The Supreme Court held Monday that securities fraud plaintiffs need not prove loss causation in order to obtain class certification.

To prevail on the merits in a private securities fraud action, investors must demonstrate that the defendant’s deceptive conduct caused their claimed economic loss, commonly referred to as “loss causation.”

In Erica P. John Fund, Inc. fka Archdiocese of Milwaukee Supporting Fund, Inc., v. Halliburton Co. et al, the issue was whether securities fraud plaintiffs must also prove loss causation in order to obtain class certification. The Court held Monday that they need not.

The Erica P. John fund, Inc., is the lead plaintiff in a securities fraud class action filed against Halliburton Co. and one of its executives. The suit was brought on behalf of all investors who purchased Halliburton common stock between June 3, 1999 and Dec. 7, 2001.

The District Court found that the action could proceed as a class action but for one problem: Circuit precedent required securities fraud plaintiffs to prove “loss causation” in order to obtain class certification. The Court of Appeals affirmed the denial of class certification. The Supreme Court granted certiorari to resolve a conflict among the circuits.

In a unanimous decision, Chief Justice John Roberts ruled that it was not necessary to prove loss causation to obtain class certification.

In order to certify a class under Rule 23(b)(3), a court must find that the questions of law or fact common to class members predominate over any questions affecting only individual members, and that a class action is  superior to other available methods for fairly and efficiently adjudicating the controversy. 

Whether common questions of law or fact predominate in a securities fraud action often turns on the element of reliance, according to the court. 

“The courts below determined that EPJ Fund had to prove the separate element of loss causation in order to establish that reliance was capable of resolution on a common, classwide basis,” the court stated.

“Reliance by the plaintiff upon the defendant’s deceptive acts is an essential element of the section 10(b) private cause of action, according to the Court, because “proof of reliance ensures that there is a proper ‘connection between a defendant’s misrepresentation and a plaintiff’s injury.’ Basic Inc. v. Levinson, 485 U.S. 224, 243 (1988).”

The court recognized in Basic that requiring proof of individualized reliance from each member of the proposed plaintiff class effectively would prevent such plaintiffs from proceeding with a class action, since individual issues would overwhelm the common ones. The court in Basic sought to alleviate that concern by permitting plaintiffs to invoke a rebuttable presumption of reliance based on what is known as the fraud-on-the-market theory, according to the court. Under that theory, the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations. Under that doctrine, the court said, one can assume an investor relies on public misstatements “whenever he buys or sells stock at the price set by the market.”

“This case restates the status quo and breathes new life into the class certification process for securities cases,” said Mark Foster, a partner at Morrison & Foerster LLP. “The Halliburton decision adds muscle power to the right of defendants to rebut the presumption of reliance that the Supreme Court endorsed in the Basic decision 25 years ago.”

“It’s seldom been the case where defendants are successful in defeating class certification, and that might change a little bit because of Halliburton,” he added.

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