By Thomas R. Ajamie and John W. Clay
A June 6th U.S. Supreme Court decision eliminated a class certification hurdle faced by securities fraud plaintiffs in the 5th U.S. Circuit Court of Appeals. In this article for Texas Lawyer, Tom Ajamie and John Clay analyze the impact of Erica P. John Fund Inc. v. Halliburton Co., et al. on securities fraud class actions in Texas and other states within the 5th Circuit’s jurisdiction.
The opinion concerns two basic issues in securities fraud litigation: presumption of reliance and loss causation.
The first issue is whether a court can presume that the plaintiff relied on the alleged misstatements simply because the plaintiff bought the stock on a public market at a price that incorporated the misinformation.
The plaintiff must show at the class certification stage that the presumption of reliance should apply. Plaintiffs typically do this by showing that the stock trades on an efficient market – one that quickly incorporates public information and misinformation.
This issue is crucial for class certification. Without the presumption of reliance, each class member would have to prove her specific reliance on the misstatements. As a result, individual issues potentially could overwhelm common issues, which would prevent a court from certifying a class.
The second issue, so-called “loss causation,” involves whether the correction of previous misstatements actually caused a drop in the stock price at the end of the class period. Such a drop serves as the basis for a plaintiff’s and the class’ damages. The plaintiff must show at trial that the revelation of the fraud is what caused the price drop, not some other factors.
Alone among the circuits, however, the 5th Circuit previously held that the plaintiff must prove loss causation at the class certification stage to get the presumption of reliance.
The Supreme Court disagreed in its June 6 decision in Halliburton, holding that the 5th Circuit had conflated the two issues. There is no connection between the presumption of reliance, which concerns what happened when the plaintiff purchased the stock during the class period, and loss causation, which concerns what happened when the stock price fell at the end of the class period.
The high court also noted that there is no mention of loss causation in Basic Inc., et al. v. Levinson, et al. (1988), the opinion that established the fraud-on-the-market presumption of reliance. Loss causation is irrelevant to the fraud-on-themarket presumption of reliance and hence to class certification.
The court also rejected Halliburton’s attempt in its brief to the high court and at oral argument to re-characterize the 5th Circuit’s decision as holding only that the plaintiff must show “price impact,” i.e. whether the misrepresentations affected the stock price. Clearly, said the Supreme Court, the 5th Circuit said and meant loss causation, not “price impact.”
The opinion is noteworthy for its brevity and unanimity (on a Supreme Court that generally has been seen in recent years as more pro-business and less welcoming to securities class action litigation) and for the court’s decision not to wait for other circuits to weigh in on the issue.
The high court’s decision will impact lawyers who bring securities fraud class actions in Texas and other states within the 5th Circuit’s jurisdiction. Until the 5th Circuit’s Halliburton opinion was reversed, the 5th Circuit approach required a plaintiff to spend significant funds – typically tens or hundreds of thousands of dollars on expert opinions and testimony – to demonstrate that the fraudulent statements caused the stock price’s drop.
Although it sounds simple – just show that the price drop immediately followed the revelation of the fraud – establishing loss causation often is complex and costly. This is because the bad news disclosing the fraud typically is mixed with other items, such as quarterly earnings releases, and it often is dribbled out over periods of weeks or months.
These conditions can make it difficult to establish whether, and how much of, the stock price drop was due to the fraud and not due to other factors, such as a bad earnings release or a general malaise in the sector or in the stock market as a whole.
Now, the plaintiff is relieved of that burden at the class certification stage in all circuits, although he still must show that the stock traded on an efficient market to avail himself of the fraud-on-the-market presumption of reliance. This itself may require expert testimony, but this burden no longer is compounded by the additional loss causation proof that the 5th Circuit had imposed at this early stage of the litigation.
Thomas R. Ajamie of Houston is managing partner of Ajamie LLP in Houston. He is the author of “Financial Serial Killers: Inside the World of Wall Street Money Hustlers, Swindlers and Con Men.” John W. Clay is a partner in the firm in Houston. His practice focuses on energy litigation, commercial litigation, civil RICO liability and arbitrations.