By Andrew Trask
The U.S. Supreme Court has handed down another class-action decision, Erica John Fund v. Halliburton. On one side was Halliburton, the multi-national energy company, that has assumed the status of a pop-culture villain for many. On the other was the class action trial bar, for whom securities class actions are a billion-dollar business. The plaintiffs accused Halliburton of committing securities fraud by downplaying the liability it faced from asbestos litigation (a fact that might lower its stock price), and overstating the benefits of a proposed merger (which would drive the price up). Once the truth came out about the lawsuits and the merger, Halliburton’s stock dropped. When the plaintiffs moved to certify a class of similar investors (a ruling that would change their smaller individual claims into a multi-million dollar lawsuit), Halliburton argued that they could not show that its misstatements actually caused the loss. The trial court denied certification, and the Court of Appeals for the Fifth Circuit affirmed.
Cynical Court-watchers might have expected a 5-4 decision for Halliburton, either because five justices were Republican appointees, or because this Court has a pro-business reputation. But they would have been wrong. The Court ruled unanimously in favor of the investors. Why would it do that? To answer that, we have to look at how securities class actions work.
A class action allows a plaintiff to aggregate a large number of claims into a single lawsuit. If the plaintiff can convince the court her claim is identical to the rest of the proposed class, the court certifies the case as a class action. Once the class is certified, the plaintiff offers proof of her individual claim at trial. If she wins, the whole class wins; but if she loses, then the whole class loses with her. (Class actions rarely go to trial, though. They’re so big defendants will usually settle without trying the case.)
In most securities fraud cases, a plaintiff must prove four facts. First, she must prove the defendant made a statement. (“This merger will make our stock soar 50%!”) Second, she must prove the statement was false. (The company knew the merger was worthless.) Third, she must prove she relied on the statement. (She bought the stock because she believed the company’s statement.) And finally, she must prove she was damaged. (The stock price fell.)
Proving that third fact–reliance–is notoriously difficult to do on behalf of other people. An investor can explain what she was thinking when she bought a stock, but other investors will have different reasons for doing the same thing.
Recognizing that fact, the Supreme Court decided years ago, in a case called Basic, Inc. v. Levinson, that, because stock markets spread price information very quickly, a court could presume a class-action plaintiff had relied on company statements. In other words, if I bought Halliburton stock after they announced their merger, it didn’t matter if I personally knew about it; I would have paid a higher price just because the news was out there.
But to prove fraud, the plaintiff also has to prove “loss causation,” that the misstatement actually caused her loss. Or, as the Court observed, just because a stock price dropped didn’t mean fraud was the cause:
“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.”
So the question the Court faced in this case was: would the plaintiffs have to prove loss causation at class certification, or just later at trial? This issue might sound hypertechnical, but it has very real consequences. Securities class actions are billion-dollar business. The average settlement in a securities class action in 2010 was $109 million. The sums involved are so tempting that many lawyers risk jail to bring cases before their competition does.
Moreover, most of us are investors somehow. Many securities class plaintiffs are pension funds that hold the retirements savings of various workers. The Erica P. John Fund is a charitable foundation. These are not investors that most people want to see losing money. So any rule that changes the balance in these cases can have a significant effect not just on the economy, but on individual’s futures.
In this case, the Supreme Court held that requiring plaintiffs to prove loss causation wrongly imposed a new requirement at class certification–that the plaintiffs prove that the specific misrepresentation actually caused the plaintiffs’ loss. Or, as Justice Roberts wrote for the Court:
“Loss causation addresses a matter different from whether an investor relied on a misrepresentation, presumptively or otherwise, when buying or selling a stock.”
This is basically a case of the Supreme Court preserving the current balance. But in a year when it has had the opportunity to impose stunning changes in how class actions are tried, sometimes just affirming the current law can seem radical.
Andrew Trask, co-chair of the Securities Class Action Group at McGuireWoods LLP, is the co-author of The Class Action Playbook, and discusses class-action strategy at Class Action Countermeasures. Read his previous posts here.