Originally uploaded at SSRN.


No coherent doctrinal statement exists for calculating open-market damages for securities fraud class actions. Instead, courts have tried in vain to fashion common-law deceit and misrepresentation remedies to fit open-market fraud. The result is a relatively ineffective system with a hallmark feature: unpredictable damage awards. This poses a significant fraud deterrence problem from both a practical and a theoretical standpoint.

In 2005, the Supreme Court had the opportunity to clarify open-market damage principles and to facilitate earlier dismissal of cases without compensable economic losses. Instead, in Dura Pharmaceuticals v. Broudo, it further confused the damage issue by (1) perpetuating the idea that courts can tailor damages from common-law deceit and misrepresentation actions to remedy open-market fraud despite the practical disparities between the two and (2) opening the door to a new form of hypothetical losses where the stock price increases after an opportune disclosure of fraud.

The Supreme Court's insinuation that a new form of hypothetical losses might be recoverable further inhibits predictability and could have perverse effects on investor education and motivation. In Dura, the Court implied that an investor might be able to recover damages when a stock's price does not increase as much as it might have absent the fraud. This suggests that plaintiffs might not be limited to traditional out-of-pocket losses. A number of intrinsic problems could result from compensating investors for more than their out-of-pocket losses. For example, providing investors with a double-recovery, one from the net stock price increase and one from class-action damages, could create a perverse incentive to invest purposefully in companies showing signs of fraud. Accordingly, to minimize these effects and to promote predictability, this Article suggests that courts should limit plaintiffs to recovery for their out-of-pocket losses.

My intention in this Article is not to imply that simply limiting investors to their out-of-pocket losses will provide a quick "fix" for the ills of the securities class-action system. Instead, I hope to highlight some of the intrinsic problems that could result from compensating investors with a net gain and from stretching traditional common-law remedies to fit modern securities-fraud class actions. The out-of-pocket measure is the only common-law remedy that recognizes the distinctions between face-to-face transactions and open-market fraud, that complies with the loss causation requirement, and that limits plaintiffs to their actual damages. Restricting investors to out-of-pocket losses also advances optimal deterrence by increasing predictability through a clear doctrinal damage calculation.