On June 6, 2011, the U.S. Supreme Court held in Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. ____ (2011) that plaintiffs accusing Halliburton Co. of securities laws violations do not have to prove loss causation in order to obtain class certification.   

The Halliburton plaintiffs sought class certification for shareholders who allege that Halliburton made misrepresentations designed to inflate its stock price in violation of §10(b) and Rule 10b-5 of the Securities Exchange Act.  The 5th Circuit held that to satisfy Federal Rule of Civil Procedure 23(b)(3) (which requires plaintiffs to show that common questions of law or fact predominate before obtaining class certification), the plaintiffs must show reliance, which may be done through the fraud-on-the-market theory.  The fraud-on-the-market theory gives a rebuttable presumption of reliance to plaintiffs in securities fraud actions, based on the premise that investors rely on any misstatements in the marketplace at the time they buy or sell stock.

The Halliburton plaintiffs were denied class certification by the 5th Circuit, which held that plaintiffs had to prove loss causation to trigger the fraud on the market presumption.  This meant that the plaintiffs had to prove that a causal connection existed between a material misrepresentation made by defendant and the economic loss suffered by plaintiffs at the class certification stage.

A unanimous Supreme Court vacated the 5th Circuit’s decision.  Loss causation, the Court ruled, is different from whether an investor relied on a misrepresentation when buying or selling a stock.  Loss causation requires a plaintiff to show that a misrepresentation that affected the integrity of the market price also caused a subsequent economic loss.  But whether economic loss is caused by a misrepresentation or other factors “has nothing to do with whether an investor relied on that misrepresentation in the first place, either directly or through fraud-on-the-market.”  Thus, the Court held that the Halliburton plaintiffs do not have to prove loss causation for class certification.

Writing for the Wall Street Journal blog, Nathan Koppel calls the decision a “big win” for those who bring shareholder class actions.  Without a doubt, the decision will have an impact on securities class actions currently working their way through the courts.