On June 6, 2011, in the case of Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. ___ (2011), the Supreme Court held that Rule 23(b)(3) of the Federal Rules of Civil Procedure does not require securities class action plaintiffs to prove loss causation in order to obtain class action certification for securities fraud actions.^[1]Loss causation refers to the causal connection between a defendant’s deceptive conduct and an investor plaintiff’s claimed economic loss.

In the unanimous decision authored by Chief Justice John G. Roberts, Jr., the Supreme Court vacated the judgment of the Court of Appeals of the Fifth Circuit, which denied class certification based on a securities fraud plaintiff’s failure to establish loss causation.^[2]Notably, the Supreme Court’s ruling in Erica P. John Fund resolved a split between the Fifth Circuit, which required that plaintiffs establish loss causation for class certification, and the First, Second and Seventh Circuits, which maintained that securities fraud plaintiffs did not have to prove loss causation in order to obtain class certification.

In Erica P. John Fund, the lead plaintiff in a putative securities fraud class action brought suit against Halliburton Co. (“Halliburton”) and one of its former executives on behalf of all investors who purchased Halliburton common stock between June 1999 and December 2001. The lead plaintiff alleged that Halliburton made multiple misrepresentations in order to inflate the company’s stock price in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Furthermore, the lead plaintiff alleged that Halliburton made various corrective disclosures that caused the company’s stock price to decline, thereby resulting in losses to investors.

While the District Court held that the lead plaintiff satisfied the general requirements for class action certification under Federal Rule of Civil Procedure 23(a), it ultimately concluded that the remaining prerequisites for class action certification under Rule 23(b)(3) could not be satisfied—in light of Fifth Circuit precedent requiring securities fraud plaintiffs to prove loss causation. Accordingly, the District Court denied class certification.^[3]According to the Fifth Circuit, which affirmed the denial of class certification, the lead plaintiff had to establish loss causation at the certification stage in order to invoke a rebuttable presumption of reliance based on the “fraud-on-the-market” theory, as set forth in Basic, Inc. v. Levinson, 485 U.S. 224 (1988).

Rejecting the Fifth Circuit’s approach, the Supreme Court emphasized that it had never “mentioned loss causation as a precondition for invoking Basic’s presumption of reliance.” Indeed, the Supreme Court explained that loss causation concerns “a matter different from whether an investor relied on a misrepresentation, presumptively or otherwise, when buying or selling a stock.” Loss causation, on the other hand, requires a securities fraud plaintiff to prove “that a misrepresentation that affected the integrity of the market price also caused a subsequent economic loss.”

Because loss causation “has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory,” the Supreme Court held that the Fifth Circuit erred by requiring proof of loss causation as a condition for class certification. Thus, while a lead plaintiff still must establish loss causation at trial, it does not need to do so when seeking class action certification.