Will the Fifth Circuit Get to Keep Its Oscar?: The Fraud-on-the-Market Presumption in Certification of a Securities Fraud Class Action

Abstract

This commentary analyzes the 2010-11 Supreme Court Term case, Erica P. John Fund v. Halliburton. The Erica P. John Fund sued Halliburton Co. in a securities fraud class action for losses stemming from alleged misleading statements. The Court will determine the plaintiff’s burden of proof to support class certification based on so-called “fraud-on-the-market” presumption. 

The issue in Fund focuses on whether plaintiffs seeking certification of a securities fraud class action also must, in addition to invoking a rebuttable fraud-on-the-market presumption, demonstrate by a preponderance of the evidence “loss causation” ― that alleged misrepresentations had an impact on a company’s stock price.

Nearly two decades after the Supreme Court’s articulation of the fraud-on-the-market presumption of reliance in Basic v. Levinson, the Fifth Circuit in its 2007 Oscar decision clarified standards for applying the presumption. The Fifth Circuit indicated that courts may not apply the presumption where the evidentiary record at class certification shows that the alleged misstatements did not affect market price. And, one year after Oscar, the Second Circuit similarly concluded that a court may not certify a securities class action using the fraud-on-the-market presumption if the evidence offered by the parties demonstrates that the alleged market misrepresentations did not affect market price. 

In 2010, however, the Seventh Circuit strongly repudiated the Fifth and Second Circuit’s approach, holding that a securities class action may be certified on the fraud on-the-market presumption without considering whether alleged misrepresentations affected market price. The Seventh Circuit indicated that the requirement that plaintiffs show that statements actually caused material changes in stock prices erroneously  required that plaintiffs prove everything (except falsity) that would be required to win on the merits at trail. The Seventh Circuit held that price impact was a question related to the merits of the case, and therefore courts could not and should not consider this question at the class certification stage.

In addition to the Seventh Circuit’s strong repudiation of the Oscar approach, several federal district and circuit courts have disagreed with or distinguished the Oscar holdings. Consequently, there currently is a split among the federal courts concerning how the Court’s Basic presumption applies at the class certification stage of proceedings.

The Fund appeal is significant because the Court will determine whether to re-impose a very liberal set of standards for certification of securities class actions, upholding the Basic presumption of fraud-on-the-market without any other showing, or will affirm lower court decisions which have, in effect, tightened and enhanced those Basic requirements.  The fight embodies a dispute between the Fifth and Seventh Circuits concerning what plaintiffs have to demonstrate at the class certification stage to permit a court to allow a securities class action to proceed.

As such, the Fund decision has broad implications for stock market investors seeking recovery for investment fraud. The plaintiffs and their many friends-of-the-court amici have cast the appeal as a consumer protection case, asking the Court not to turn investors away from the courthouse door at the class certification stage. The United States government, as a friend-of-the-court amicus, has joined the plaintiffs in asking for reversal of the Fifth Circuit’s decision and the Oscar interpretation of the Basic holdings.

The Court will have to determine whether federal courts may require plaintiffs to prove loss causation at the class certification stage. The plaintiffs have suggested that this requirement embodies illegitimate “heightened pleading” at the class certification stage and imposes an improper assessment of the merits of the case, before trial.

In recent years, the Supreme Court has evinced a trend towards supporting heightened pleading requirements for ordinary and class action complaints. In addition, several prominent lower federal courts, including the Second and Third Circuits, also recently have issued landmark decisions clarifying and strengthening the evidentiary burdens of production and persuasion at class certification. Court watchers will now focus on whether the Court in this Fund appeal will endorse the Oscar standard, in light of these recent trends in pleading and class certification.