Plaintiffs in a securities class action are not required
to prove loss causation as part of the class certification process, the Supreme
Court held in a unanimous decision handed down on Monday. Erica P. Hon Fund,
Inc. v. Halliburton Co., No. 09-1403 (Decided June 6, 2011) [the enhanced version of this opinion is available to lexis.com
subscribers / unenhanced version available from lexisONE Free Case Law].
The ruling reversed a decision by the Fifth Circuit Court of Appeals. This is
the second ruling favorable to securities class action plaintiffs this term.
Earlier the Court handed down a ruling favorable to plaintiffs on the question
of materiality (Matrixx Initiatives v. v. Siracusano) [enhanced version / unenhanced version].
The Court's Decision
The Court's opinion, authored by Chief Justice Roberts,
is brief, narrow and to the point. After reciting the background to the case it
notes that "the sole dispute here is whether EPJ Fund satisfied he
prerequisites of Rule 23(b)(3)." Slip at 3. That subsection of Rule 23, which
governs class certification, requires that common questions of law or fact
predominate over individual question for the class to be certified. Since the
district and circuit courts had agreed that the requirements of Rule 23 were
met, by posing the question in this manner the case was immediately resolved.
The Court went on however to explain the predicate for
its ruling, explaining the erroneous premise on which the lower court's ruling
turned. The question under Rule 23(b)(3) the Chief Justice wrote, centers on
the question of reliance. Proof that the plaintiffs relied on the deceptive
actions of the defendants is an essential element of an Exchange Act Section
10(b) private cause of action for damages. Citing Basic Inc. v. Levinson, 485
U.S. 224, 243 (1988) [enhanced version / unenhanced version], the Court went on to note that
reliance assures there is a proper connection between the defendant's
misrepresentation and a plaintiff's injury.
Traditionally reliance is established by a plaintiff
through proof that he or she was aware of the misrepresentation and purchased
or sold the securities based on it. When the securities are purchased in the
open market this is not feasible. Accordingly, Basic permits the
plaintiff to invoke a rebuttable presumption of reliance called the
"fraud-on-the-market theory." Under this theory the price of a security traded
on an efficient market reflects all of the publically available information,
including any material misrepresentation. Investors who purchase securities in
such a market are presumed to rely on its integrity.
The Court of Appeals confused loss causation and reliance.
The Circuit Court held that to invoke the Basic presumption plaintiff is
required to prove at the class certification stage that the decline in the
price of the shares resulted because of a correction to the prior misleading
statement and that the subsequent loss could not be explained by other factors
revealed in the market at the time. This is loss causation as required by Dura
Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005) [enhanced version / unenhanced version], the High Court noted.
Dura loss causation is distinct
from Basic and the question of reliance. Reliance typically focuses on
the facts regarding an investor's decision to engage in a transaction. Loss
causation requires the plaintiff to show that the misrepresentation affected
the integrity of the price and caused the subsequent economic loss. "According
to the Court of Appeals, however, 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 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 the
misrepresentation in the first place, either directly or presumptively through
the fraud-on-the-market theory. Loss causation has no logical connection to the
facts necessary to establish the efficient market predicate to the
fraud-on-the-market theory." Slip at 8.
The Lower Courts
The case arose from a decision of the Fifth Circuit Court
of Appeals in The Archdiocese of Milwaukee Supporting Fund, Inc. v.
Halliburton Co., 597 F. 3d 330 (5th Cir. Feb. 12, 2010) [enhanced version / unenhanced version]. The complaint is based on three
categories of claimed misstatements. First, plaintiffs alleged that statements
concerning Halliburton's exposure to liability in asbestos litigation, and its
stated reserves for that litigation, are false and misleading. That liability
derived from Halliburton's merger with Dresser Industries. Supposedly
corrective statements were made in press releases and SEC filings on four dates
The second and third groups of alleged misrepresentations
focus on the benefits to Halliburton of its merger with Dresser and its
accounting for revenue from cost-overruns on fixed-price construction and
engineering contracts. Corrective disclosures were supposedly made on four
dates in 1999 and 2000.
The Fifth Circuit affirmed the district court's denial of
class certification, concluding that plaintiffs had failed to establish loss
causation as required by the Supreme Court's decision in Dura
Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005) [enhanced version / unenhanced version]. The Circuit Court began its
analysis by noting that a securities law plaintiff basing a claim on Exchange
Act Section 10(b) must establish six elements: 1) a material misrepresentation
or omission; 2) scienter; 3) a connection with the purchase or sale of a
security; 4) reliance; 5) economic loss; and 6) loss causation.
