FIFO VS LIFO

CLASS ACTION

IPE Sponsored Supplement

FIFO VS LIFO

Different ways to calculate shareholder losses for purposes of appointing lead

plaintiff lead to different results

Lawrence Sucharow, Esquire

Managing Partner

Christopher J Keller, Esquire

Partner

Labaton Sucharow & Rudoff LLP

n law, as in life, different paths often lead to different results. In

the context of securities class action litigation and the

calculation of shareholders’ losses, this often becomes evident

during the battle for lead plaintiff. Alternative methods of

calculating a shareholder’s losses can result in very different

amounts of those ‘losses’. In fact, where one methodology appears

to show substantial investor losses, courts have sometimes found

that another, more appropriate, methodology shows substantial

investor losses, courts have sometimes found that another, more

appropriate, methodology shows substantial investor profits under

the same facts.

Since the Private Securities Litigation Reform Act of 1995

(PSLRA) does not require that one particular method be used for

calculating losses, it is imperative that when engaged in a contest

for lead plaintiff, a shareholder carefully considers competing loss

calculation methodologies. This is crucial since the method

selected by a competing lead plaintiff (or by the court) will, in

many cases, be determinative as to who will be appointed lead

plaintiff. Knowledgeable counsel can often persuade the court to

use the appropriate methodology.

The PSLRA presumes that the most adequate shareholder to

protect the interests of the class (the ‘lead plaintiff’) is the investor

that has the largest financial interest in the litigation and has made

a timely motion to serve as the lead plaintiff. In other words, the

primary factor for selection of lead plaintiff is how much money

the shareholder lost on his investment in the stock during the time

of the alleged fraud.

However, while the PSLRA requires that a shareholder seeking

to be lead plaintiff file a certification containing, among other

things, a list of his transactions in the stock, it provides no specific

method for calculating his financial loss. As of this time, two

competing methodologies have emerged as the principle loss

calculation methodologies:

 the ‘first-in/first-out’ (FIFO) method, and

 The ‘last-in/first-out’ (LIFO) method.

Until recently, the FIFO methodology was the more common

approach to calculating shareholder losses. Under this method, to

calculate class period losses, the first shares sold by a prospective

lead plaintiff during the class period are matched against the first

shares purchased by that shareholder. Thus, if a shareholder had

purchased shares of the security prior to the class period, those

pre-class purchases (ie, the shareholder’s holdings at the start of

the class period) are matched against the first shares sold during

the class period, and any resulting gain or loss would be excluded

from that shareholder’s loss calculation. Once all pre-class period

purchases have been offset, class period sales will then be

matched against class period purchases to determine the

shareholder’s losses. Further, shares retained by the shareholder

after the class period ends are typically assigned a value equal to

the 90 day post-fraud average price.

For example, assume that Pension Fund A holds 10,000 shares

of Company XYZ at the beginning of the class period. During the

class period, Pension Fund A buys and sells as follows:

 Sale – 10,000 shares, at $110/share, with total proceeds of

$1,100,000

 Purchase – 10,000 shares, at $100/share, for a total cost of

$1,000,000

In calculating losses under a FIFO-based methodology,

Pension Fund A’s sale of 10,000 shares of XYZ stock during the

class period will be offset or matched against its pre-class period

holdings, and, in effect, these sales will be ‘zeroed out’. Next,

assuming that the post-class period 90-day average price of a

share of XYZ stock is $80, Pension Fund A’s loss would be

$200,000, calculated as follows:

 Purchase price ($100) – 90-day average price ($80) x

10,000 shares = $200,000 Loss

Although the FIFO methodology has been accepted by many

courts, recently there has been a strong trend towards using the

LIFO methodology. Proponents of LIFO argue that FIFO often

provides an inaccurate result by ‘zeroing out’ intra-class period

sales with shares that were purchased prior to the class period –

ie, at a time when the stock price had no artificial inflation due to

the alleged fraud. Put differently, when pre-class period pur-

It is important to note that the ‘losses’ for purposes of determining the lead plaintiff in a PSLRA

action is not the same as ‘damages’, which is the amount of money that class members would be

entitled to receive if the plaintiffs win the case at trial. Damages can be described as those losses

that were actually caused by the fraud. Assume, for example, that an investor purchased a stock

at $100 per share during the class period, the stock then declined by $20 per share for reasons

unrelated to the fraud, and then declined by another $10 per share when the fraud was revealed,

so that its price was $70 at the end of the class period. Under these facts, the investor has PSLRA

losses of $30 per share, but damages of only $10 per share.

May 2006

chases were made, there was no artificial inflation in the stock

price. If those shares were later sold during the class period while

the stock was inflated, the shareholder actually benefited from the

fraud by selling at a higher price than the fair value of the stock.

FIFO disregards those profits and thereby exaggerates

shareholders’ fraud-related losses.

In contrast, under a LIFO inquiry, a shareholder first matches

his sales of a security during the class period against the last

shares purchased during the class period (rather than against

shares he held at the start of the class period). If the price of a

stock was inflated by $10 per share when the shareholder

purchased it, and was still inflated by $10 per share when the

shareholder sold it, this method eliminates the losses on the

purchase by matching them with corresponding gains on the sales.

