Last Monday the Fifth Circuit affirmed a Texas district court’s decision certifying one class of BP PLC shareholders suing BP over the Deepwater Horizon disaster, and denying certification of another class of shareholders who purchased BP Stock prior to the explosion. Ludlow v. BP, P.L.C., No. 14-20420, (5th Cir. Sept. 8, 2015). The plaintiffs sought certification of two classes: one for pre-spill representations relating to the risk of an oil spill, and one for post-spill misrepresentations. The district court certified the post-spill class, but denied certification of the pre-spill class. The district court found that the post-spill class of plaintiffs had appropriately established a model of damages consistent with their liability case, and capable of measurement across the class, as required by the Supreme Court’s decision in Comcast Corp. v. Behrend, 133 S.Ct. 1426, 185 L.Ed.2d 515 (2013). However, it refused to certify the pre-spill class because this proposed class of shareholders failed to satisfy Comcast’s common damages requirement. Both plaintiffs and BP appealed the district court’s decision to the Fifth Circuit Court of Appeals.
The proposed post-spill class alleged that following the Deepwater Horizon oil spill, BP made misrepresentations that vastly underestimated the spill rate of the oil from the well, violating Section 10(b) of the Exchange Act and SEC Rule 10b-5. This sub-class alleged that due to misrepresentations regarding the spill rate, the stock market price failed to fall to the level reflecting the magnitude of the crisis facing BP, and that when the market learned the truth regarding the spill, the stock market price corrected. This class’s damages model relied on a theory that the “inflation” in the stock price caused by the misstatements would be exposed by the fall in the price when “corrective events” brought the “true” information to the market’s attention. This class of shareholders thus sought recovery of the difference between a model-driven “true” stock price and the actual stock price. The district court accepted this damages theory as consistent with the liability theory and certified the sub-class. BP challenged the certification of this class, arguing that Rule 23(b)(3)’s requisites had not been met and that plaintiffs failed to show “that the questions of law or fact common to class members predominate over any questions affecting only individual members, and that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy.”
In assessing the certification of this class, the Fifth Circuit first quoted Comcast Corp. v. Behrend’s holding relating to liability, damages and commonality:
[A] model purporting to serve as evidence of damages in this class action must measure only those damages attributable to that theory. If the model does not even attempt to do that, it cannot possibly establish that damages are susceptible of measurement across the entire class for purposes of Rule 23(b)(3). Calculations need not be exact, but at the class certification stage (as at trial), any model supporting a plaintiff’s damages case must be consistent with its liability case, particularly with respect to the alleged…effect of the violation. And for purposes of Rule 23, courts must conduct a rigorous analysis to determine whether that is so.
To determine damages, the plaintiffs’ expert’s conducted an “event study” of BP’s stock price during the oil spill. An event study, the Fifth Circuit explained, “is a statistical regression analysis that examines the effect of an event, such as a release of information, on a dependent variable, such as a corporation’s stock price.” These events, called “corrective disclosures” or “corrective events,” partially or entirely correct a previous misrepresentation. The plaintiffs’ expert identified six events which indicated to the public that the spill rate of the oil far exceeded what BP initially represented. The expert then measured the stock inflation by calculating the price drop following a corrective disclosure. To calculate damages, a plaintiff in the class need only know the date they bought the BP shares, and then multiply the price inflation on that date by the total number of shares. On appeal, BP argued that the plaintiffs’ expert failed to establish by a preponderance of the evidence that this methodology was capable of calculating damages on a class-wide basis, by pointing out that the expert acknowledged that it was “possible” that BP’s stock price would have similarly declined even if the true spill rate had been disclosed. However, the Fifth Circuit rejected this critique, stating that BP had taken the expert’s statement out of context.
