In Basic Inc. v. Levinson, 485 U.S. 224 (1988), the Supreme Court held that in a federal securities fraud class action, if the plaintiff proves that the defendant’s shares are publicly traded on an efficient, well developed market and that the plaintiff purchased shares of the defendant after the defendant made material false representations and before the truth about these misrepresentations was revealed, then a rebuttable presumption arises that the plaintiff relied on the defendant’s misrepresentations in purchasing the shares. While reliance is typically an issue that requires individualized proof, defeating certification, the fraud on the market presumption allows the class representative to use common proof to establish that putative class members relied on an alleged misrepresentation.
The Private Securities Litigation Reform Act of 1995 requires a plaintiff in a federal securities fraud action to prove, among other things, “loss causation”—that plaintiff suffered a loss when the truth about defendant’s misrepresentation was revealed, causing the price of defendant’s shares to fall from the artificially high level plaintiffs bought at in reliance on defendant’s falsehoods. In class actions, class members prove loss causation with the same evidence for all class members: evidence about the nature of defendant’s statements and about the timing of share price movements. As the class members typically attempt to prove loss causation with the same evidence for all class members and with evidence relating to the merits of the case, the Second and Seventh Circuit Courts of Appeal and district courts in the First, Second, Fourth, Sixth, Ninth, Tenth, and Eleventh Circuits have not required proof of loss causation for class certification.
The Fifth Circuit Court of Appeals, however, has held in a series of cases that the securities fraud plaintiff who seeks to rely on the fraud on the market presumption must prove loss causation by a preponderance of the evidence for the presumption to apply and for a class to be certified. The Supreme Court recently granted certiorari to review the most recent such case, Erica P. John Fund, Inc. v. Halliburton Co., No. 09-1403 (S. Ct. Jan. 7, 2011). In this case, an investor in Halliburton Company, filed a securities fraud class action against Halliburton and one of its executives in a Texas federal court, alleging that misrepresentations by Halliburton violated federal securities laws, including Rule 10b-5. The district court denied the plaintiff’s motion for class certification because it held that the plaintiff had failed to prove loss causation. The plaintiff appealed. The Fifth Circuit Court of Appeals affirmed the district court’s decision. Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330 (5th Cir. 2010). The plaintiff then petitioned the Supreme Court for a writ of certiorari.
In its certiorari petition, the plaintiff contended that the Fifth Circuit’s holding that proof of loss causation is required for the fraud on the market presumption to apply and for class certification conflicts with the Supreme Court’s holding in Basic Inc and with contrary holdings by the Second Circuit Court of Appeals and by multiple district courts. The plaintiff also contends that by requiring proof of loss causation for class certification, the Fifth Circuit’s holding conflicts with Federal Rule of Civil Procedure 23, which governs class actions but does not require proof of loss causation for class certification.
At the Supreme Court’s request, the Solicitor General filed an amicus brief urging the Court to grant certiorari. This brief argued that the Fifth Circuit had improperly added additional requirements for Rule 23 certification and had erroneously required the plaintiff to prove an essential element of its case on the merits as a precursor to class certification.
On January 7, 2011, the Supreme Court granted the petition for certiorari and decided to review the Fifth Circuit’s decision. Erica P. John Fund, Inc. v. Halliburton Co., No. 09-1403 (S. Ct. Jan. 7, 2011). A decision is likely later this year.