I am pleased to reprint below as a guest post a detailed article about the oral argument this past week before the United States Supreme Court in the case of Erica P. John Fund v. Halliburton Co., No. 09-1403. This guest post was submitted by my friend Kimberly M. Melvin. Kim is a partner in the Wiley Rein law firm in Washington D.C. Background regarding the Halliburton case can be found here. The parties’ briefs in the case, including briefs from amici curiae, can be found here.
I would like to thank Kim for her willingness to publish her article on this site. I welcome guest post from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly.
Here is Kim’s guest post:
This week, the United States Supreme Court heard oral argument in Erica P. John Fund v. Halliburton Co., No. 09-1403 (U.S.). The case involves the denial of a motion for class certification in a securities fraud suit that was affirmed by the United States Court of Appeals for the Fifth Circuit. The argument signals that the Justices are virtually certain to reverse the Fifth Circuit’s decision. Even Halliburton’s attorney, David Sterling of Baker Botts LLP, distanced himself from the Fifth Circuit’s holding that loss causation must be proven at the class certification stage to invoke the fraud-on-the-market presumption of reliance. Yet the Justices’ questions reveal the challenges of determining the specific contours of plaintiffs’ burden of proof at the class certification stage under Basic, Inc. v. Levinson, 485 U.S. 224 (1988), given the scope of inquiry under Federal Rule of Civil Procedure 23. The Supreme Court’s ruling in this case therefore should provide greater guidance to lower courts regarding: (1) what elements plaintiffs must prove to trigger the presumption of reliance at the class certification stage, including whether plaintiffs must prove stock price impact tied to the operative misleading statements; and (2) the contours of plaintiffs’ initial burden of production and ultimate burden of persuasion when defendants present rebuttal evidence.
In Halliburton, the shareholder plaintiffs maintain that from 1999 to 2001, Halliburton made false and misleading statements that understated its asbestos liability and overstated its revenues. At the class certification stage, plaintiffs argued that that a class-wide presumption of reliance applied based on the fraud-on-the-market theory. Defendants countered that plaintiffs could not show any statistically significant price movements in response to either the allegedly false statements or the so-called “corrective disclosures” that assertedly revealed the truth about the prior misstatements. As such, they argued that plaintiffs had not satisfied their burden of proving the operative facts necessary to establish the applicability of the fraud-on-the-market presumption of reliance. Without the presumption, plaintiffs would need to show individual reliance by each class member on the alleged misrepresentation to proceed, and therefore common issues would not predominate over individual issues as required to certify a class under Rule 23.
The district court agreed, denying plaintiffs’ motion for class certification based on the Fifth Circuit’s holding in Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F. 3d 261 (5th Cir. 2007). According to the district court, plaintiffs were unable to employ the fraud-on-the-market presumption of reliance because they failed to show any price distortion as a result of defendants’ alleged misrepresentations. The district court reasoned that plaintiffs presented no evidence that “‘false, non-confirmatory positive statements caused a positive effect on the stock price.’” Archdiocese of Milwaukee Supporting Fund, et al. v. Halliburton Co., et al., No. 3:02-CV-1152-M, 2008 WL 4791492, at *3 (N.D. Tex. Nov. 4, 2008) (quoting Ryan v. Flowserve Corp., 245 F.R.D. 560, 569 (N.D. Tex. 2007)). They also did not show: “‘(1) that an alleged corrective disclosure causing the decrease in price is related to the false, non-confirmatory positive statement made earlier, and (2) that it is more probable than not that it was this related corrective disclosure, and not any other unrelated negative statement, that caused the stock price decline.’” Id.
The Fifth Circuit affirmed, reasoning that plaintiffs could not invoke the fraud-on-the-market presumption of reliance because they had not proven loss causation. According to the Fifth Circuit, “because loss causation speaks to the semi-strong efficient market hypothesis upon which class wide reliance depends,” loss causation must be proven to determine whether class wide reliance may be presumed so that common issues predominate over individual issues under Rule 23. Oscar, 487 F.3d at 269. The Fifth Circuit requires “this showing ‘at the class certification stage by a preponderance of all admissible evidence.’” Archdiocese of Milwaukee Supporting Fund, et al. v. Halliburton Co., et al., 597 F.3d 330, 335 (5th Cir. 2010) (citation omitted).
