On June 6, 2011, the Supreme Court decided Erica P. John Fund, Inc. v. Halliburton Co. et al., No. 09-1403, holding that plaintiffs in a putative securities fraud class action alleging "fraud-on-the-market" need not prove loss causation—i.e., that the material misrepresentation caused the economic loss—to obtain class certification.
The Erica P. John Fund, Inc. ("EPJ Fund"), on behalf of those similarly situated, filed suit against Halliburton Co. and one of its executives, alleging violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The complaint asserted, among other things, that Halliburton intentionally made false statements regarding its potential liability in litigation and expected revenues, and that investors of Halliburton were injured when the company subsequently made corrective disclosures, which caused its stock price to drop. After defeating Halliburton's motion to dismiss, the EPJ Fund sought to certify a class comprising all investors who purchased common stock in Halliburton between June 3, 1999 and December 7, 2001.
The District Court denied class certification, citing binding precedent in the Fifth Circuit, Oscar Private Equity Invs. V. Allegiance Telcom, Inc., 487 F.3d 261, 269 (5th Cir. 2007), which required plaintiffs bringing a securities fraud class action to prove loss causation to obtain class certification. The Fifth Circuit Court of Appeals affirmed, holding that the EPJ Fund's failure to "prove loss causation, i.e., that the correct truth of the former falsehoods actually caused the stock price to fall and resulted in the losses," precluded class certification. 597 F.3d 330, 334 (5th Cir. 2010). The Fifth Circuit's decision conflicted with decisions of the Second, Third, and Seventh Circuits, which do not require plaintiffs to prove loss causation at the class certification stage.
In a unanimous decision, the Supreme Court reversed, holding that the Fifth Circuit Court of Appeals erred by requiring plaintiffs to establish loss causation at the class certification stage to invoke the "fraud-on-the-market" theory of liability. Under that theory, reliance on public misstatements is presumed whenever an investor "buys or sells stock at the price set by the market," because "the market price of shares traded on well-developed markets reflects all public available information [including] any material misrepresentations." Basic Inc. v. Levinson, 485 U.S. 224, 246-47 (1988).
To invoke the "fraud-on-the-market" rebuttable presumption, however, plaintiffs must demonstrate that the misrepresentation was known publicly, that there was an efficient market for the stock, and that the transaction occurred between the misrepresentation and the corrective statement. The Fifth Circuit's additional loss causation requirement "contravenes Basic's fundamental premises." Whether the economic loss was caused by the misrepresentation has "no logical connection" to whether an investor relied on the public misrepresentation in engaging in the relevant transaction.
Chief Justice Roberts delivered the opinion for a unanimous Court.