April 14, 2011


NCLC Urges the U.S. Supreme Court to Allow Loss Causation to be Considered at the Class Certification Stage of 10b-5 Civil Actions

By Richard D. Bernstein, James C. Dugan, and Erin L. Carroll, Willkie Farr & Gallagher LLP

The National Chamber Litigation Center (NCLC) recently filed an amicus brief in the United States Supreme Court urging the Court to affirm the Fifth Circuit's decision in Erica P. John Fund, Inc. v. Halliburton Co., which denied class certification of Plaintiff's Rule 10b-5 claim for failure to establish loss causation. NCLC's brief argues that loss causation should be considered at the class certification stage of a securities class action because the absence of loss causation: (i) tends to disprove that the alleged misrepresentation was material and/or the market in which securities traded was efficient, both of which are necessary to invoke the fraud-on-the-market presumption of reliance; (ii) may be used by defendants to rebut the presumption; and (iii) is independently relevant to class certification issues such as the definition of class period and the manageability of the class action.

Plaintiff in Erica P. John Fund brought a Rule 10b-5 claim alleging that Halliburton made false statements about three areas of its business during the relevant class period. Plaintiff alleged that it and other investors lost money when Halliburton corrected these false statements through subsequent disclosures and that the market declined following the disclosures.

The district court, following Fifth Circuit precedent, declined to certify a plaintiff class because Plaintiff could not establish that a corrective event related to the alleged misrepresentations, as opposed to other negative company information, caused the decline in stock price. The Fifth Circuit affirmed on the grounds that Plaintiff had failed to establish loss causation, that is, for each of the alleged misrepresentations, Plaintiff had not established that a curative event had resulted in a negative stock price impact. Petitioner's writ of certiorariseeking reversal of the Fifth Circuit's decision was granted on January 7, 2011.

In its amicusbrief, NCLC argued that the Supreme Court's decision in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), which created the fraud-on-the-market presumption in order to permit securities fraud plaintiffs to meet class certification requirements by allowing them to benefit from a class-wide presumption of reliance, significantly expanded both the Rule 10b-5 implied right of action and Rule 10b-5 class actions. However, Basic expressly limited its expansion by, at the class certification stage, (i) requiring plaintiffs seeking to benefit from the presumption to allege and prove that the alleged misrepresentations were material and that the securities traded in an efficient market, and (ii) permitting defendants to rebut the presumption by "[a] showing that severs the link between the alleged misrepresentation and . . . the price received (or paid) by the plaintiff ... ." Id. at 248. Basicmakes reliance and loss causation relevant to the class certification decision because the absence of loss causation tends to prove either that the alleged misrepresentation was not material or the market was not efficient - either of which independently undermines the fraud-on-the-market presumption. For the same reason, evidence disproving loss causation "severs the link between the alleged misrepresentation and ... the price received (or paid) by the plaintiff" by proving that no event correcting that alleged misrepresentation caused the market price to move downward. Therefore, as NCLC's brief argued, unless the common-sense principle of what goes up must come down is repealed, the absence of loss causation disproves the presumption of reliance.

NCLC also argued that loss causation is independently relevant to two additional class certification issues: definition of the class period, and manageability of the putative plaintiff class. Rule 23(c)(1)(B) requires a court certifying a class action to define, among other things, the class period - when the class begins and ends. In a Rule 10b-5 class action, the class period begins with the first material misrepresentation and ends when the market is cured, that is, when the market has fully absorbed the corrective event, such that it is fully reflected in the market price of the stock. In the absence of loss causation, plaintiff cannot show that the market was ever cured because there is no evidence of a price drop resulting from a curative event. Therefore, an end point for the class period cannot be identified and class certification must be denied. Similarly, Rule 23(b)(3)(D) requires a court to consider whether likely difficulties in managing a class action impact the superiority and predominance requirements of Rule 23(b)(3). Before certifying a Rule 10b-5 class, a court must consider whether multiple subclasses are necessary for those plaintiffs who bought and sold stock while curative events were ongoing, those who sold before any curative events occurred, and those who never sold, or those who sold after all curative events had been absorbed by the market. This could give rise to inter-class conflicts as to how fairly to divide settlement proceeds that may render a broad plaintiff class unmanageable or inefficient. A trial court should be able to consider whether loss causation-related differences among subgroups within a broad class render a proposed class unmanageable, inefficient, or unfair.

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The authors, Richard D. Bernstein and James C. Dugan, are partners at Willkie Farr & Gallagher LLP, and Erin L. Carroll is an associate at the firm. For further information, please contact Richard at (202) 303-1108 or James at (212) 728-8654.

The National Chamber Litigation Center is the leading voice of business in the courts. For more information about this and other NCLC litigation, please contact Sheldon Gilbert, (202) 463-5685, or