In Erica P. John Fund, Inc. v. Halliburton Co., No. 12-10544, 2013 WL 1809760 (5th Cir. Apr. 30, 2013), the United States Court of Appeals for the Fifth Circuit held that a defendant in a securities fraud class action is not entitled to rebut the fraud-on-the-market presumption of reliance at the class certification stage by showing the alleged misstatement caused no market price impact. The Fifth Circuit adopted the same analysis the United States Supreme Court used in Amgen Inc. v. Connecticut Ret. Plans and Trust Funds, 133 S. Ct. 1184 (2013) [blog article here]. There, the Court held that class certification procedures afford securities fraud defendants no right to rebut the presumption through evidence showing the alleged misstatements were not material. The Fifth Circuit’s opinion now extends Amgen by further narrowing the range of rebuttal evidence a district court may consider at the class certification stage.
Plaintiff alleged that Halliburton Co. (“Halliburton”) and its CEO made a series of public misstatements concerning the company’s liabilities and revenues and the cost savings expected from a recent merger. These misstatements purportedly inflated Halliburton’s stock price. According to plaintiff, when Halliburton eventually revealed the truth, the stock price fell, injuring plaintiff and other investors who purchased at the allegedly inflated prices. Plaintiff, on behalf of a putative class, asserted claims against Halliburton and its CEO for violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder.
Plaintiff moved for class certification under Rule 23 of the Federal Rules of Civil Procedure, seeking to satisfy Rule 23(b)(3)’s requirement that common questions predominate by invoking the fraud-on-the-market presumption of reliance. That presumption, when it applies, allows for common proof of reliance on the theory that investors rely upon the integrity of a stock’s trading price and, when the stock trades in an efficient market, such price reflects all public information, including any alleged material misstatements. See Basic, Inc. v. Levinson, 485 U.S. 224, 241-42 (1988). Plaintiff failed, however, to prove loss causation, a fraud-on-the-market prerequisite in the Fifth Circuit at the time (see Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007)), and the district court denied its motion. The appeal of that order reached the Supreme Court, which reversed after concluding loss causation is not among the presumption’s prerequisites. See Erica P. John Fund, Inc. v. Halliburton, 131 S. Ct. 2179, 2184 (2011). On remand, Halliburton further opposed class certification by arguing the alleged misstatements did not in fact affect the market price of the stock. The district court, however, declined to consider the evidence, finding it did not bear on the Rule 23(b)(3) predominance question, and certified the class. Halliburton appealed.
The Fifth Circuit affirmed. It first reviewed Supreme Court precedent. Citing Basic, the Court acknowledged that a defendant is entitled to rebut the fraud-on-the-market presumption by using any showing that “severs the link” between the misrepresentations and the price paid for the security. It also noted, however, that Basic did not decide the extent to which a defendant is entitled to rebut the presumption at the class certification stage. The Fifth Circuit next described Amgen as making clear that at least one prerequisite to proving the fraud-on-the-market presumption on the merits — materiality — is not necessary to justify certification. Amgen instead held that, because materiality is itself a separate Rule 10b-5 element, a failure to prove materiality on the merits causes all claims to fail, leaving no individual issues to adjudicate, much less predominate.
Turning to price impact issue before it, the Fifth Circuit agreed with Halliburton that the absence of price impact removes the basis for presuming the market price of a security in fact transmitted the alleged fraudulent statements. It also agreed that unlike materiality, price impact is neither a Rule 10b-5 element nor a distinct fraud-on-the-market predicate, but rather is probative of the presumption as a whole, and generally rebuts it as a showing that “severs the link” between the fraud and price paid. Nevertheless, the Fifth Circuit deemed the “pivotal inquiry” to be whether a determination of price impact is needed to ensure that common questions predominate under Rule 23(b)(3). It identified the Supreme Court’s Amgen opinion as supplying the proper analytical framework to answer that question.
The Fifth Circuit applied Amgen’s two-part approach. The first question under Amgen asks whether the rebuttal evidence at issue is common to the class. Since price impact evidence measures the alleged misstatement’s effect on the security’s share price, it undoubtedly is common. This answer suggests a district court should not address the evidence at the class certification stage.
The second Amgen question asks whether a failure to show price impact on the merits will cause individual reliance questions to predominate. In other words, does the absence of price impact proof, like the materiality issue in Amgen, “cause all plaintiffs’ claims to fall together?” As price impact is, unlike materiality, not a substantive element of a Rule 10b-5 fraud claim, Halliburton argued that even absent price impact, individual plaintiffs could still pursue viable individual Rule 10b-5 claims.
The Fifth Circuit disagreed. “Although the 10b-5 fraud action does not expressly require proof of price impact as an element of the claim, a plaintiff must nevertheless prevail on this fact in order to establish another element on which the plaintiff does bear the burden of proof: loss causation.” The Court explained that if Halliburton succeeded in showing no price impact (i.e., that stock prices did not increase in response to the alleged misstatements), Halliburton would also necessarily show the alleged corrective disclosures could not have caused any decrease in price. But such decrease — loss causation — is a substantive Rule 10b-5 element, and, without it, all individual plaintiffs’ claims would fail. For this reason the Fifth Circuit concluded that evidence of no price impact posed no risk that individualized questions would predominate and, therefore, did not bear on the district court’s predominance inquiry.
In light of the Supreme Court’s decisions in Halliburton and Amgen, it comes as no surprise that the Fifth Circuit would hold that evidence of no price impact may not be used to rebut the fraud-on-the-market presumption at the class certification stage. That evidence may still be used at summary judgment or trial to undermine several elements of the plaintiffs’ claim, including reliance (through rebuttal of the fraud-on-the-market presumption), materiality and damages.