The US Court of Appeals for the Third Circuit recently reversed a district court’s decision to exclude expert testimony in a case involving allegations of securities fraud. The court distinguished the loss causation and damages analyses applicable in the Third Circuit to a “typical” § 10(b) case from those which are applicable to a “non-typical” § 10(b) case, and found that the district court improperly applied the more stringent “typical” § 10(b) analysis in finding the expert’s report unreliable under Federal Rule of Evidence 702.

Gregory W. Call agreed to sell three companies under his control to Pure Earth, Inc.(Pure Earth) in exchange for Pure Earth stock pursuant to a Stock Purchase Agreement (SPA). According to the facts set forth by the court in its opinion, Call agreed to the exchange due in part to Pure Earth officers’ false representation that there were no pending government investigations of Pure Earth or its subsidiaries. In November 2007, one of Pure Earth’s largest subsidiaries effectively had its license to operate in the waste-management industry revoked as a result of such an investigation, and Pure Earth’s stock price fell dramatically.

To establish the loss causation and damages elements necessary to prove his securities fraud claims, Call retained Steven Scherf as an expert. Scherf provided a report summarizing the terms of the SPA and highlighting the misrepresentations concerning the government investigation. The district court found Scherf’s report unreliable under FRE 702 because it did not establish the elements of loss causation and damages. The district court held that the report was lacking in its loss causation analysis because it failed to show how much Pure Earth’s stock was overvalued in March 2007 due to the misrepresentations of Pure Earth’s officers. On damages, the district court held that Scherf failed to isolate the causal factors leading to the stock’s depressed trading value, and therefore had presented no evidence that his damages assessment was accurate.

The court distinguished between the analyses necessary for loss causation and damages in the Third Circuit’s “typical” and “non-typical” cases. A typical § 10(b) case involves a situation in which a plaintiff claims that a defendant affected a publicly traded stock price by making public misrepresentations or omissions. However, this was a “non-typical” § 10(b) case because it involved a specific misrepresentation made to Call to induce him to enter into a securities transaction. The district court erred because it used a typical § 10(b) analysis when it excluded the Scherf report as unreliable, requiring the Scherf report to show that Pure Earth’s stock was “overvalued” and “that the subsequent declines [were] the consequence of dissemination to the market of information regarding the true valuation that caused the subsequent deflation of the stock price.” The district court also erroneously inserted “typical” § 10(b) requirements in its damages analysis which are more stringent than those applied in “non-typical” cases. Scherf’s report did not need to conduct a study ruling out other market factors that contributed to the decline in value of Pure Earth’s stock as it would have in a “typical” § 10(b) case. The Third Circuit concluded that because Scherf’s report could have assisted the trier of fact to determine loss causation and damages, it should therefore have been admitted as expert evidence on both elements.

Pure Earth, Inc. v. Call, No. 12-2130, 2013 WL 3776218 (3rd Cir. Jul. 19, 2013).