cir.) (technical damages formula adopted), cerL denied, 434 U.S. 922 (1977); Fischel, Use ofModern Finance Theory in Securities Fraud Cases Involving Actively Traded Securities, 38 Bus. Law. 1 passim (1982)(discussing general precepts applied in per-share calculations); Cornell & Morgan, Using Finance Theory to Measure Damages in Fraudon the Market Cases, 37 UCLA L. Rev. 883 passim (1990)(discussing problems arising in application of financial theory to per-share damage calculations); Note, The Fraudon the Market Theory and the Efficient MarketsHypothesis: Applying a Consistent Standard, 14 J. Corp. L. 443, 477-83 (1988)(application of market model to quantification of damages). 2. Damages analysis is primarily relevant to private Rule lob-5 litigation. It is accepted that the key to enforcing Rule lOb-5 is the availability of a private cause of action to shareholders who have relied on a fraud, generally a misrepresentation or omission of a material fact, that has distorted the market price of a security. See, eg., Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988)(a private cause of action certainly exists under Rule lOb-5 and is key to enforcing 1934 Act); Comment, The Fraudon the Market Theory: The Debate Rages On, 27 Duq. L. Rev. 277, 277 n.2 (1988)(citing Kardon v. National Gypsum Co., 69 F. Supp. 512 (E.D. Pa. 1946) as first federal court case which implied private cause of action under Rule lOb-5). An increasing number of private Rule lOb-5 cases have been class actions brought on behalf of all shareholders affected by the fraud. See e.g., Basic Inc. v. Levinson, 485 U.S. 224 (1988); Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970); Sharp v. Coopers & Lybrand, 649 F.2d 175 (3d Cir. 1981), cert. denied, 455 U.S. 938 (1982); Sirota v. Solitron Devices, Inc., 673 F.2d 566 (2d Cir.), cert. denied, 459 U.S. 838 (1982); In re Warner Communications Sec. Litig., 618 F. Supp. 735 (S.D.N.Y. 1985). 3. 17 C.F.R. § 240.10b-5 (1990). 4. See Alexander, Do the Merits Matter? A Study of Settlements in Securities Class Actions,43 Stan. L. Rev. 497, 524-26; Reder, Measuring Buyers' Damagesin lOb-5 Cases, 31 Bus. Law. 1839, 1852-54 (1976); Note, Rule 10b-5 Damage Computation: Application of FinancialTheory to Determine Net Economic Loss, 51 Fordham L. Rev. 838, 838 n.2 (1983). FORDHAM LAW REVIEW [Vol. 59 Litigants must know the total sum of money at stake in order accurately to determine the risks of further litigation. They also rely on estimates of total potential damages to negotiate the size of any pool of money to settle claims.5 An assessment of total actual damages is likewise essential to judges who must ultimately approve class-action settlements and fees. 6 Finally, damages estimates may be critical in cases that actually go to trial. In bifurcated trials, for example, which determine liability before examining the issue of damages, courts may hesitate to recognize liability if subsequent exorbitant damages awards threaten the defendant with inappropriate harm.7 While the traditional per-share models aid judges and class-action litigants in estimating per-share damages under Rule lOb-5, these financial models are subject to a number of limitations and complications. The models also fail to analyze all the relevant factors necessary to establish a methodology for estimating aggregate damages for class actions under Rule lOb-5. Specifically, they don't determine the number of shares affected by the fraud. In an effort to bridge this gap, this Note presents a practical model for estimating aggregate damages of defrauded share- holders in Rule lOb-5 class-action litigation. Part I of this Note briefly reviews the elements of Rule lob-5 liability and the implications for calculating damages, and surveys general theories of damages under Rule lOb-5. Part II discusses the application of financial theory to damages calculations and reviews the employment of the market model, which is based on the capital asset pricing model ("CAPM"), s in calculations of damages on a per-share basis. Part II also discusses certain modifications and limitations of the per-share model. Part III proposes expanding the per-share model in order to present a practical method of estimating aggregate class-wide damages and dis5. See Reder, supra note 4, at 1852. Cf. Mullaney, Theories of MeasuringDamages in Security Cases and the Effects of Damages on Liability, 46 Fordham L. Rev. 277, 277- 78 (1977)(because few decisions on measure of damages and potential of "ruinous" damages, litigants often settle securities fraud cases rather than proceed to trial). 6. See Reder, supra note 4, at 1839 ("[j]udicial confusion over the appropriate measure of damages against fraudulent sellers has hindered settlement discussions because neither party can accurately view the ultimate potential recovery"); see also Bonime v. Doyle, 416 F. Supp. 1372, 1382-86 (S.D.N.Y. 1976)(settlement of class ac (...truncated)