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High court agrees to decide securities fraud class action

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WASHINGTON—The U.S. Supreme Court could raise the bar for plaintiffs seeking to certify classes in securities fraud litigation when it decides a case involving allegations against Halliburton Co.

The case—Erica P. John Fund Inc. fka Archdiocese of Milwaukee Supporting Fund Inc. vs. Halliburton Co. et al.—involves what a plaintiff has to prove before it can obtain class certification on its claims, which in this case include allegations that Halliburton misrepresented its asbestos liabilities.

In the case, which the Supreme Court accepted for review last week, a three-judge panel of the 5th U.S. Circuit Court of Appeals held plaintiffs to a higher standard of proof concerning losses than many other circuits, said legal observers.

But some observers also said the high court is unlikely to go against the approach taken by most appeals courts in certifying classes where securities fraud is alleged.

“Depending on which way the court rules, it could be very significant or, more likely, it won't change much at all,” said Dan A. Bailey, a member of Columbus, Ohio-based law firm Bailey Cavalieri L.L.C.

The case began with a suit brought by the Archdiocese of Milwaukee Supporting Fund as the lead plaintiff in a putative securities fraud class action against Halliburton. It involves the “fraud on the market” theory, under which it is assumed that all public information about a company is known in an efficient market and is reflected in the stock price.

The plaintiff alleged that Halliburton made false statements regarding three areas of its business between June 1999 and December 2001. These were its potential liability in asbestos litigation, its accounting of revenue in its engineering and construction business, and the benefits to Halliburton of a merger with Dresser Industries.

Writing for the 5th Circuit panel, Judge Thomas Reavley said the fund contended that investors lost money when Halliburton later issued disclosures correcting the false statements and the market declined. “In order to obtain class certification on its claims, (the) plaintiff was required to prove loss causation, i.e., that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in the losses,” Judge Reavley wrote.

The U.S. District Court for the Northern District of Texas denied class certification because it held that the fund had not proved the causal relationship. On appeal, the appeals court panel upheld the lower court.

Before the justices agreed to hear the case last week, the acting solicitor general had urged the nation's highest court to take up the case. In its brief, the government argued that the appeals court panel “erred by onset” by considering loss causation at the class certification stage “without determining that it was relevant” to any federal prerequisites for class certification.

According to the government, the appeals court compounded its error by requiring the plaintiff to prove loss causation by a preponderance of the evidence. “As a result, the court requires plaintiffs to prove a significant element of their case at the class-certification stage, without the benefit of full discovery and without consideration of their claims by a jury,” the acting solicitor general argued.

The 5th Circuit decision requires that if plaintiffs want to bring a securities class action, they must show that the misrepresentation affected the company's stock price and the defendant's conduct was intentional, said Chris Appel, an associate in the public policy practice of Shook, Hardy & Bacon L.L.P. in Washington. What's at stake is how “large the window will be open to bring securities suits,” he said.

“The whole issue (of) when should a class action be certified in a securities class action is kind of a hot issue,” said Richard Samp, chief counsel at the Washington Legal Foundation. In practice, companies aren't very happy with the fraud-on-the-market theory and “they would like to make it more difficult for plaintiffs lawyers to certify these as class actions,” he said.

The reason is simple—class actions are expensive to defend, he said. In fact, the cost can lead companies to settle even when the plaintiffs' case appears weak.

“If the case goes for Halliburton, this would be a real breakthrough for corporate defendants,” Mr. Samp said.

“If the court rules as I think it will and rejects the 5th Circuit standard, we're back to where most people thought where we were all along,” said Mr. Bailey. “If the court does adopt the 5th Circuit standard, it in essence it could give the defendants a second bite at the apple.”

“It's important to understand that what the Supreme Court holds as the actual standard may be more important than the resolution of the case,” said Kimberly Melvin, a partner at Wiley Rein L.L.P. in Washington. “The guidance given to the district courts about the level of scrutiny of the merits—especially the loss causation issue—will determine whether class certification provides defendants with a real opportunity to test the merits of a securities class action.”

Historically, class certification was viewed as sort of a fait accompli after the Supreme Court adopted the fraud-on-the-market theory, said Ms. Melvin. “Now that the courts, including the 2nd Circuit and not just the 5th Circuit, are conducting a more rigorous analysis of the Rule 23 class certification requirements, class certification has become another potential tipping point in a securities class action cases.”

“I think it is an important case. Clearly, there is a split among the circuits,” said John LaBarbera, a member in the Chicago office of Cozen O'Connor P.C. “What probably gives the business community pause is over the tension between the apparent merits of the case itself, whether the class claims have merits vs. the process and procedures under Federal Rule 23 for certifying the class.”

Publicly traded companies and their directors and officers have to be concerned about any allegation that they misstated or misrepresented the company's litigation risk as it related in this case to asbestos litigation, said Mr. LaBarbera.

He noted that the appeals court seemed to indicate that Halliburton had issued disclaimers about its litigation risk, the difficulty in assessing that risk and that it had updated its reserves for liability after receiving several adverse verdicts.

“Any publicly traded company has to be concerned that they may also fall victim to a claim similar to those asserted here because of an adverse litigation result, which is extraordinarily difficult to control. Depending on how the Supreme Court ultimately decides, that could certainly have an affect on other publicly traded companies including pharmaceuticals and other businesses that are susceptible to litigation,” Mr. LaBarbera said.