A unanimous Court rejected the Fifth Circuit's approach to class certification in certain securities fraud class actions on June 6 when it published Erica P. John Fund, Inc. v. Halliburton Co., No. 09-1403. The Court confirmed that securities fraud plaintiffs who are proceeding under the fraud on the market theory need not establish loss causation when moving for class certification. Most observers expected this outcome following the oral argument at which the Justices pulled no punches about their disagreement with the Fifth Circuit's analysis.
These plaintiffs brought a putative securities fraud class action for all purchasers of Halliburton common stock between June 3, 1999, and December 7, 2001. They alleged that Halliburton made false statements "about (1) the scope of its potential liability in asbestos litigation, (2) its expected revenue from certain construction contracts, and (3) the benefits of its merger with another company." Slip op. at 2. The complaint survived a motion to dismiss, but the district court denied class certification, finding that plaintiffs failed to establish loss causation (i.e., that the correction of earlier misrepresentations, rather than other market forces, led to a decline in share prices). Adhering to its earlier precedent, the Fifth Circuit affirmed. Id. at 2-3.
Claims based on § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 (like the claims here) require proving (1) a material misrepresentation or omission, (2) scienter, (3) a connection between the misrepresentation/omission and the purchase or sale of a security, (4) reliance, (5) economic loss, and (6) loss causation. Id. at 4. Recognizing that requiring individual proof of reliance would make certifying a securities fraud class nearly impossible, the Court adopted the fraud on the market theory in Basic Inc. v. Levinson, 485 U.S. 224 (1988). That is a rebuttable presumption that purchasers relied on misrepresentations/omissions if the shares are traded in a well-developed market; such markets are presumed to reflect all publicly-available information about the company and its shares, so a misrepresentation/omission affects the share price even if the individual purchaser did not directly rely on it. Slip op. at 5.
The John Fund satisfied its burden to invoke the fraud on the market presumption, which the district court and Fifth Circuit recognized. Those lower courts, however, also demanded that the plaintiff prove that the decline in Halliburton's stock price occurred because of Halliburton correcting earlier misstatements (rather than other factors affecting the market) as part of class certification. Id. at 6. The Court bluntly rejected the notion that plaintiffs must establish such loss causation at the class certification stage in order to invoke the fraud on the market presumption of reliance on the misrepresentation/omission. Id. at 6-7. "The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on a misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory." Id. at 7.
The Court also rejected Halliburton's argument that the Fifth Circuit did not really mean "loss causation" even though it repeatedly used that phrase in its opinion. Instead, according to Halliburton, the Fifth Circuit truly meant that the plaintiff had not shown "price impact" (i.e., whether the misrepresentations originally affected the market price). "[W]e simply cannot ignore the Court of Appeals' repeated and explicit reference to 'loss causation,'" which is a distinct matter in securities law. Id. at 9.
Practitioners in the Fifth Circuit formerly had another tool to oppose class certification in securities fraud class actions. While this opinion eliminates that argument, it brings all circuits in line on the issue.