On appeal to the Supreme Court, plaintiffs maintain that the Fifth Circuit imposed an improper burden on them because loss causation is a merits issue that is not relevant to the class certification inquiry under Rule 23. Halliburton and its CEO contend that under Basic, defendants are entitled to rebut the presumption of reliance based on lack of market impact, and that the outcome of the Fifth Circuit’s decision is consistent with that theory.
Summary of the Oral Argument
Plaintiff’s Opening Argument
Counsel for the shareholder plaintiffs, David Boies of Boise Schiller & Flexner, led off the argument by focusing on the limited nature of the inquiry to certify a class under Rule 23. Nearly immediately, however, Mr. Boies was stopped by Chief Justice Roberts, who asked whether the existence of an efficient market could be disputed at the class certification stage. While noting that the issue had been conceded by defendants below, Mr. Boies responded affirmatively that the efficient market issue is properly addressed at the class certification stage because “the issue of [an] efficient market goes to the presumption of reliance,” and if the court holds that the presumption is not available, “you can have a situation in which the common issues do not predominate over the individualized issues.” Transcript of April 25, 2011 Oral Argument in Erica P. John Fund v. Halliburton Co., No. 09-1403 (U.S. Apr. 25, 2011) (“Tr.”) at 4.
This concession shaped the remainder of Mr. Boies’s argument. Thereafter Justices Alito, Kagan, Scalia and Sotomayor posed questions largely focused on why a court could address the efficient market issue at the class certification stage but not the issue of price impact. Mr. Boies repeatedly responded that loss causation was a merits issue only because it is a class-wide common issue whereas market efficiency addresses the reliance issue, which could raise individualized issues if plaintiffs could not invoke the fraud-on-the-market presumption. As such, Mr. Boies maintained that Basic provides that defendants can only rebut the reliance presumption at the class certification stage with “proof generally disproving the efficiency of the market” and other proof (such as a lack of market impact) must be “reserved for trial,” relying on footnote 29 in Basic. Tr. at 6.
During Mr. Boies’s argument, Justice Scalia honed in on defendants’ position that although the Fifth Circuit used the term loss causation, the court was focused on market impact as a means of rebutting the fraud-on-the-market presumption of reliance. In this regard, Justice Scalia inquired: “Would you be satisfied if we just said we agree with you that the requirement to prove loss causation is -- no good, and sent it back to the Fifth Circuit and then let the Fifth Circuit adopt the theory that Respondents assert they have already adopted? I mean, it’s sort of a Pyrrhic victory, it seems to me, if you haven’t just disapproved loss causation.” Tr. at 9. Mr. Boies acknowledged in responding that “if [the Fifth Circuit] simply changed the wording and called loss causation reliance, obviously it wouldn’t make any difference.” Id. However, Mr. Boies did reply that loss causation and reliance are distinct elements, and that loss causation could only be a class-wide common issue. Tr. at 9-10.
Argument on Behalf of the United States as Amicus Curiae
Nicole A. Saharsky for the government was up next. She focused on three asserted deficiencies in the Fifth Circuit’s decision: “First, the Fifth Circuit [is] conducting a merits inquiry that’s not tethered to the Rule 23 requirements; second, it’s taking a presumption and requiring plaintiffs to prove it; and third, it’s confusing the distinct elements of reliance and loss causation.” Tr. at 15. In addressing the questions posed to Mr. Boies, she affirmed that “[t]he Fifth Circuit could not be more clear” that it “is not talking about rebutting the presumption of reliance . . . [i]t is putting an affirmative burden on plaintiffs [of proving loss causation] that they have to meet in every single case, even if the defendants do not come to court with any evidence.” Tr. at 15.
