Supreme Court to Review Fifth Circuit’s Halliburton Decision Requiring Securities Fraud Plaintiffs to Prove Loss Causation as a Condition of Class Certification
As reported on January 7, 2011, the U.S. Supreme Court will hear an appeal from the Fifth Circuit Court of Appeals’ decision in Erica P. John Fund Inc v. Halliburton, No. 09-1403 that, for a lawsuit to proceed as a class action, the plaintiffs must prove, by a preponderance of the evidence, that the alleged misrepresentations caused the stock price to fall, resulting in investor losses. The appellate court’s decision requiring that plaintiffs prove this significant element of their case at the class certification stage, without the benefit of full discovery of the facts, has been challenged by attorneys in the Obama administration.
A common theme in criticism of the Fifth Circuit’s ruling is the impossibility of requiring plaintiffs to do at the class certification stage what would otherwise be done at the merits stage after full discovery. Showing proof of loss causation requires plaintiffs to produce empirical evidence, such as an event study, to analyze all possible causes of the drop in stock price and prove that it is more probable than not that the corrective disclosure, and not some other piece of bad news, caused the drop in stock price. At such an early stage of a litigation, discovery may not be complete, or even substantially underway and yet the Halliburton ruling requires plaintiffs to make that showing by a preponderance of all admissible evidence.
Plaintiffs’ lack of access to discovery at the class certification stage of a securities fraud suit is particularly significant if the Fifth Circuit’s opinion in this case is read to require proof of scienter as well as, or as a component of, loss causation. Under Fifth Circuit precedent, establishing loss causation requires plaintiffs to prove the corrective disclosure shows the misleading or deceptive nature of the prior positive statements and that the corrective disclosure more probably than not show that the original estimates or predictions were designed to defraud. Proving the nature of statements and a design to defraud before discovery has taken place is impossible for all practical purposes, absent a confession by a defendant or some other smoking gun.
As the brief filed by the Obama administration correctly notes, at the class certification stage, the Supreme Court has held that the question is not whether the plaintiff or plaintiffs have stated a cause of action or will prevail on the merits, but rather whether the requirements of Rule 23 are met. Aside from requiring plaintiffs to meet a monumental evidentiary burden prior to any significant discovery, the brief argues that this ruling is wrong for the additional and fundamental reason that it is based on a ground not found in Rule 23.