Rather than attempting to prove that they themselves actually relied on misstatements or omissions by the defendant, investors bringing 10b-5 claims frequently employ a fraud-on-the-market theory, whereby they can win a presumption of reliance by showing that they reasonably relied on the integrity of an efficient market for the security they purchased.  The success of class actions in particular generally depends on a fraud-on-the-market argument, because showing actual reliance by each individual plaintiff would tend to raise so many individual factual issues as to render the class uncertifiable under Rule 23.

There is a circuit split as to the showing that a plaintiff must make to support a fraud-on-the-market presumption for the purpose of class certification.  In The Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton, the Fifth Circuit required “plaintiffs to establish loss causation in order to trigger the fraud-on-the-market presumption . . . at the class certification stage by a preponderance of all admissible evidence.”  597 F.3d 330, 335 (5th Cir. 2010).  The Seventh Circuit rejects that rule.  Schleicher v. Wendt, 618 F.3d 679, 685–86 (7th Cir. 2010).  On Friday the Supreme Court granted cert in the Fifth Circuit case to address the issue.

More documents at SCOTUSblog.  Also see 10b-5 Daily.  Following the links in the paragraph above, other than to the cases themselves, will give you a sense of how Spindle Law handles splits.

While the Supreme Court’s decisions in Bell Atlantic v. Twombly and Ashcroft v. Iqbal have left Rule 8 pleading in a state of flux and uncertainty, it hasn’t been obvious whether the “plausible on its face” standard of those cases will have much effect on securities cases governed by the already (expressly) heightened pleading requirements of the Private Securities Litigation Reform Act.  Kevin LaCroix of D & O Diary has a good discussion of this issue, including of last week’s McAdams v. McCord, in which the Eighth Circuit affirmed a dismissal for failure to satisfy the new plausibility requirement as to loss causation.  I recommend reading it in full if you’re interested in this issue.

He does draw a conclusion I don’t agree with, namely that by affirming without deciding whether the complaint satisfied the scienter pleading requirement of the PSLRA, the McAdams court implied “that Iqbal’s generalized pleading requirements must be considered analytically prior to the PSLRA’s more particularized requirements.”  That would probably be correct if the court had applied Twombly/Iqbal in analyzing the complaint’s scienter or misstatement allegations, because the PSLRA’s heightened standard applies to those elements.  By applying it to loss causation, though — to which the PSLRA standard does not apply (rule on Spindle) — I think the court simply asserted its authority to affirm on any legally sufficient basis and to pass on other issues.  (Whether there is any special specificity required in pleading loss causation is an issue as to which there has been some disagreement.)  Although there are issues that courts feel they ought to address first (e.g., jursidiction) or avoid if possible (e.g., undecided constitutional issues), the court here faced no such special-priority issues, just a choice among elements to analyze.  (It is notable that the court chose to decide the loss causation issue, because the district court did not reach that issue.  Assuming that loss causation was argued on appeal, though, it’s pretty much your basic affirmed-on-other-grounds.)

I also have a quibble with the rhetorical question that Mr. LaCroix, who supports the plausibility standard, poses to the standard’s opponents:  “are they suggesting that complaints that are not facially plausible should be allowed to go forward?” he asks.  The right question, I think, is whether enough meritorious cases appear implausible to judges prior to discovery to justify letting a case move forward if the complaint satisfies a notice pleading standard.  Reasonable people can disagree.

Those interested in the Twombly/Iqbal pleading standard in general might want to check out several posts and columns on the subject by Mike Dorf, who opposes the standard (and to whose blog I sometimes contribute).  You can find links from his post on strategies for overruling it.

Last Thursday, in In re Williams Securities Litigation – WCG Subclass, — F.3d –, 2009 WL 388048 (10th Cir. Feb. 18, 2009), the Tenth Circuit affirmed the district court’s exclusion, under Federal Rule of Evidence 702 and Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579, 589 (1993), of testimony of plaintiffs’ expert witness as to loss causation.  It therefore also affirmed a summary judgment order against the plaintiffs on the ground that they had failed to offer evidence raising a reasonable inference of loss causation.

Loss causation, an element of a Rule 10b-5 claim, is the causal connection between the defendant’s material misrepresentation or omission and the plaintiff’s loss.   In Williams, the Williams Companies had allegedly misled the market as to the reasons for spinning off a subsidiary, calling it “the best way to ensure that both our energy and communications businesses have the efficient and effective access to the capital necessary to pursue the substantial growth that each enjoys.”  Within two years, the former subsidiary had filed for bankruptcy protection, its stock price having fallen from a peak of $61.81 to $0.06.

The slide in the stock price, however, began well before the alleged misrepresentations, and at no point was there a sharp fall in price immediately following any alleged misstatement.  The plaintiffs therefore relied on testimony of an expert witness, Blaine Nye, a professional expert consultant in these kinds of cases, to explain how the revelation of the truth caused the price drop and plaintiffs’ loss.

Nye offered two theories, neither of which impressed the district court or the Circuit.  The first was that the truth slowly leaked into the market, causing a gradual fall in the stock price.  While plaintiffs are, in principle, free to show loss causation through a “truth leaked out” kind of theory, the Circuit disallowed it here, because, it held, they were required, regardless of the theory, “to show some mechanism for how the truth was revealed,” and they had not done so here.  The second theory was that four specific corrective disclosures caused specific drops in the price.  The court, however, held that Nye had been unable to “tie these four particular disclosures to any of the alleged misrepresentations or describe why they should be considered ‘corrective.’”

Having held that the district court had not abused its discretion by excluding the expert testimony, the Circuit then rejected the plaintiffs’ argument that the jury should be permitted to reach its own inference that the misstatements caused plaintiffs’ loss, based on one of the same two theories.