Justice Scalia quickly focused Ms. Saharsky on price impact and secured the concession that defendants can rebut the efficient market issue. Ms. Saharsky, however, reiterated Mr. Boies’s view that the rebuttal evidence could not include loss causation-related proof because loss causation raises merits issues that “stand or fall on a class-wide basis.” The response prompted Justice Kennedy to posit, “[t]he rule isn’t . . . that simply because the issue is on a class-wide basis, it can’t be challenged at the certification stage. We don’t have a rule that’s that broad, do we?” Tr. at 17. He, together with the Chief Justice, went on to suggest through further questioning that if a class-wide, merits-based issue must be proven to show that common issues predominate (i.e., to invoke the fraud-on-the-market presumption of reliance), like an efficient market, then inquiry as to that issue is appropriate under Rule 23. Tr. at 17-18.
Attempting to address this suggestion, Ms. Saharsky replied that the inquiry is more limited: “when the plaintiffs invoke fraud on the market and they show that there is an efficient market, this Court said in Basic, they can all proceed together because they are showing that . . . the material misstatement was reflected in the stock price. This is an impersonal market in which you rely on the stock price. They all rely on it the same way.” Tr. at 19. Justice Alito seized on this response raising the critical issue to be addressed in the Court’s decision: “And if they show that the statement was not incorporated in the price . . . , then why doesn’t reliance cease to be a common issue and become a question of an individual issue that would have to be proved by each . . . member of the class?” Tr. at 19-20. Ignoring that in such a circumstance individual plaintiffs may still be able to prove direct reliance, Ms. Saharsky responded “[w]ell, in that circumstance reliance ceases to be and the case cannot be established on the merits. They stand or fall together on the merits.” Tr. at 20. Justice Alito followed up, questioning: “[B]ut the fact that they would lose on the merits doesn’t necessarily mean that they are entitled to class certification.” Tr. at 20. Ms. Saharsky rejoined, “They’re entitled to class certification if they have a common issue.” Tr. at 20.
At the end of Ms. Saharsky’s argument, Justice Scalia asked a series of question trying to show that reserving price movement for consideration later because it is a “class-wide common issue” makes little sense when the efficient market issue itself is a common issue: “Instead of proving the efficient market,” what if plaintiff “can prove that there was a statement correcting the alleged misrepresentation, the price of stock went down . . . and they can certify the class.” Tr. at 22. Ms. Saharsky responded that such an approach does not square with Basic, which provided that “in order to establish the presumption that you need to show the efficiency of the market.” Tr. at 22. Scalia pressed further, “They’re not relying on that assumption. . . . [T]hey come in and show that there was a correction of what we alleged was a misstatement and the market went down. . . . And of course, that proves anything only if there’s an efficient market. But that will be a common question to the whole class, so we’ll . . . save that for later.” Tr. at 22. Ms. Saharsky simply responded “Certainly in the courts of appeals now, that’s not the way the plaintiffs proceed. The way they proceed is on the Basic theory.” Tr. at 23. Justice Scalia rejoined, “I understand that. I’m just saying that seems to me it’s a crazy way to run a railroad.” Tr. at 23. Ms. Saharsky concluded by indicating that the courts have applied Basic for 20 years, Congress “has not seen fit to change it,” and respondents have never suggested that it should be revisited. Tr. at 24. The “problem in this case,” according to Ms. Saharsky, is that the Fifth Circuit “was not satisfied with the rules as they exist, and it took the class certification stage and turned it into a merits inquiry stage.” Tr. at 24.
Mr. Sterling then faced the Court. Almost immediately, he conceded that defendants “are not defending all of the language in Oscar, clearly, but the basic test in the Fifth Circuit . . . is not loss causation; it’s price impact, because Basic says . . . any showing that severs the link between the misrepresentation and the stock price defeats the presumption.” Tr. at 26 (citing Basic, 485 U.S. at 248). According to Mr. Sterling, “Basic makes clear . . . that a showing that the stock price was not distorted by the misrepresentation defeats the presumption.” Tr. at 26. He also acknowledged that “the Fifth Circuit put the initial burden on plaintiff and that’s contrary to Basic.” Tr. at 29.
