Plaintiffs, common stock investors in Allegiance, a national telecommunications provider, brought a securities fraud class action lawsuit under section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 alleging that former Allegiance executives fraudulently misrepresented information about the company’s operations, which resulted in a drop in the company’s stock price when a corrective disclosure was ultimately made. The District Court certified Plaintiffs’ class based on the “fraud on the market theory,” which permits the court to presume that each class member has satisfied the reliance element of a 10b-5 claim.

The Fifth Circuit Court of Appeals, in a decision that the dissenting Judge characterized as “a breathtaking revision of securities class action procedure,” reversed. The Court ruled that class certification based on the fraud-on-the-market doctrine must be supported by a showing by a preponderance of the evidence of “loss causation,” i.e., an empirically-based showing that the market reacted negatively to the corrective disclosure of the alleged misrepresentations. In justifying its imposition of this requirement at the class certification stage, the court noted both the “lethal force” and “in terrorem” effect upon defendants of certifying a class based upon the fraud on the market doctrine.

The Court then examined the corrective disclosure relied upon by plaintiffs, which both corrected the alleged misrepresentations and included other negative information about the company. Because the plaintiffs’ showing of the effect of the disclosure did not isolate and establish the negative impact, if any, attributable solely to correcting the misrepresentations, the court vacated the order and remanded the case for further proceedings. (Oscar Private Equity Investments v. Allegiance Telecom, Inc., 2007 WL 1430225 (5th Cir. May 16, 2007))