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At SEC's Request, Supreme Court Will Review Loss Causation Element of Rule 10b-5 in Class Certification Context

By Jim Hamilton

In a case the SEC urged the Court to take, the US Supreme Court has agreed to decide if plaintiffs in securities fraud actions must satisfy not only the requirements to trigger a rebuttable presumption of fraud on the market, but must also establish loss causation at class certification by a preponderance of admissible evidence without merits discovery. The Supreme Court granted certiorari on January 7, 2011 in the case of Erica P. John Fund, Inc. v. Halliburton Co., et al., 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.

In order to certify a case as a class action, a federal district court must determine that the proposed class satisfies all of the requirements contained in Federal Rule of Civil Procedure 23, one of which is that questions of law or fact common to class members predominate over any questions affecting only individual members.

So long as the plaintiffs have established that the fraud-on-the-market theory is applicable generally by showing that the alleged misrepresentations were made publicly, that the company?s shares were traded in an efficient market, and that they traded shares between the time the misrepresentations were made and the time the truth was revealed, noted amicus, then they have shown that common questions predominate on the question of reliance. If the plaintiffs are subsequently unable to prove that they suffered any loss as a result of the alleged misrepresentations, the defendant will prevail on the merits, but the presence or absence of such proof is irrelevant to the question of class certification.

With respect to loss causation, the only relevant question at the class-certification stage is whether reso¬lution of the loss-causation issue can be expected to turn on proof that is common to class members generally. So long as the loss-causation issue affects investors in common and therefore can be made on a class-wide basis, said the brief, a court may not deny class certification based on its view that the plaintiffs cannot prove that element of their claims. The SEC pointed out that the Fifth Circuit did not suggest that the loss-causation inquiry would vary from plaintiff to plaintiff in a way that would prevent common issues from predominating. Rather, the clear thrust of the court?s analysis was that proof of loss causation was lacking with respect to all members of the class. Amicus contends that the Fifth Circuit erred by denying class certification on a ground unrelated to the requirements of Rule 23.

The Fifth Circuit compounded that error by requiring the plaintiffs to prove loss causation by a preponderance of the evidence at the class certification stage. The Fifth Circuit did not simply ask if the plaintiffs had adequately alleged loss causation or had established a prima facie case on that element, but instead required them to prove loss causation by a preponderance of the evidence, which improperly preempted the merits inquiries that occur at the summary-judgment stage and at trial. The brief contends that the Fifth Circuit erred by requiring plaintiffs to prove loss causation at that early stage.

According to the SEC, the Fifth Circuit?s approach improperly requires district courts to usurp the role of juries in resolving disputed loss causation issues by requiring them to decide at the class-certification stage whether the named plaintiff has proved loss causation by a preponderance of the evidence, not simply whether a reasonable fact-finder could so conclude. That standard denies class plaintiffs in securities-fraud suits the opportunity to have loss causation resolved by a jury.

Full post as published by Jim Hamilton's World of Securities Regulation on January 18, 2011 (boomark / email).