The U.S. Supreme Court once again confounded critics who accuse it of a pro-business bias, unanimously rejecting a lower-court decision that would have made it harder to pursue securities class actions based on falling stock prices.
In Erica P. John Fund vs. Halliburton, Chief Justice John Roberts ruled that the Fifth Circuit Court of Appeals in New Orleans had erred by stripping the plaintiff lawyers of the ability to form a class action because they couldn’t prove “loss causation.” The term refers to the cause-and-effect relationship between a company’s false statements, which presumably pump a stock price up, and subsequent corrections that cause it to crash. Forcing plaintiffs to prove loss causation merely to form a class, Roberts wrote, would make such litigation nearly impossible.
The decision reaffirms the entire court’s approval of securities class actions as a method of compensating investors for stock-market losses.While the Supreme Court has tinkered with class actions at the margins, and Congress has written laws to make them harder to pursue, Halliburton shows none of the justices is willing to scrap the entire procedure.
“The message is the court itself is not going to upset settled precedent, and it doesn’t want lower courts reaching out in either direction” to restrict or liberalize class actions, said Jordan Eth, co-chair of Morrison Foerster’s securities litigation group.
Securities class actions have been under strong and periodically successful attack by critics who say it is a lucrative industry for plaintiff lawyers that rarely rewards individual shareholders, or does so at the expense of the current investors in a company that pays a big settlement (the cases almost never go to trial.) Last year, in Morrison vs. National Australia Bank, the court rejected securities suits by foreign plaintiffs over foreign stocks in U.S. courts. And in a 2005 decision hailed by class-action critics, Dura Pharmaceuticals, the court required plaintiffs to show “loss causation” — that the company did something to cause investors’ losses — in order to survive a motion to dismiss.
But the Halliburton decision supports one of the fundamental building blocks of securities cases, that a company’s false statements caused a “fraud on the market” that drove a stock up. That concept, affirmed in the 1988 case Basic vs. Levinson, eliminates the need for lawyers to show that every individual investor relied on company statements to buy stock at an inflated price.
The problem with the Halliburton case, Roberts wrote, is that the Fifth Circuit threw out the lawsuit because the plaintiffs couldn’t show “loss causation” as the common thread connecting all the investors. That’s still a requirement, but it kicks in after the defense moves for summary judgment. That typically happens as soon as a case is filed, and then again after the court certifies it as a class action and the defense requires the plaintiffs to supply facts supporting their case. At that point the defense may try to show that the stock fell because of bad economic news in general, or that it fell in the absence of any information from the company.
Halliburton admitted the plaintiffs didn’t have to prove this element of their case merely to get the case certified as a class. The company’s lawyers argued the Fifth Circuit really meant “price impact,” or proof that Halliburton’s statements about its asbestos exposure and the value of contracts actually inflated its stock price.
Roberts wasn’t buying it:
Loss causation is a familiar and distinct concept in securities law; it is not price impact. Whatever Halliburton thinks the Court of Appeals meant to say, what it said was loss causation.The Court takes the Court of Appeals at its word. Based on those words, the decision below cannot stand.