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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.
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For more cutting edge commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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