The U.S. Supreme Court unanimously held on June 6, 2011 that securities fraud plaintiffs do not have to prove loss causation in order to obtain class certification.1 The Supreme Court’s decision overturns Fifth Circuit precedent, which had concluded that plaintiffs must show loss causation in order to establish an entitlement to the rebuttable presumption of reliance stemming from Basic, Inc. v. Levinson, 485 U.S. 224 (1998).2 In a brief opinion, the Court rejected the Fifth Circuit’s loss causation requirement at the class certification stage as “not justified by Basic or its logic.”3 Notably, the Court’s narrow opinion did not disturb key potential defenses to class certification and did not reach the question of whether proof that alleged misstatements had no impact on the stock price can successfully rebut the reliance presumption and defeat class certification.
This update summarizes and analyzes the Court’s opinion and its potential impact.
Background of the Lawsuit
Federal Rule of Civil Procedure 23(b)(3) permits class certification when, among other things, “the questions of law or fact common to class members predominate over any questions affecting only individual members.” Determining whether common issues predominate necessarily begins with the elements of the underlying cause of action. Of particular import in a private securities fraud claim based on violations of §10(b) and Rule10b-5 promulgated thereunder is the element of reliance. As the Supreme Court recognized in Basic, “[r]equiring proof of individualized reliance from each member of the proposed plaintiff class effectively would” foreclose all securities-related class actions, “since individual issues” would “overwhelm  the common ones.”4 As a solution to this concern, the Court in Basic permitted plaintiffs to invoke a rebuttable presumption of reliance based on what is known as the “fraud-on-the-market” theory. Pursuant to that theory, “the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material representations.”5 To trigger Basic’s presumption, plaintiffs must show that the misstatements were public, that the stock traded in an efficient market, and that the relevant transaction took place “between the time the misrepresentations were made and the time the truth was revealed.”6
In the Halliburton case, the Erica P. John Fund (the “EPJ Fund”) brought a securities fraud class action against Halliburton Co. alleging that the company had made various misstatements designed to inflate its stock price in violation of §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.7 In seeking to obtain class certification, the EPJ Fund invoked Basic’s rebuttable presumption of reliance. The district court ruled that while the EPJ Fund otherwise met the test set forth in Basic, it could not show loss causation, i.e., that Halliburton’s public misstatements in fact caused its losses.8 The Fifth Circuit agreed that loss causation is a prerequisite to the fraud-on-the-market presumption, and affirmed the denial of certification.9
The Halliburton Decision
The Supreme Court granted certiorari and reversed. In a unanimous decision, the Supreme Court rejected the Fifth Circuit’s loss causation requirement at the class certification stage. Specifically, the Court held that “[l]oss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory.”10 Rather, the “element of reliance in a private Rule 10b-5 action” is “‘transaction causation,’ not loss causation.”11
Halliburton conceded in its brief, and again at oral argument, that Basic does not require pre-certification proof of loss causation, but argued that, when read properly, the Fifth Circuit’s use of the term “loss causation” was merely shorthand for “price impact,” reflecting the fact that Halliburton had successfully rebutted the fraud-on-the-market presumption by showing that the alleged misstatements did not affect the market price.
The Court rejected Halliburton’s “wishful interpretation” of the lower court’s decision.12 But in doing so, the Court arguably left the door open to the “price impact” argument on remand. In fact, two of the three decisions cited by the Court (to illustrate a split among the circuits) expressly support Halliburton’s position.13
Consistent with the unanimity among the Justices, the Halliburton decision is a narrow one. The Court saw the Fifth Circuit’s imposition of a loss causation requirement at the class certification stage as an unwarranted extension of its ruling in Basic and did what it needed to do -- but no more -- to correct that error. It declined to revisit its controversial ruling in Basic, to address the loss causation element that it had previously considered in Dura Pharm., Inc. v. Broudo14 or to take the opportunity to more broadly review other aspects of class certification standards that can prove so pivotal in securities class actions. What remains to be seen is how the lower courts will continue to answer the question that the Court elected not to answer: can proof that alleged misstatements failed to affect a company’s stock price serve to rebut the presumption of reliance and defeat class certification?
Thus, coming on the heels of its decision in Matrixx Initiatives, Inc. v. Siracusano,15 the Supreme Court’s decision in Halliburton represents a second decision this term permitting a securities fraud claim to proceed. However, it is best seen as a narrow effort to correct an outlier circuit approach, rather than a shift to a more plaintiff-friendly perspective on such actions.