In response to Justice Kagan’s questions, Mr. Sterling described the Fifth Circuit’s essential test espoused by defendants: The test is “not loss causation as this Court knows it in Dura; the test is simply price impact,” meaning plaintiffs had to show price impact to invoke the presumption of reliance. Tr. at 27. This showing can be made one of two ways. First, “[t]hey can show price inflation upon a misrepresentation, which, as this Court made clear in Dura, is not synonymous with loss causation.” Second, they can “show a price decline following a corrective disclosure.” Drawing the distinction between this showing and loss causation, Mr. Sterling posited “while [the price impact] showing is similar to loss causation, it’s an easier, less rigorous showing of loss causation, because under the price impact test at the Fifth Circuit, all the plaintiff needs show is that it’s reasonable to infer that some portion of the decline was attributable to the revelation of the truth.”
In an interesting exchange, Justice Breyer interposed a hypothetical in which a Company issues a false statement saying it found oil in a well, numerous people buy the company’s stock and when it turns out there is no oil, those people lose their money. Tr. at 30. Under his hypothetical, Breyer explains that the presumption of reliance says to a typical plaintiff, “[w]e’re going to say what happened to the typical person on the stock market during that period happened to you, and there are a lot of people who bought and sold on the stock market. And that’s why efficient markets is needed to show at the certification stage.” Tr. at 30. Turning to defendants’ position, Justice Breyer opined, “[b]ut what you’re just saying in terms of whether the revelation lowered the price has nothing to do with the question of what happened to the typical person. . . . It has to do with whether anybody was hurt” and “that has nothing to do with the certification stage.” Tr. at 20.
Mr. Sterling replied that Basic created “an exception to the long understood rule that fraud cases were not appropriate vehicles for class actions because each individual would have to say . . . I read Halliburton’s statement and I relied upon it.” Because such proof would be impractical in most cases, the presumption assumes the entire stock market is like the typical plaintiff and relies on the integrity of the stock price when the stock price is distorted by the misrepresentation. But if the stock price was not in fact distorted by the misrepresentation, it makes no sense to say everybody relied on the misrepresentation through its effect on the stock price.” Tr. at 31. Mr. Sterling further stressed, “it’s not just enough to allege the operative facts” to invoke the presumption, Basic says plaintiffs “have to plead and prove them” subject to rebuttal proof. Tr. at 32. Ultimately, he explained these operative facts are “just surrogates of whether it is reasonable to believe or to infer that the stock price was in fact distorted by the misrepresentation.” Tr. at 33. In contrast to “circumstantial proof” of general market efficiency or the other operative facts, proof of no market impact is “direct proof” undermining “the whole premise of the Basic class-wide presumption of reliance.” According to Mr. Sterling, the lack of price movement “is the DNA proof” and “it makes no sense for district courts to be certifying class actions based upon this indirect or circumstantial proof while ignoring the direct proof of the absence of price impact.” Tr. at 35. Appealing to the Court’s conservative Justices, Mr. Sterling opined that “it would do violence to [the Court’s] admonition [in Stoneridge Investment Partners v. Scientific-Atlanta, 552 U.S. 148 (2008),] that the 10b cause of action ought not be further expanded to make [the] rebuttable presumption of reliance irrebuttable at the class certification stage.” Tr. at 35.
In response to Justices Ginsburg’s and Kagan’s questions regarding what would be left to decide on the merits after the class certification inquiry, Mr. Sterling argues that “falsity, scienter, actual proof of loss causation and damages” would all be undetermined at class certification. Tr. at 37. Along the same lines, Justice Kagan expressed concern about permitting defendants to rebut the presumption by putting an expert on the stand, and then the “Basic presumption falls away, and the plaintiffs have to actually prove their case at the very early stage.” Tr. at 40. Mr. Sterling explained, however, that showing price impact is “not a hard burden to show”: plaintiffs needed only to show a statistically significant price movement in response to any one of the 22 alleged misstatements or one of the alleged corrective disclosures. Tr. at 40.
