In light of two decisions by 5th Circuit panels and a recent district court decision within the circuit, it appears that the 5th may be the place where class actions go to die, and the cause of death is likely to be loss causation.
Oscar Private Equity Investments v. Allegiance Telecom, Inc., a 2007 5th Circuit decision, is the starting point. Although the court decided this case after the Supreme Court's Dura decision, the 5th Circuit made virtually no mention of the Dura holding. In Oscar, the appeals panel, in an interlocutory appeal, vacated a class certification that was based on a presumption of reliance under the fraud on the market theory. The appellants, a telecommunication provider's officers and directors, successfully argued that the investors did not prove loss causation between the provider's allegedly false statements and the loss to the investors from a lower stock price.
According to the majority opinion, "[e]ssentially, we require plaintiffs to establish loss causation in order to trigger the fraud-on-the-market presumption." The panel rejected the district court's conclusion that the class certification stage was not the proper time for the defendants to rebut the lead plaintiffs' fraud on the market presumption. As characterized by the appellate panel, the district court "suggested that the presumption of reliance was rebuttable, but only as related to a summary judgment motion." The appellate court described this as "an outdated view that fails to accord this signal event of the case its due," because the separation of the merits of the claim from certification was not appropriate with regard to "a class exceeding purchasers of millions of shares in a volatile and downward-turning market over a ten-month period, claiming injury from one of several simultaneous disclosures of negative information." In effect, the 5th Circuit reversed the burden of proof involved with the fraud on the market presumption. Rather than requiring the defendant to rebut the presumption, plaintiffs were required to prove by a preponderance of the evidence the existence of a sufficient and specific causal link.
The court concluded that "[w]e cannot ignore the 'in terrorem' power of certification, continuing to abide the practice of withholding until 'trial' a merit inquiry central to the certification decision, and failing to insist upon a greater showing of loss causation to sustain certification, at least in the instance of simultaneous disclosure of multiple pieces of negative news."
In a dissenting opinion, Circuit Judge Dennis criticized what he called "a breathtaking revision" and an "an unjustified revision of securities class action procedure." He disagreed with the majority's required showing of loss causation at the class certification stage. The holding, noted Judge Dennis, dramatically expands the scope of class certification review in this circuit to effectively require a mini-trial on the merits of plaintiffs' claims at the certification stage.
In an unpublished September 2008 opinion, Catogas v. Cyberonics, Inc., dealing with the review of a dismissal motion rather than class certification, the 5th affirmed the dismissal of claims based on allegations concerning stock option backdating. The district court had dismissed the action on scienter grounds, but the appeals panel affirmed on loss causation without addressing whether scienter was adequately pleaded. The plaintiffs pointed to a press release which disclosed that the company's internal investigation was ongoing and that its 10-K filing would be delayed. The press release also revealed a Nasdaq staff letter informing the company that it was subject to delisting from the exchange if it did not file its Form 10-K. According to the plaintiffs, the press release was "the first time that the market learned the full ramifications of the backdating and repricing scheme," and that before the press release, "the investing public did not know and was never told that the illegal scheme could eventually lead Cyberonics' market to stop trading on the Nasdaq exchange." After this release, the company's stock price dropped by almost 25 percent.
The appeals court disagreed, as it found that the press release did not "reveal anything regarding the accounting of options that had not already been disclosed to the investing public." The court said that the market had been apprised of the stock option problems through analyst reports and disclosures concerning an SEC investigation and subpoenas from the U.S. Attorney. The only new information in the press release, according to the panel, involved the delisting possibility. Because this information "did nothing to reveal previous misstatements with respect to Cyberonics' stock-option accounting," it was not relevant with regard to the loss causation question.
The last sentence of the opinion's introductory paragraph also raises an interesting question. Dura did not directly address the question of whether loss causation was subject to the more stringent pleading rules for fraud under the Federal Rules of Civil Procedure. The court in Catogas did not answer the question, but it certainly hinted at a stricter view in stating that the "plaintiffs failed to plead loss causation with the requisite particularity.
The effect of Oscar can be seen in a decision handed down in November 2008 by the U.S. District Court for the Northern District of Texas. In Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., the court refused to certify a class on loss causation grounds. The court agreed that the plaintiffs met all the requirements for certification except the Oscar loss causation requirement, which "imposes an exceedingly high burden on Plaintiffs at an early stage of the litigation." Because the plaintiffs failed to link "the alleged corrective disclosures with prior actionable misrepresentations," the court declined to certify the class.
A Split Between the Circuits?
The answer to the question above is yes, but the follow-up response to that is likely to be"So?" While the 5th and 9th Circuits have taken dramatically different approaches to the loss causation question, it is unlikely that the Supreme Court will re-visit the issue to resolve these unanswered questions.
In Gilead Sciences Securities Litigation, a 9th Circuit panel reversed a lower court dismissal on loss causation grounds. The appellate court stated that "[p]erhaps what truly motivated the dismissal was the district court's incredulity" with regard to loss causation claims. In stark contrast to the 5th Circuit in Catogas, the panel noted that "a district court ruling on a motion to dismiss is not sitting as a trier of fact." While trial courts need not "accept as true conclusory allegations, nor make unwarranted deductions or unreasonable inferences," the appellate panel held that "[s]o long as the complaint alleges facts that, if taken as true, plausibly establish loss causation, a Rule 12(b)(6) dismissal is inappropriate."