BP then argued that the district court misconstrued Comcast when it “conclud[ed] that it could not consider flaws in the plaintiff’s damages methodology because those flaws overlap with the merits” and that the district court should have determined whether the corrective events relied upon by the expert were tied to the alleged misrepresentations. The Fifth Circuit noted that Comcast mandates that before a class is certified, a class must establish that the theory of damages is consistent with the theory of liability. The Fifth Circuit then noted that in HalliburtonI, 131 S. Ct. 2179 (2011) the Supreme Court held that loss causation need not be proven in order to certify a class, and in Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 133 S.Ct. 1184 (2013), emphasized that the plaintiff need not prove an element of its case at the certification whose resolution “is common to the class.” The Fifth Circuit, while acknowledging that BP’s argument was not without merit, held that the district court acted appropriately. The court noted that conceptually, the theory of liability was consistent with the theory of damages, as required byComcast. In Comcast, some plaintiffs sought to recover under a theory of damages that corresponded to a theory of liability that was no longer in the case. The court held that in the case before it, the theory of damages was appropriately tied to a theory of liability common to all plaintiffs. The court also rejected BP’s assertion that the district court erred in failing to consider the relationship between the alleged misrepresentations and the corrective events. The Fifth Circuit held that requiring the district court to address whether the misrepresentation was the cause of the loss was in tension with Halliburton I’s holding that no proof of loss causation is required at the class certification stage. And, the court pointed out that the Supreme Court’s holding in Amgen makes clear that questions “common to the class” do not need to be proved at the class certification stage, as long as they are capable of common resolution.
Next, BP argued that several of the corrective events in question did not measure stock price inflation stemming from the nondisclosure, but rather reflected the consequences of the spill itself. BP argued that damages stemming from the spill itself were not recoverable. The court agreed with this. However, the Fifth Circuit characterized BP’s argument as an attack on the “fit” between the corrective event and the misstatements. The Fifth Circuit explained that the tightness of that fit was a question common to the class, and thus Amgen does not require proof at the certification stage. The court held that to conclude otherwise would contraveneHalliburton I’s requirement that loss causation does not need to be proved at the certification stage.
The Fifth Circuit then turned to the district court’s refusal to certify the pre-spill class. The pre-spill damage theory was based on BP’s alleged misstatement regarding the efficacy of its safety procedures, creating an impression that the risk of a catastrophic failure was lower than it actually was. According to the plaintiffs’ theory, these statements resulted in investors being defrauded into taking a greater risk than disclosed, and removed the plaintiffs’ opportunity to decide whether to divest in light of the heightened risk. The Fifth Circuit concluded that the damages were not susceptible to measurement across the entire class for purposes of Rule 23(b)(3), as required by Comcast. The Fifth Circuit explained that the plaintiffs’ theory hinged on the conclusion that each plaintiff would not have bought BP stock at all but for the alleged misrepresentations. However, the court pointed out that this conclusion required an individualized inquiry, because each plaintiff may have been willing to accept a different degree of risk. Thus, for some plaintiffs, the degree of risk that would have been presented had BP disclosed the efficacy of its safety procedures may not have prevented them from purchasing the stock, while for others, the degree of risk disclosed may have been unacceptable. Thus, the first plaintiff may be entitled to damages for paying an inflated price for the stock, but the first plaintiff could not be compensated for the materialization of a risk they were willing to take. The court concluded that because the expert’s model did not provide any mechanism for separating these two classes of plaintiffs, it could not provide an adequate measure of class-wide damages under Comcast. Consequently, the class could not be certified.
The plaintiffs also contended that under the fraud-on-the-market theory, it is presumed that the misrepresentations were a cause in fact of their losses. The Fifth Circuit corrected this assertion, explaining that the fraud-on-the-market theory does not provide any presumptions with respect to loss causation. The court noted that where the economic loss depends on the plaintiff’s risk tolerance, loss causation cannot be presumed nor can it be found class wide. Furthermore, the court pointed out that the fraud-on-the market-theory may not be applicable to the plaintiffs. The fraud-on-the-market theory presumes that investors rely on price and price alone in making investment decisions. But the plaintiffs’ theory presumed that investors relied on the additional factor of risk. Thus, plaintiffs’ own argument undercut their ability to rely on the fraud-on-the-market theory.
As the Fifth Circuit noted at the outset of its decision, this is likely not the last time this class action will be before the Fifth Circuit. However, it does provide helpful guidance for future applications of Comcast, and no doubt this case will continue be fodder for further clarification of Rule 23 standards as the case proceeds.