Resolving a split among the United States Courts of Appeals, the United States Supreme Court issued an opinion holding that investors seeking to sue companies for securities fraud do not have to prove that the company’s allegedly deceptive conduct caused their losses before obtaining class certification. Erica P. John Fund, Inc. v. Halliburton Co. No. 09-1403, 2011 WL 2175208 (June 6, 2011). In so ruling, the Supreme Court reversed the United States Court of Appeals for the Fifth Circuit. Had the Court affirmed the Fifth Circuit, it would have significantly altered the balance of power between plaintiffs and defendants in securities class actions. However, the Court’s ruling, which is in line with the majority of the Courts of Appeals that have addressed the issue, does little to change the landscape at the class certification stage outside of the Fifth Circuit.
In 2002, plaintiff, Erica P. John Fund Inc., sued Halliburton and its former CEO David Lesar on behalf of all purchasers of Halliburton common stock between June 1999 and December 2001 in the United States District Court for the Northern District of Texas alleging that the company made various false and misleading statements in violation of federal securities laws. The plaintiff alleged defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 by making false and misleading statements about its potential liability in asbestos litigation, its accounting of revenue in its engineering and construction business, and the benefits of a merger with Dresser Industries.
The lead plaintiff Erica P. John Fund moved for class certification seeking to represent all Halliburton investors during the proposed class period of June 3, 1999 to December 7, 2001. The plaintiff sought to show under Rule 23(b)(3) of the Federal Rules of Civil Procedure that common questions of law and fact, such as whether the company’s conduct caused the investors’ loss, predominated over questions that were individual to each member of the class.
The district court denied the motion for class certification, holding that plaintiff failed to establish loss causation under the Fifth Circuit’s “stringent loss causation requirement.”
The Fifth Circuit affirmed the district court’s denial of class certification, ruling that the lawsuit could not proceed because the plaintiff had failed to prove loss causation, i.e., “that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in the loss.”
Shareholders Suing a Company For Securities Fraud Need Not Prove Loss Causation at the Class Certification Stage
The Supreme Court ruled in a unanimous opinion that the Fifth Circuit improperly and prematurely required proof of loss causation at the class certification stage. The decision overrules the Fifth Circuit’s rule requiring investors to demonstrate loss causation at the class certification stage by showing that the company’s deceptive conduct caused their losses before invoking a rebuttable presumption that they had relied on the misrepresentations.
The Court ruled that the Fifth Circuit’s requirement ran afoul of the Court’s seminal decision in Basic v. Levinson by conflating reliance, also referred to as “transaction causation,” with loss causation. As the Court explained:
According to the Court of Appeals . . . an inability to prove loss causation would prevent a plaintiff from invoking the rebuttable presumption of reliance. Such a rule contravenes Basic’s fundamental premise ─ that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction.
The Court emphasized that “loss causation,” which requires a plaintiff to show that a misrepresentation actually caused a subsequent economic loss, has no logical connection to the issue of reliance or to the facts necessary to establish the efficient market predicate to the “fraud-on-the-market theory.” On the basis of this reasoning, the Court reversed the Fifth Circuit’s ruling on this point and brought its law in line with other circuits that have addressed the issue.
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This article was originally published by Bingham McCutchen LLP.