LOSS CAUSATION AND CLASS CERTIFICATION
The Supreme Court granted certiorari in a significant securities case on Friday. Erica P. John Fund, Inc. v. Halliburton Co, No. 09-1403. The question the Court agreed to consider focuses on whether plaintiffs in a securities fraud class action must prove loss causation at the class certification stage. Specifically, the question is: “Whether, in a private action under Section 10(b) of the Securities Exchange Act of 1934 . . a plaintiff who invokes the fraud-on-the market presumption of reliance must prove loss causation in order for the suit to be maintained as a class action.”
The case arises from a decision of the Fifth Circuit Court of Appeals in The Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., No. 08-11195 (5th Cir. Feb. 12, 2010). The complaint presented 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 in 2001.
The second and third groups of claimed misrepresentations focus on the benefits to Halliburton of its merger with Dresser and its accounting of 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)(here). The court began its analysis by noting that a securities law plaintiff basing a claim on 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, 485 F. 3d 307 (1988). Citing its decision in Greenberg v. Crossroads Sys., Inc., 364 F. 3d 657 (5th Cir. 2004), 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 market price.
The critical question is this case, according to the court, is the misrepresentation. 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. Thus the court held that “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.
In requesting that the High Court review the case plaintiffs argued that the Fifth Circuit’s decision conflicted with an earlier opinion of the Second Circuit as well as those of several district courts. Plaintiffs claimed that the decision was also contrary to the dictates of Rule 23 which governs class certification since it does not require proof of loss causation. Halliburton argued that there was no split in the circuits and, in any event, this case presented a poor vehicle to consider the issue.
The United States and the SEC, in an amicus brief, urged the Court to hear the case. The government told the Court that in fact the circuit courts are split on the application of Dura and loss causation at the class certification stage. One view, adopted by the Seventh Circuit in its recent decision in Schleicher v. Wendt, 618 F. 3d 679 (7th Cir. 2010), expressly rejects the Fifth Circuit’s requirement that loss causation be established at the class certification stage. Rather, 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 takes what is essentially an intermediate view according to the government. In In re Salomon Analyst Metromedia Litig., 544 F. 3d 474 (2nd Cir. 2008) 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 Solicitor argued that class certification should be governed by Federal Rule 23. Applying Dura at the certification stage when analyzing the application of the fraud-on-the-market theory confuses the requirements of loss causation and reliance the government noted. In any event it would be inappropriate to go beyond the dictates of Rule 23 at the class certification stage since discovery may well be incomplete and the evidence not fully developed.
The case is in briefing.
Webcast Sponsored by Celesq Legal Education and Thomson/West: By Tom Gorman: FCPA Enforcement at a Cross Roads: Demands for Larger Monetary Payments, Longer Prison Terms and Calls for Reform on January 11, 2011 at noon. http://bit.ly/eaLUCP