The 2nd Circuit Court of Appeals recently revived a securities fraud class action involving the drug giant Pfizer that had died following the district court’s exclusion of the plaintiffs’ loss causation and damages expert.
‘Inflation-maintenance’ theory: Shareholders in Pfizer sued the company, alleging it made fraudulent misrepresentations about the safety of its Celebrex and Bextra drugs— nonsteroidal anti-inflammatory drugs to treat chronic pain and inflammation. According to the plaintiffs, even though Pfizer and the prior owners of the drugs knew about the drugs’ dangerous side effects as early as 1998, they kept touting the drugs’ safety to keep the public’s misperception going and cash in on the drugs’ commercial success.
The issue for the plaintiffs was how to show whether Pfizer’s fraud, as opposed to the fraud by previous owners of the drugs, caused Pfizer’s stock price to fall. The plaintiffs presented an “inflation-maintenance” theory of liability, which said that, even though during part of the class period (2000-2005) Pfizer did not yet own the drugs, it was liable for all of the misrepresentations because it had control over the statements the then-owners made. Pfizer also made its own misrepresentations and engaged in fraudulent omissions.
The plaintiffs hired one of the most prominent experts working in the field to prove the fraud actually caused losses and compute the extent of the loss. He performed an event study to determine whether and to what degree Pfizer’s stock price changed when investors discovered the risks associated with the two drugs. He explained he was asked to assume liability in step with the plaintiffs’ theory and was hired to identify the “artificial inflation” in the company’s stock resulting from the alleged fraud. Pfizer offered rebuttal testimony only. Its expert “overall” did not have “any major criticism” of the event study but objected to certain assumptions the opposing expert made about certain corrective disclosures.
Court ‘went astray’: Almost a decade into the litigation, the district court granted Pfizer’s request to exclude the plaintiffs’ expert under Federal Rule of Evidence 702 and Daubert. It found two irremediable flaws in the testimony. One was an insufficiently explained adjustment the expert made to his stock price inflation calculation in response to the court’s earlier rulings; the other was the expert’s failure to “disaggregate” the effects of Pfizer’s alleged misrepresentations from the effects of statements from the prior owners of the drugs. Without the testimony, the plaintiffs had no more case, and the district court granted judgment in favor of Pfizer.
The 2nd Circuit Court of Appeals said the district court “went astray.” Its point about the need to disaggregate was based on a “misapprehension” of the plaintiffs’ theory of liability, under which it did not matter which company made the misrepresentations at what point. The expert’s loss causation model assumed that Pfizer’s misrepresentations repeated the same false messages and served to maintain Pfizer’s stock price at a constant, inflated level.
The appeals court allowed that the expert’s explanation of the adjustment to the inflation calculation was inadequate and made this aspect of the testimony unreliable. However, this “was but one small part of an extensive economic analysis,” the Court of Appeals noted. “When faced with expert testimony that contains both reliable and unreliable opinions, district courts often exclude only the unreliable testimony.” Here, the expert’s error did “not render the remainder of his analysis useless.”
Excluding the entire opinion was an abuse of discretion, the 2nd Circuit concluded and remanded the case “for further proceedings consistent with this opinion.”
Takeaway: According to the 2nd Circuit, “parsing” expert testimony and excising the unreliable testimony from the reliable testimony accords with the “liberal admissibility standards” of Daubert and Rule 702.
Find a detailed discussion of Showers v. Pfizer, Inc. (In re Pfizer Inc. Sec. Litig.), 2016 U.S. App. LEXIS 6622 (April 12, 2016), in the June edition of Business Valuation Update; the court’s opinion will appear soon at BVLaw.
Extra: A big part of the analysis in this case involved an event study. A new chapter on event studies is included in the just-published Comprehensive Guide to Economic Damages, 4th edition. Also, BVR recently conducted a webinar on event studies.