Supreme Court Hears Securities Fraud Loss Causation Arguments

The U.S. Supreme Court considered Monday whether to make it more difficult for shareholders to proceed with certain class-action securities-fraud lawsuits against publicly traded companies.

The hour-long arguments before the justices in the case comes at a time when dozens of shareholder class actions stemming from the financial meltdown are making their way through the federal courts.

At issue in the case, Erica P. John v. Halliburton, is how courts should set the threshold for certifying a shareholder class action alleging securities fraud.

A group of mutual and pension fund investors sued Halliburton in 2002, alleging the oilfield services company understated its asbestos liabilities while overstating revenues in its engineering and construction business and the benefits of its merger with Dresser Industries.

Those misstatements artificially pumped up Halliburton’s stock price, the lawsuit alleged, adding that the company eventually made corrective disclosures that caused its stock price to fall.

A federal trial court in Texas threw out the case, ruling that shareholders had not proved that their losses were tied to a particular statement made by the company or its officers — a concept known as loss causation.

A U.S. appeals court agreed, ruling that, for the lawsuit to proceed as a class action, the plaintiffs must first prove at the outset, by a preponderance of the evidence, that the alleged misrepresentations caused the stock price to fall, resulting in investor losses.

David Boies, who represented Al Gore before the Supreme Court in the disputed U.S. presidential election in 2000, argued on behalf of the plaintiffs in urging the justices to reinstate the lawsuit.

He said the question of loss causation normally was tested later in the litigation, such as at trial, and that the appeals court has imposed a new test at the class-certification stage.

He was supported during the arguments by Nicole Saharsky, a U.S. Justice Department lawyer who said the appeals court was wrong in essentially requiring the plaintiffs to prove their entire case at such an early stage of the litigation.

“You have to prove there was an initial material misstatement, that it distorted the stock price, that it led to a price decrease and that the price decrease can’t be shown by any other superceding cause,” she said.


Justice Antonin Scalia questioned her argument. “I’m just saying that seems to me it’s a crazy way to run a railroad.”

David Sterling of Houston-based Baker Botts argued for Halliburton and said the proper test had been used.

Justice Ruth Bader Ginsburg said to Sterling: “Your argument seems to say, to get a class certification you have to virtually prove your case on the merits.”

Sterling said class certification was a significant event, with major repercussions.

“The sheer grant of class certification which aggregates … tens of thousands of these claims together in one big case makes every one of these cases, in effect, a company case and it puts huge settlement pressure on the defendant,” he said.

The justices gave no clear indication of how they would rule. A decision is expected by the end of June.

A ruling for Halliburton could have a “devastating effect” on shareholders’ ability to survive the class-certification stage, said Arthur Miller, a professor at New York University Law School who also practices law at Milberg LLP, which represents plaintiffs in shareholder cases.

Having to prove loss causation at that early stage of a case — when plaintiffs have limited power to demand information from the other side — would make it difficult for many classes to be certified, which is bad news for investors, Miller said.

The issue has particular resonance for shareholders who sued companies in the wake of the financial crisis. Many defendants in these cases have argued that large stock drops were caused by the broader financial situation, not by company misstatements.

If the appeals court’s ruling is upheld, “plaintiffs are going to be required to separate market losses from particular alleged misstatements,” said Scott Musoff, a lawyer at Skadden, Arps, Slate, Meagher & Flom, a defense firm. “That’s why this is such a significant case.”

An array of industry trade groups including the Securities Industry and Financial Markets Association and U.S. Chamber of Commerce, have filed briefs for the company.

The Supreme Court in recent years has issued a string of decisions curtailing shareholder lawsuits, rulings that made it harder for plaintiffs to survive motions to dismiss and limited the kind of third parties, such as lawyers and accountants, that shareholders can sue.

This is the second significant case involving class-action certification argued before the Supreme Court in a month. In late March the court consider a case stemming from a lawsuit brought by female employees of Wal-Mart Inc. that could determine the scope of class action lawsuits in employment discrimination cases.

The case is Erica P. John Fund v. Halliburton, No. 09-1403. (Reporting by Jim Vicini and Carlyn Kolker; Editing by Eric Effron)