Behavioral Economics Applied: Loss Causation

Current securities fraud doctrine applying section 10(b) and Rule 10b-5 set a high bar for civil damages plaintiffs who must plead and prove both loss causation and transaction causation in order to prevail. Such a strict standard is not demanded by the law, given that the purpose of the Securities Act of 1933 and Securities Exchange Act of 1934 was to provide more protection for investors than had the common law of fraud. Nonetheless, the courts, especially the Supreme Court in Dura Pharmaceuticals v. Broudo, have chosen to impose this additional requirement. This Article examines the behavioral psychology literature, much of which is traceable to the work of Nobel Prize-winner Daniel Kahneman, in order to determine whether such a strict standard is warranted as a policy matter.

As it turns out, there is substantial evidence that people often make less-than-rational judgments regarding causation, can be manipulated to find causation where none exists, and mis-assign causation. This evidence argues for a high standard for proving loss causation in order to protect securities fraud defendants from unwarranted liability. Yet, there is also evidence of a psychological tendency to “blame the victim,” which suggests that perhaps it is plaintiffs who need the law’s protection.