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No Need for Loss Causation – Erica John Fund v. Halliburton

Posted in Certification

It’s June, which means the Supreme Court is issuing a spate of opinions to finish out its 2010-11 term. Yesterday, the Court announced its opinion for Erica John Fund v. Halliburton. It’s a short opinion, and a unanimous one. (Chief Justice Roberts wrote the opinion for the 9-0 Court.)

As you may remember, this case concerns an alleged securities fraud. The plaintiffs had alleged that Halliburton understated its asbestos litigation liability and overstated the benefits of a proposed merger. Once the truth came out, the price of Halliburton’s stock dropped. When the plaintiffs moved for class certification, Halliburton argued that they could not show that the misrepresentations actually caused the loss. The trial court denied certification, and the Fifth Circuit affirmed.

I noted when the Court granted certiorari that the Fifth Circuit’s opinon had drawn fire from academics for requiring an early merits inquiry. The Court did not address that criticism directly. Instead, it focused on defining loss causation.

The question presented in this case is whether securities fraud plaintiffs must also prove loss causation in order to obtain class certification. We hold that they need not.

The Court discusses how its opinion in Basic, Inc. v. Levinson (which allows a court to presume reliance where an efficient securities market exists) establishes the standard for determining causation at the class certification stage.

It is undisputed that securities fraud plaintiffs must prove certain things in order to invoke ’s rebuttable presumption of reliance. It is common ground, for example, that plaintiffs must demonstrate that the alleged misrepresentations were publicly known (else how would the market take them into account?), 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.”

However, according to the Court,

The Court of Appeals’ requirement is not justified by Basic or its logic. To begin, we have never before mentioned loss causation as a precondition for invoking Basic’s rebuttable presumption of reliance. 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.

(Emphasis added.) The Court calls the kind of causation represented by reliance "transaction causation." In other words, did the misrepresentation cause the buyer to buy?

Loss causation, by contrast, requires a plaintiff to show that a misrepresentation that affected the integrity of the market price also caused a subsequent economic loss. As we made clear in Dura Pharmaceuticals, the fact that a stock’s “price on the date of purchase was inflated because of [a] misrepresentation” does not necessarily mean that the misstatement is the cause of a later decline in value. We observed that the drop could instead be the result of other intervening causes, such as “changed economic circumstances, changed investor expectations, new industry-specific or firm-specific facts, conditions, or other events.” If one of those factors were responsible for the loss or part of it, a plaintiff would not be able to prove loss causation to that extent. This is true even if the investor purchased the stock at a distorted price, and thereby presumptively relied on the misrepresentation reflected in that price.

In other words:

Loss causation has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory.

What’s the likely effect of this opinion? For most circuits, which did not observe the loss causation requirement, not much. The opinion largely reaffirms the status quo. In the Fifth Circuit, we’re likely to see an uptick in class action filings, and certifications of securities class actions.