(CN) – Investors seeking class certification in securities fraud litigation do need to prove that a company’s deceptive conduct caused their economic loss, though that connection is necessary to ultimately prevail on the merits, the Supreme Court ruled Monday.
A Texas federal judge had refused to certify a class action against Halliburton and its former CEO David Lesar, filed by lead plaintiff Erica P. John Fund. To artificially inflate its stock price between 1999 and 2001, Halliburton lied about the scope of its potential liability in asbestos litigation, its expected revenue from certain construction contracts and the benefits of its merger with another company, according to the investors’ complaint.
The fund survived a motion to dismiss, but the Northern District of Texas would not certify the class, even though it met the basic requirements of numerosity and commonality.
After the 5th Circuit affirmed, the Supreme Court took up the fund’s appeal to resolve a conflict among the federal appeals courts.
On Monday, the high court said that the trial court improperly used the loss-causation theory as a basis to deny class certification.
Though circuit precedent requires plaintiffs in securities fraud litigation to prove that a company’s deceptive conduct caused their economic loss, they have more latitude for class certification, according to the 10-page ruling.
In deciding differently, the 5th Circuit misapplied the requirements set in the Supreme Court’s 1988 decision for Basic Inc v. Levinson..
“To begin, we have never before mentioned loss causation as a precondition for invoking Basic‘s rebuttable presumption of reliance,” Chief Justice John Roberts wrote for unanimous court. “The term ‘loss causation’ does not even appear in our Basic opinion. And for good reason: Loss causation addresses a matter different from whether an investor relied on a misrepresentation, presumptively or otherwise, when buying or selling a stock.”
Since the requirements for proof of reliance could amount to an unnecessarily unrealistic evidentiary burden for plaintiffs and effectively foreclose the possibility of class actions, the court in Basic green-lit the “fraud-on-the-market” theory.
“According to that theory, ‘the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations,” Roberts wrote.
“According to the Court of Appeals, however, an inability to prove loss causation would prevent a plaintiff from invoking the rebuttable presumption of reliance,” he added. “Such a rule contravenes Basic‘s fundamental premise – that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction. The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory. Loss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory.
The Court of Appeals erred by requiring EPJ Fund to show loss causation as a condition of obtaining class certification.”
Halliburton had argued that the court simply used the words “loss causation” and rejected class certification on the basis of price impact, but the high court called this a “wishful interpretation.”
“Whatever Halliburton thinks the Court of Appeals meant to say, what it said was loss causation,” Roberts wrote, adding: “We take the Court of Appeals at its word. Based on those words, the decision below cannot stand.”