Argument recap: “A crazy way to run a railroad?”

On April 25, the Court heard oral argument in Erica P. John Fund, Inc. v. Halliburton Co. (No. 09-1403), a case involving the denial of class certification of a proposed Rule 10b-5 securities fraud litigation, brought against Halliburton. The case focuses on the appropriate burden of production at class certification in a securities fraud case, for a plaintiff to be entitled to rely on a presumption of a “fraud on the market.” The Court’s existing precedent creating the “fraud on the market” presumption in Rule 10b-5 securities fraud cases is known as the Basic decision. A plaintiff who properly invokes the so-called Basic presumption thereby satisfies the predominance requirement for certification of a Rule 23(b)(3) damage class action.

 

The Fifth Circuit denied class certification, reasoning that although the plaintiffs satisfied their burden of establishing an efficient market to invoke the presumption, they did not satisfy their burden of showing loss causation, relying on a Fifth Circuit case (Oscar). The plaintiffs contended, on appeal, that the Fifth Circuit imposed an improper burden on the plaintiff class to prove loss causation at class certification, which they argued is a merits issue to be decided at trial. Halliburton argued that under prevailing Supreme Court authority (the Basic decision), that defendants are entitled to present evidence rebutting the presumption based on price impact, and the Fifth Circuit’s decision was consistent with that theory. The Seventh Circuit has repudiated the Fifth Circuit’s Oscar approach to class certification, invoking the fraud on the market presumption.

 

David Boies argued the appeal on behalf of the plaintiff class. Assistant to the Solicitor General Nicole A. Saharsky argued on behalf of the federal government as an amicus in support of the plaintiff class. David Sterling argued on behalf of Halliburton Co.

 

Mr. Boies began his argument on behalf of the plaintiff class by pointing out that both sides had conceded, during the class certification process, that there was an efficient market (a requirement for invoking the “fraud on the market” presumption). In response, Chief Justice Roberts sounded a theme that concerned some other Justices, as well:  he asked whether, if the parties had not mutually conceded the existence of an efficient market, that could have been contested by the defendant? Justice Alito similarly queried whether a defendant has a right to rebut the presumption of reliance. Mr. Boies conceded that the existence of an efficient market could be challenged at class certification.  

Justice Kagan – joined by Justices Sotomayor, Scalia, Kennedy, and the Chief Justice, who all circled back to this point – questioned why if the existence of an efficient market could be contested at class certification, then other elements such as price impact or materiality could not be challenged at class certification. Justice Kagan wanted to know why defendants could rebut one part of the case (efficient market), but not other parts of the case (such as price impact and materiality of corporate statements).

 

When Mr. Boies suggested that these issues were reserved for trial, and not for class certification, Justice Alito suggested that Mr. Boies’s authority, based on a footnote in the Court’s Basic decision, was “pretty thin, isn’t it? It’s a ― it’s dictum in a footnote in an opinion issued at a time when conditional class certification was permitted.” When asked if he had any additional authority to support his position, or any rule-based authority, Mr. Boies conceded that he did not. 

In response to questioning from Justice Ginsburg concerning how a plaintiff class could prove loss causation, Mr. Boies argued that this was susceptible of common proof and could be tested three times: on the pleadings, at summary judgment, and at trial. He suggested that it was improper to impose a fourth opportunity to challenge loss causation at the time of class certification. 

Justice Scalia raised the specter of a possible compromise decision whereby the Court would indicate that the Fifth Circuit was incorrect in requiring a plaintiff to prove loss causation at class certification, and would then remand the case to the Fifth Circuit to clarify that it meant a burden-shifting standard with regard to a showing of price impact.  

Arguing on behalf of the United States, Assistant to the Solicitor General Nicole A. Saharsky stated that the Fifth Circuit erred in three ways in requiring proof of loss causation at class certification: (1) by conducting a merits inquiry that was not tethered to Rule 23 requirements; (2) by taking a presumption and requiring plaintiffs to prove it; and (3) by confusing distinct elements of reliance and loss causation. Ms. Saharsky maintained that loss causation stands or falls on a classwide basis and is a merits issue for trial. Ms. Saharsky argued that “[t]he Fifth Circuit in this case said basically: Prove your whole case.” 

In response to these assertions, Justice Kennedy sought to probe the reach of the class certification process. He asked: “The rule isn’t, I take it ― or correct me if I’m wrong ― that simply because the issue is on a classwide basis, it can’t be challenged at the class certification stage. We don’t have a rule that’s that broad, do we? Or am I missing a point?”  Justice Kennedy further pressed: “But suppose there’s no demonstrated basis that common issue exists?” Ms. Saharsky stuck to her guns and indicated that the plaintiff should then lose at the pleadings stage, because this was a merits issue. Returning to this point, Justice Alito skeptically observed that “Yeah, but the fact that they would lose on the merits doesn’t necessarily mean that they are entitled to class certification.” 