Indeed, in Dura Pharmaceuticals, Inc. v. Broudo,

the United

States Supreme Court recently noted that “if … the purchaser

sells the shares quickly before the relevant truth begins to leak

out, the misrepresentation will not have led to any loss”.

he following analysis illustrates how LIFO can provide a

very different result from FIFO. Pursuant to LIFO, class-

period sales would not be offset against pre-class period

holdings. Rather, Pension Fund A would match the last purchase

it made during the class period with the first sale it made during

the class period. Using the same assumptions set forth in the

hypothetical above, the calculation is as follows:

 Sale proceeds ($1,100,000) – Cost of shares ($1,000,000) =

$100,000 Gain

Thus, rather than having a $200,000 loss under FIFO, Pension

Fund A would have a $100,000 gain under LIFO. This seems to

be a fair result because with respect to the 10,000 shares of XYZ

stock that Pension Fund A purchased and sold during the class

period – ie, during the time when the price of XYZ stock may

have been inflated due to the alleged fraud – Pension Fund A

apparently did not suffer any financial loss (assuming that the

stock price was inflated by the same amount throughout the class

period).

This hypothetical has many real life counterparts. In In re

Cardinal Health, Inc. Securities Litigation, for example, the court

rejected the use of the FIFO method and noted that one pension

fund that “reported a loss of approximately $1.9 million … ac-

tually had a net gain of approximately $7 million when sales of

pre-class period holdings are counted. Similarly, [another pen-

sion fund] reported a loss of approximately $2.1 million, but ac-

tually had a net gain of approximately $4.7 million when sales of

pre-class period holdings are incorporated.”

Similarly, in In re eSpeed, Inc. Securities Litigation,

the court

recently rejected the supposedly larger loss of a movant who used

125 S. Ct. 1627 (2005).

226 F.R.D. 298 (S.D. Ohio 2005).

232 F.R.D. 95 (S.D.N.Y. 2005)

In re Comdisco Sec. Litig., 150 F.Supp. 2d 943, 945 (N.D.Ill. 2001).

In re NTL, Inc. Securities Litigation, 2006 WL 330113, *10(S.D.N.Y. Feb. 14, 2006) (“Plaintiffs

… allege several disclosing events throughout the class period that gradually alerted investors to

the truth about NTL.”)

the FIFO method in favour of another applicant who used the

LIFO method. Judge Shira Scheindlin explained that “the main

advantage of LIFO is that, unlike FIFO, it takes into account gains

that might have accrued to plaintiffs during the class period due to

the inflation of the stock price. FIFO, as applied by the pension

fund and others, ignores sales occurring during the class period

and hence may exaggerate losses.”

Likewise, just last month in Johnson v. Dana Corporation,

Chief Judge James Carr of the Northern District of Ohio stated, in

finding that LIFO rather than FIFO must be used for determining

losses in a lead plaintiff motion, that “using FIFO, plaintiffs with

significant preexisting holdings of defendants’ securities can

profit substantially from defendant’s misconduct and then turn

around and show a loss for purposes of litigation”. Thus, the

current trend seems to be firmly in favour of LIFO over FIFO.

related issue in lead plaintiff motions is whether a

shareholder who sold more shares during the class period

than he bought (a ‘net-seller’) can be appointed as a lead

plaintiff. Some courts, assuming that the price of the stock was

inflated by the same amount throughout the class period, have

held that net-sellers cannot be adequate lead plaintiffs because

they profited by the artificial inflation.

This theory seems to work

best in cases where there is a single disclosure of the wrongdoing

at the end of the class period. In such a case if a shareholder sold

10,000 shares of stock during the class period and purchased only

8,000 shares, and the stock was inflated by $10 per share at all

times, then the shareholder would have profited from other fraud

by $20,000.

 10,000 shares sold – 8,000 share bought =

2,000 net shares sold x $10 per share = $20,000

However, in cases where plaintiffs allege that the truth about

the fraud was disclosed to investors through a number of partial

disclosures, the artificial inflation in the stock was lower at some

times during the class period (ie, after the first partial disclosure)

than at other times. Courts have held that under those

circumstances, a net seller can be the lead plaintiff.

As these scenarios demonstrate, the determination of losses in

an application for lead plaintiff can be complex, with many traps

for the unwary. It is crucial that a shareholder seeking

appointment as lead plaintiff carefully consider the methodology

used in calculating its financial loss, as well as the methodologies

used by other prospective lead plaintiffs, since methodology alone

may dictate who will be appointed lead plaintiff. 

Talent and Reputation Matter. Fairness Counts. These principles are

fundamental to the strength of Labaton Sucharow & Rudoff LLP. Labaton

Sucharow is one of the premier law firms that represent individual and

institutional investors in securities, antitrust and corporate governance

litigation. The firm has been a champion of investor rights for close to 45

years and has been recognised for its reputation for excellence by the courts.

The firm’s Institutional Investor Package is designed to help investors

address investor protection needs and fiduciary obligations to beneficiaries by

offering portfolio monitoring, damages anaylsis and settlement claims

notification. For more information, please contact Christopher Keller or

Lawrence Sucharow at +1 (212) 907-0070/(888) 753-2796 or visit