The Supreme Court teaches a securities lesson

Larry Ribstein —  7 June 2011

In Erica P. John Fund vs. Halliburton the Court held that the Fifth Circuit erred when it required loss causation for class certification.  The Court taught the lower courts the distinction among various elements of securities cases.  In order to get Basic’s presumption of reliance you have to prove, e.g.,

that the alleged misrepresentations were publicly known (else how would the market take them into account?), that the stock traded in an efficient market, and that the relevant transaction took place “between the time the misrepresentations were made and the time the truth was revealed.” Basic, 485 U. S., at 248, n. 27; id., at 241–247; see also Stoneridge, supra, at 159.

But the Court said that you don’t have to prove, as the Fifth Circuit put it

that the decline in Halliburton’s stock was “because of the correction to a prior misleading statement” and “that the subsequent loss could not otherwise be explained by some additional factors revealed then to the market.” Id., at 336 (emphasis deleted).

This is “loss causation,” an element of the plaintiff’s case, often dealt with on motion for summary judgment.

For an analysis of loss causation in the context of the other elements of a 10b-5 case, see my Fraud on a Noisy Market.

Dan Fisher correctly notes that “the U.S. Supreme Court once again confounded critics who accuse it of a pro-business bias.”

But I don’t necessarily agree with him that “[t]he decision reaffirms the entire court’s approval of securities class actions as a method of compensating investors for stock-market losses.”  Nothing fundamental has changed since the Court tightened the loss causation requirement in Dura Pharmaceuticals or limited the foreign reach of the securities laws in Morrison vs. National Australia Bank.  All the Court did is discipline a misapplication of doctrine.  Any more basic fix here will have to be up to Congress.

Larry Ribstein

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Professor of Law, University of Illinois College of Law