Justice Scalia opined that the courts had the certification process backwards in securities fraud cases, perhaps opening the door to a reconsideration of the Court’s Basic decision. He suggested that if the plaintiffs could prove that a stock price declined after a corporation issued a statement correcting an alleged misrepresentation, then these facts would supply a common question regardless of whether the market was efficient. When Ms. Saharsky pointed out that such a procedure was not consistent with what the Court had articulated in its Basic decision, Justice Scalia indicated: “I know that. I’m just saying that seems to me it’s a crazy way to run a railroad.” Perhaps alarmed at the implied import of Justice Scalia’s comments, Ms. Saharsky quickly noted that Halliburton had never suggested that the Court’s Basic decision should be revisited; that this was not an issue the Fifth Circuit had considered; that it was not an issue briefed to the Court; and that it was not something that, in the government’s view, should be reconsidered. 

On behalf of Halliburton, Mr. Sterling argued that Halliburton was not defending all the language in the Fifth Circuit’s Oscar opinion, particularly that court’s characterization of the class certification issue as one of loss causation. Mr. Sterling suggested that the Basic test in the Fifth Circuit is not loss causation, but price impact. Referring to the Court’s Basic decision, Mr. Sterling pointed out that the Court had indicated that while plaintiffs may invoke the fraud on the market presumption, any showing by a defendant in rebuttal that severs the link between an alleged misrepresentation and the stock price would defeat the presumption.

 

Mr. Sterling agreed with Justice Kagan that, if the Fifth Circuit in Oscar said that loss causation needs to be shown at the class certification stage, then that was an incorrect statement of the law. But Mr. Sterling stressed that the test is not loss causation; it is simply price impact. He also clarified, for Justice Kagan, that his argument was that the defendants have an opportunity to rebut the plaintiff’s use of the Basic presumption, by showing that there was no price impact. According to Mr. Sterling, the defendant has an initial burden to show the absence of price impact. Once the defendant satisfies that threshold showing, the burden shifts back to the plaintiff to show by a preponderance of the evidence that the market price was in fact distorted. He also agreed with Justice Ginsburg that the Fifth Circuit in Oscar had improperly placed an initial burden of production on the plaintiff, and that was contrary to the Court’s decision in Basic. 

To meet its burden of production on the price impact issue and shift the burden to plaintiffs, Mr. Sterling suggested that the defendant could put an expert on the stand to demonstrate that there was no price impact. Justice Kagan expressed skepticism, noting: “Well, that does suggest that the Basic presumption isn’t worth much in your world. That you put an expert on the stand, and the Basic presumption falls away, and the plaintiffs have to actually prove their case at that very early stage that there was no price impact.” 

Justice Ginsburg struggled with the problem of what would be left of the case for trial, if “to get a class certified you have to virtually prove your case on the merits” at the class certification stage. Mr. Sterling responded that demonstrating a break in the link between disclosures and price impact was not a finding on the merits, and several issues would be left for trial, such as the elements of falsity, scienter, loss causation, and damages.  

Mr. Sterling stressed that the Court in Basic had eight times indicated that the fraud on the market presumption was a rebuttable presumption. He argued that the plaintiffs were asking the Court to extend the Basic presumption. To do so, Mr. Sterling contended, “would do violence to [the Court’s Stoneridge] admonition that the 10b cause of action ought not to be further expanded to make that rebuttable presumption of reliance irrebuttable at the class certification stage.” Mr. Sterling further argued that it would make no sense to require federal courts to conduct a rigorous analysis of class certification requirements and make a Rule 23(b)(3) finding, without considering the defendant’s rebuttable proof of whether, in fact, there was price impact. 

In response to questioning from Chief Justice Roberts and Justice Scalia about the possible necessity for enhanced discovery on the price impact issue at class certification, Mr. Sterling suggested that the discovery issue was a “complete red herring.” On the facts in the underlying case, Mr. Sterling pointed out that the Erica P. John Fund had never asked the court for additional discovery. More broadly, Mr. Sterling pointed out that judges can manage limited and tailored discovery prior to class certification proceedings.

 

Finally, Mr. Sterling stressed that a court’s grant of certification in a Rule 10b-5 securities fraud case was a seminal event that has huge repercussions for the defendant. Mr. Sterling pointed out that certification in such class actions places huge pressures on the defendant to settle.

 

In rebuttal, Mr. Boies returned to the discovery problem, suggesting that this was indeed an issue. Mr. Boies suggested that if the Fifth Circuit’s decision was upheld, courts would be making merits decisions without discovery, or that courts would be having discovery before they had class certification.  In addition, Mr. Boies suggested that if the Court was inclined to remand the case to the Fifth Circuit to repudiate that court’s loss causation statements, then the Supreme Court should supply some guidance to the Fifth Circuit on what the right standard is for a court when certifying a securities fraud class action.