The US Supreme Court heard oral argument about what elements of a Rule 10b-5 private cause of action must be tested at the class certification stage, such as loss causation and reliance. David Boies, arguing for the petitioner-investor noted that loss causation is currently tested at three stages, pleading, summary judgment and trial. The question before the Court is whether it should be tested at a fourth stage, the class certification stage. He said that in Basic and last month in Matrixx, the Court said that loss causation and reliance are two distinct elements and this is an important distinction because individual reliance issues can predominate over common ones and loss causation issues cannot. The case is on appeal from the Fifth Circuit. Erica P. John Fund Inc. v. Halliburton Co., Dkt. No. 09-1403.
At the invitation of the Court, the SEC had filed an amicus brief asking the Court to resolve a split in the federal circuits over when a plaintiff in a securities fraud action relying on a fraud-on-the-market reliance presumption must demonstrate loss causation to obtain class certification. The brief contends that a Fifth Circuit panel erroneously required the plaintiff to prove loss causation at the class certification stage by a preponderance of the evidence. The petition asks the Court to review the significant threshold issue of the proper procedural standard for loss causation at the class certification stage.
The Fifth Circuit’s approach to class certification in securities fraud cases conflicts with the decisions of two other courts of appeals. The Seventh Circuit has expressly rejected the Fifth Circuit’s approach, said the Commission, and the Second Circuit, while allowing some consideration of the merits at the class certification stage, does not require the putative class representative to prove loss causation. The question presented is a recurring and important one, emphasized the SEC, and the Court was urged to grant review and use the suitable vehicle of the instant action to address it.
Justice Alito noted that there can be instances in which the market does not incorporate certain statements into the price of a
stock; and therefore even when it is demonstrated that the market meets the test for efficiency that the lower courts have settled upon in the wake of Basic, the defendant in a class action where there is reliance on the Basic presumption should be permitted at the class certification stage to prove that the allegedly fraudulent statements had no impact on price, and by doing that destroy the theory that the class relied on the statements, because they relied on the price which incorporated the statements.
Mr. Boies replied that if you have a situation in which the proof is class-wide, it is something that goes only to summary
judgment or trial. It does not go to the class certification stage. With respect to the issue of whether somebody is relying on an efficient market, that is distinct from whether a particular statement was or was not actionable.
Nicole Saharsky, arguing amicus for the Government, said that the Fifth Circuit erred in requiring proof of loss causation at class certification for three reasons: First, it's conducting a merits inquiry that's not tethered to the Rule 23 requirements; second, it's taking a presumption and requiring plaintiffs to prove it; and third, it's confusing the distinct elements of
reliance and loss causation. Investors are entitled to class certification if they have a common issue. And what the Court said in Basic is that if they set out the prerequisites for the fraud on the market, which the court of appeals agreed were met in this case, that they could proceed together. That threshold showing is required.
Justice Kagan noted that the Fifth Circuit said basically prove your whole case. You don't just have to prove that there was a price decrease; you have to prove that there was an initial material misstatement, that it distorted the stock price, that it led to a price decrease and that the price decrease can't be shown by any other superseding cause
Keying on Justice Kagan's remarks, amicus said that the Fifth Circuit took it upon itself to tighten the Rule 23 requirements. It was not satisfied with the rules as they exist, and it took the class certification stage and turned it into a merits inquiry stage. They required plaintiffs to prove almost their entire case at this stage of the litigation, and that just wasn't right, because the class certification stage is about whether plaintiffs can proceed as a group together.
David Sterling, arguing for the respondent, said that Basic is an exception to the long-understood rule about the nonsusceptibility in class actions to class treatment of fraud cases. Basic says it's not just enough to allege the operative facts,
and we will presume reliance. Basic says you have to plead and prove them, and all of those operative facts are subject to common proof.