In a putative class action, plaintiffs can establish a
rebuttable presumption of reliance using the fraud-on-the-market theory under Basic
Inc. v. Levinson, 486 U.S. 224 (1988) [enhanced version / unenhanced version]. Citing its earlier decision in Greenberg
v. Crossroads Sys., Inc., 364 F. 3d 657 (5th Cir. 2004) [enhanced version / unenhanced version], the Court noted that plaintiffs
can make the required showing by demonstrating that the defendant company made
a material misrepresentation at a time when its shares were traded in an
efficient market and that they traded between the time those statements were
made and the truth was revealed. The defendant can rebut the presumption by any
showing that severs the link between the claimed misrepresentation and either
the price received or paid by the plaintiff or the decision to trade at fair
The critical question here, the Court noted, is the
misrepresentations. The parties did not dispute the efficiency of the market or
the trading. Under these circumstances to use the Basic
fraud-on-the-market presumption of reliance plaintiffs must establish loss
causation the Court held: "Plaintiff must prove that the
complained-of-misrepresentation or omission materially affected the market
price of the security . . .. In other words, Plaintiff must show that an
alleged misstatement 'actually moved the market.' Thus, we require plaintiffs
to establish loss causation in order to trigger . . . " the presumption
(internal citations and quotations omitted). That proof must be by a
preponderance of the evidence. After a detailed analysis of the proof,
including expert testimony, the Circuit Court concluded that plaintiffs failed
to adequately establish loss causation.
This decision is in accord with and follows the Fifth
Circuit's earlier ruling in Oscar Private Equity Investments v. Allegiance
Telecom, Inc., 487 F. 3d 261 (5th Cir. 2007) [enhanced version / unenhanced version] which the district court applied
in dismissing the complaint. The Halliburton panel stated at the outset
that it was bound by Oscar.
Circuit courts had split over the application of the Basic
presumption in the wake of Dura. The Fifth Circuit however is the
only one which require proof of loss causation at the class certification stage
and imposes the burden on the plaintiff. The Seventh Circuit, in contrast,
expressly repudiated Oscar in Schleicher v. Wendt, 618 F. 3d 679
(7th Cir. 2010) [enhanced version / unenhanced version]. Under this decision the
question of class certification should be governed solely by the dictates of
Federal Civil Rule 23. The merits should only be considered to the extent
necessary to comply with that Rule.
The Second Circuit has taken an intermediate view. In In
re Salomon Analyst Metromedia Litig., 544 F. 3d 474 (2nd Cir. 2008) [enhanced version / unenhanced version] the court concluded that some
consideration of the merits is allowed at the class certification stage. Salomon
declined to consider loss causation at the certification stage however. The
Third Circuit has also declined to require proof of loss causation at the class
certification stage. In re DVI, Inc. Securities Litigation, No. 08-8033,
2011 WL 1125926, *7 (CA 3, Mar. 29, 2011).
The Supreme Court agreed to hear the case to resolve the
split in the circuits.
This is the second victory for plaintiffs this Term from
a Court considered to be pro-business. It is interesting to note that while the
first came in an opinion authored by Justice Sotomayor from the liberal wing,
the second was authored by the Chief Justice who supposedly has helped guide
the Court on its pro-business path.
While two victories have undoubtedly bolstered the
spirits of the plaintiff's bar, potentially the most important decision for
class actions is yet to be decided, Janus Capital v. First Derivative
Traders (here). That case
may decide the scope of primary liability in a Section 10(b) case, a question
which has been litigated since the High Court concluded that there is no aiding
and abetting liability under the Section in its decision in Central Bank of
Denver v. First Interstate, 511 U.S. 161 (1994) [enhanced version / unenhanced version].
Furthermore, Matrixx and Halliburton represent,
in many ways, little more than a continuation of existing precedent which may
explain the victories for the plaintiffs. The former essentially reiterates the
long standing test for materiality, although its application by the Court does
appear to somewhat dilute it. The latter is a narrowly drawn decision which
focuses on the requirements of Rule 23 and the underlying theory of Basic.
Finally, in penning the opinion Chief Justice Roberts
took care to note that that "we need not, and do not, address any other
question about Basic, its presumption, or how and when it may be
rebutted. To the extent Halliburton has preserved any further arguments against
class certification, they may be addressed in the first instance by the Court
of Appeals on remand." The Court thus sidestepped many of the issues presented
at the oral argument in which the parties debated Basic and how it
should be applied. At the same time it emphasized the narrow focus of the decision.
In emphasizing this point the Court also knew that Halliburton had reserved
significant issues about Dura causation for the dispositive motion stage
of the case.
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