According to the American Bar Association, from 2000 through 2009, the average securities fraud class-action settlement amounted to $25 million. During this period, the average settlement amount nearly quadrupled from $11 million in 2000 to $42 million in 2010. These numbers are but one illustration of the cost of non-compliance with securities law on a company’s bottom line.
In Indiana, companies and individuals offering and selling securities or investment advice must comply with the Indiana Uniform Securities Act, Indiana Code 23-19-1 et seq. (the “Act”). Often, claimed violations of the Act are pursued by the Indiana Securities Division. However, the Act also permits private litigants – typically the purchasers of securities or investment advice – to sue for damages. See Indiana Code § 23-19-5-9(a). Often, such lawsuits assert violations of Indiana Code § 23-19-5-1(2), which states, in pertinent part:
It is unlawful for any person in connection with the offer, sale or purchase of any security, either directly or indirectly, …to make any untrue statements of a material fact or to omit to state a material fact necessary in order to make the statements made in the light of circumstances under which they are made, not misleading.
A defendant faced with a Division action or a private lawsuit has a variety of arguments at its disposal. The purpose of this article is to address one such argument that has the potential to defeat many claims based upon the above provisions. Specifically, a defendant sued for a violation of this provision can argue that the Act actually requires the plaintiff to prove that the defendant’s violation caused the plaintiff’s loss. In legal terms, this concept is known as loss causation: the plaintiff must establish that the defendant’s violation of the Act was the reason for the plaintiff’s damages in order to pursue litigation against the defendant.
While the argument might not seem on its face to be particularly novel, the issue is not as clear cut as potential defendants would prefer. Unlike other statutes in the Indiana Code, the language of the Act does not explicitly state that a violation of the Act must actually cause harm to the plaintiff or alleged victim in order for a cause of action to exist. It is thus not hard to imagine a scenario where a buyer of a security loses money from the security and sues the seller of the security for a violation of the Act in order to recover damages — but market volatility, and not the seller’s alleged violation, was responsible for the buyer’s loss. This raises the question: could the buyer successfully sue the seller for the seller’s violation of the Act if the violation did not cause the buyer’s loss but merely coincided with it?
Loss Causation in the Act
As noted, the Act itself does not contain a loss causation requirement. Similarly, Indiana cases interpreting the Act are silent as to whether loss causation is an element of a claim under the Act. (As an initial matter, it is important to note that the majority of the law discussing the Act is addressing a preceding version that was in effect until July 1, 2008. Because the provisions of the preceding Act are virtually identical to the current Act, they are applicable, and indeed vital, to an understanding of the Act that implicitly includes loss causation.) There are, however, at least two arguments strongly in favor of reading a requirement of loss causation into the Act. First, the Act is essentially identical to its federal counterpart, which requires loss causation. Second, the Indiana Supreme Court has read a loss causation requirement into a similar statute, the Indiana Franchise Fraud Act.
The Indiana Uniform Securities Act is Substantially Similar to Its Federal Counterpart, Which Requires Proof of Loss Causation.
Although there are no Indiana cases stating outright whether loss causation is an element a claim under the Act, the Indiana Supreme Court, in Kirchoff v. Selby, 703 N.E.2d 644, 650-651 (Ind. 1998), explained that liability under the Act is based on § 410 of the Uniform Securities Act of 1956, which in turn is based on § 12 [15 USCS § 77l] of the Securities Act of 1933. Interestingly, § 12(b) of the Securities Act of 1933, at the time of the Kirchoff decision (1998), expressly required loss causation:
In an action described in subsection (a)(2) [virtually identical to Ind. Code § 23-19-5-1(2)], if the person who offered or sold such security proves that any portion or all of the amount recoverable under subsection (a)(2) represents other than the depreciation in value of the subject security resulting from such part of the prospectus or oral communication, with respect to which the liability of that person is asserted, not being true or omitting to state a material fact required to be stated therein or necessary to make the statement not misleading, then such portion or amount, as the case may be, shall not be recoverable. (Emphasis added.)
Moreover, the relevant provisions of the Act are nearly identical to their federal counterparts, Section 10(b) of the Securities Act of 1934, and SEC Rule 10b-5. Courts interpreting SEC Rule 10b-5 and Section 10(b) have routinely concluded that “[t]he elements of a private securities fraud claim based on violations of § 10(b) and Rule 10b-5 are: “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179, 2184 (U.S. 2011) (emphasis added).
This is important, because Indiana courts have concluded that these federal statutes are similar to the Act, and furthermore, that Indiana courts should look to federal law in this context whenever possible. See, e.g., Perry v. Eastman Kodak Co., IP 87-1023-C, 1991 U.S. Dist. LEXIS 20914, at *18-19 (S.D. Ind. Apr. 22, 1991) (“Violations of Section 23-2-1-12 carry the same reliance, causation and duty to disclose requirements as its federal counterpart, Rule 10b-5.”) (emphasis added). Thus, an Indiana court could soundly conclude that because (1) Section 10(b) and Rule 10b-5 each contain a causation element; (2) the Act was modeled after Section 10(b) and Rule 10b-5; and (3) the Indiana Code creates an express private cause of action for violation of the Act; the Act should be interpreted to include the causation element of the implied private cause of action.
Indiana Courts Have Concluded That the Franchise Fraud Act Requires Proof of Loss Causation.
A second argument supporting the application of the doctrine of loss causation to the Act is the Indiana Supreme Court’s interpretation of Indiana Code § 23-2-2.5-27, the Franchise Fraud Act, which states in relevant part that:
It is unlawful for any person in connection with the offer, sale or purchase of any franchise, or in any filing made with the commissioner, directly or indirectly:
- to employ any device, scheme or artifice to defraud;
- to make any untrue statements of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of circumstances under which they are made, not misleading; or (3) to engage in any act which operates or would operate as a fraud or deceit upon any person.
This language is plainly similar to relevant language in the Act. In Enservco, Inc. v. Indiana Sec. Div., 623 N.E.2d 416, 423 (Ind. 1993), the Indiana Supreme Court stated that “[a]s in an action under federal Rule 10b-5, to establish a violation of section 27, the Securities Division or a private plaintiff must also prove that the misrepresentation or omission caused some harm to the plaintiff (in a private action) or to the complaining party (in a division action).” Given the striking similarity of these provisions to the Act, this case and its holding support the conclusion that loss causation is required under the Act.
The established basis of the Act in federal securities rules requiring loss causation, the unquestionable similarity of this Act to the Indiana Franchise Fraud Act, which also requires loss causation, and common sense all call for an application of the doctrine of loss causation to the Act. To conclude otherwise would permit a plaintiff to recover potentially millions of dollars on a strict liability basis, even when the defendant’s alleged violation did not actually cause the plaintiff’s harm but merely coincided with it. Consequently, a defendant faced with such a suit can soundly argue that the legislature intended for courts to apply common sense, read loss causation into the Indiana Uniform Securities Act, and only award damages to the plaintiff in the event that the plaintiff is actually harmed by the defendant’s violation of the Act.