Sunday, May 1, 2011
Regular readers are aware that the SecuritiesLawProf and friends at The Conglomerate have been analyzing the implications (i.e., reading the tea leaves) of the Supreme Court's oral argument in Erica P. John Fund v. Halliburton Co., which was argued on April 26. Dean Michael Kaufman (Chicago-Loyola) and John Wunderlich have prepared these thoughtful comments in response to my last post. I am delighted to share them and welcome additional commentary from readers.
Erica P. John Fund, Inc. v. Halliburton Co., could very well be the most significant securities law decision since Basic, Inc. v. Levinson. Initial thoughts from oral argument at Halliburton seem to be that the Court will not revisit Basic, but refine it. Many expect the Court to hold that plaintiffs need not prove loss causation on a motion for class certification, but that defendants must be given a chance to present evidence of a lack of market efficiency or any evidence that severs the link between the investment decision and the market price, including what respondents called price impact---that a corrective disclosure did not move the market price. In other words, many expect the Court to reject the Fifth Circuit’s approach in Oscar Private Equity Invs. v. Allegiance Telecom., Inc., 487 F.3d 261 (5th Cir. 2007), adopt the Second and Third’s approaches in In re Salomon Analyst Metromedia Litig., 544 F.3d 474 (2d Cir. 2008), and In re DVI, Inc. Sec. Litig., No. 08-8033, 2011 WL 1125926 (3d Cir. Mar. 29, 2011), respectively. Professor Black calls this a Pyrrhic victory for plaintiffs.
Five of the Justices may nevertheless recognize that allowing defendants a chance to rebut the presumption of reliance with proof of market impact is perverse on many levels, and thus preserve Basic. First, opportunity-for-rebuttal approach wrongly conflates reliance (the initial investment decision) with loss causation (the dissipation of inflation), as the Court has defined those terms. The presumption of reliance assumes that because the market was efficient at the time of the fraudulent statement, the fraud is impounded in the company’s stock price. Reliance is thus limited to evidence that the fraud was incorporated into the stock price at the time of purchase. But it is important to note here that at times, there is no market impact on the date of the fraud. Professor Frank Torchio of Forensic Economics, Inc., explains this very well in a paper on event studies and securities litigation available here: http://www.forensiceconomics.com/index.php?option=com_content&task=blogcategory&id=17&Itemid=54. Loss causation, as defined by Dura, asks whether the fraud caused investors to pay an artificially inflated price that they could not recover because that inflation in some way dissipated, i.e., the company issues a corrective disclosure and the stock price drops as a result. The lack of market impact at the back end when discussing corrective disclosures is at best very thin evidence of a lack of reliance---a lack of pre-transaction price impact. Indeed, to argue that months after the fraud the disclosure of the fraud had no impact on the market price and therefore did not influence the original investment decision is nonsensical. We make this point in a recent paper available here http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1825448, as well as argue that the focus on a corrective disclosure, creates an irrational access barrier at class certification for investors.
Second, requiring plaintiffs to prove reliance on class certification still smacks of a merits-based inquiry on class certification rather than the procedural inquiry whether the case is best handled as a class action. The named plaintiff is not asserting actual reliance or else there would be no need for the presumption at all. Rather, the claim rests on presumed reliance, and thus the class will win or lose together only if they prevail on the merits of their claim of reliance on the market price. Thus, proof of reliance on the market price is common to all class members and they may lose as a class if the defendants sever the link.
And if the decision at class certification is a merits-based decision, what about Chief Justice Robert’s question at oral argument whether the decision would become the law of the case, which is actually a pro-defendant concern, much like that originally expressed in Eisen. In Eisen v. Carlisle, the Supreme Court admonished district courts to refrain from deciding the merits at class certification because the Court was concerned that merits-based decisions would actually prejudice defendants. They would be forced to litigate their claims, the Court said, without the traditional protections afforded litigants at trial. Now, if the district court finds reliance or loss causation as part of the class certification process, then defendants are saddled with that decision on the merits later on. As a legal matter, defendants have more to lose than plaintiffs. For example, if the court finds no reliance on loss causation at class certification, the named plaintiff may be bound by that decision through the law-of-the-case doctrine or collateral estoppel, but every other individual plaintiff is not bound in any way because the class was never certified. These individual litigants then are free to pursue individual litigation anew. Practically, individual suits pose a problem for plaintiffs, but legally there is no impediment. By contrast, if the district court finds reliance or loss causation at class certification, then the defendant is bound by that finding as to the entire class. And if, as the parties suggested at oral argument, all discovery relevant to reliance and loss causation is introduced at class certification, then there is no need to relitigate the matter at trial. These issues are resolved the same as if the court decided the issues on summary judgment in favor of the plaintiffs before sending the case to trial on the remaining elements. These questions raised by the law-of-the-case doctrine thus suggest a practical explanation for Basic’s footnote that relegates rebuttal to trial. We might therefore expect that a truly shrewd pro-defendant Supreme Court Justice may actually be reluctant to allow a federal judge to even come close to reaching the merits of a reliance and loss causation at class certification.