Mr. Sterling also attempted to address the concern regarding an early hearing on merits issues by indicating that Rule 23 provides district courts with discretion to permit discovery into the merits to the extent such discovery is relevant to the class certification issue, noting that plaintiffs asked for no such discovery in the instant case. Tr. at 41-42. This response drew sharp questioning from the Chief Justice and Justice Scalia, who asked why defendants would want to move up discovery if the class certification stage is so significant because of its in terrorem effect. Mr. Sterling responded that the grant of class certification is indeed a “seminal event” with “huge repercussions for the defendant.” Tr. at 43. The Chief Justice further posited that if one of Halliburton’s objections to plaintiffs’ view is that “it would just postpone the defendant’s ability to rebut the presumption” and “result in countless classes being certified with the certain knowledge that they would have to be decertified later,” if it is so certain, why is there an in terrorem effect? Tr. at 43. Mr. Sterling aptly replied that the Chief Justice’s question assumed “that the defendant has the wherewithal to stick it out through it all, but the sheer grant of class certification which aggregates hundreds . . . tens of thousands of these claims together in one big case makes every one of these cases, in effect, a company case, and it puts huge settlement pressure on the defendant.” Tr. at 43.
Plaintiffs’ Rebuttal Argument
Mr. Boies’ rebuttal attacked Mr. Sterling’s recitation of plaintiffs’ burden of proof under the price movement test as overly simplistic. In this regard, he pointed to the fact that plaintiffs showed a 42% stock price drop in response to a Halliburton asbestos-related statement that plaintiffs’ alleged was a corrective disclosure, which, as defendants’ expert conceded, did not disclose any other unrelated information. Tr. at 46. Nevertheless, the Fifth Circuit held such a showing was not sufficient because the statement did not specifically reference the prior announcement it was alleged to have corrected and therefore that statement was not a corrective disclosure. Tr. at 47. According to Mr. Boies, the Fifth Circuit therefore looked at more than just price movement in rejecting class certification; it looked at merits issues.
Predicting how the Supreme Court will rule in a case by reading the tea leaves from oral argument is no easy feat. Yet, a few observations can be gleaned from the argument:
1. The Supreme Court appears likely to overturn the aspects of Oscar that require plaintiffs to prove loss causation (as opposed to price impact) at the class certification stage.
2. The fundamental issue to be decided by the court is whether defendants are permitted to rebut plaintiffs’ evidence of an efficient market solely with proof that generally disproves the efficiency of the market. Mr. Boies conceded that the sole basis for plaintiffs’ position that defendants’ proof is limited to such evidence is footnote 29 of Basic, which Justice Alito described as “thin” support since the footnote was dictum and Basic was “issued at a time when conditional class certification was permitted.” Tr. at 6. A number of other Justices also seemed to struggle with why the inquiry should be so limited when the lack of price movement itself may at least be an indicator of an inefficient market and, even more, may in fact be direct evidence that the fraud-on-the-market presumption does not apply. Yet the challenge for the Court, if it does not stand on Basic’s footnote 29, will be in drawing the line between what proof should and should not be considered at class certification. For example, as raised in Mr. Boies’s rebuttal, will plaintiffs have to prove that certain statements were in fact corrective disclosures or will it suffice to allege that a statement was a corrective disclosure?
3. Finally, the Justices will have to determine whether on the record before it, they can apply their ruling to the instant case or whether they will remand it. If the court adopts plaintiffs’ more limited class certification inquiry, it appears the Court could reverse the Fifth Circuit and grant class certification given Halliburton’s concession that the market for its stock was efficient. If the Court, however, adopts a middle ground approach, it is likely to remand the case to the Fifth Circuit even if such a result may only be a “Pyrrhic victory,” as Justice Scalia suggests.
No matter how the Court rules, the decision should have a significant impact on the large number securities class actions working their way through the courts. By determining whether class certification will give defendants a real opportunity to test plaintiffs’ claims that the class wide presumption of reliance should apply, the Court’s decision will determine whether class certification can be an important event for settlement and will provide defendants with an opportunity to bring an early appeal. The threat of a negative ruling on the merits at the class certification stage or of an early appeal provides companies, their directors and officers and their insurers with additional leverage and an incentive to “stick it out,” as Mr. Sterling suggested, if a motion to dismiss is denied.