The U.S. Supreme Court first reviewed Rules 23(a) and 23(b) of the Federal Rules of Civil Procedure. To obtain class certification, plaintiffs must meet all the requirements of Rule 23(a) and meet one (1) of three (3) options of Rule 23(b). Which option plaintiffs have to meet under 23(b) depends on the relief sought. When the primary relief sought is monetary damages, as in the case of securities fraud actions, plaintiffs must meet the third option in Rule 23. Rule 23(b)(3) requires that there are common questions of law or fact that predominate over any individual class member’s questions and that a class action is superior to other methods of adjudication.

In a private securities fraud claim based on violations of §10(b) and Rule 10(b)(5), plaintiffs must prove: (1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation. Chief Justice Roberts, writing for the Court, explained that in securities fraud cases, whether common questions of law or fact predominate often turns on the element of reliance. Reliance, sometimes called “transaction causation,” refers to whether the plaintiff bought or sold a company’s stock specifically because of a company’s misstatement or omission.

In Basic Inc. v. Levinson, 485 U.S. 224 (1988), the Court recognized that showing that an individual specifically relied on a company’s misstatement or omission in buying or selling stock is an unrealistic burden on a plaintiff who has traded on an impersonal market. The Court, therefore, determined that if stock is traded on a well-developed market, the price of the stock reflects all publicly available information. As such, if plaintiffs can sufficiently show that the misrepresentations were publicly known, that the stock was traded on a well-developed market, and that the plaintiff bought or sold the stock during the time the misrepresentations were made, it would create a rebuttable presumption that the plaintiff relied on the misrepresentation. This is known as the “fraud-on-the-market theory.”

With the preceding understanding, Chief Justice Roberts explained that loss causation, one of the elements of a securities fraud claim, has no logical connection to the facts necessary to establish reliance using the fraud-on-the-market theory. For the fraud on the market theory, the plaintiff must establish that the misstatement of the defendant caused the plaintiff to buy or sell the defendant’s stock. For loss causation, however, the plaintiff must establish that the defendant’s misstatement caused the stock price to change in a way that resulted in an economic loss for the plaintiff. Thus, the Supreme Court found that the Fifth Circuit erred in requiring plaintiff to show loss causation to invoke the fraud-on-the-market presumption at the class certification stage.

Finally, the Supreme Court rejected Halliburton’s suggestion that the Fifth Circuit did not require the plaintiffs to prove loss causation at the class certification stage. Halliburton alleged that the Fifth Circuit merely found that the plaintiffs could not demonstrate reliance — because the alleged misrepresentation did not have any impact on the price of the stock, EPJ could not have relied on the misrepresentation. The Supreme Court did not address the merits of this argument and instead stated, “We simply cannot ignore the Court of Appeals’ repeated and explicit references to ‘loss causation.’” Finding that the Fifth Circuit specifically required EPJ Fund to prove loss causation at the class certification stage, the Supreme Court vacated and remanded the judgment.