Securities Litigation and Class Action Takeaways from the Fifth Circuit’s Decision in the Deepwater Horizon Case

09/22/2015

The Fifth Circuit Court of Appeals recently affirmed a district court ruling regarding class certification in a securities class action, Ludlow, et al. v. BP, PLC, et al., stemming from the 2010 Deepwater Horizon explosion in the Gulf of Mexico. The opinion provides several important takeaways for securities class action litigation.

In April 2010, a blowout at an underwater oil and gas well in the Gulf of Mexico resulted in more than five million barrels of oil spilling into the Gulf. B.P, P.L.C (“BP”) co-owned the site, and the company’s stock price declined after the accident. BP investors sued the company and two of its executives for allegedly violating Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. More specifically, the plaintiffs alleged that BP misrepresented the company’s pre-spill safety procedures and misrepresented the flow rate of the oil after the spill.

The plaintiffs sought class certification for two classes of plaintiffs: (1) one class for investors who purchased BP stock prior to the spill based on BP’s alleged pre-spill misstatements regarding safety and risk (“Pre-Spill Class”), and (2) one class for investors who purchased stock after the spill began based on BP’s alleged post-spill misstatements regarding the rate of the spill (“Post-Spill Class”). The district court denied class certification for the Pre-Spill Class, but certified the Post-Spill Class.

Both parties appealed. At issue was whether the district court had properly applied the Supreme Court’s decision in Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013), in analyzing whether issues common to the proposed class members predominate over individual issues.

The Fifth Circuit Court of Appeals affirmed the district court’s decisions to certify the Post-Spill Class and to not certify the Pre-Spill Class. While much of the Court’s analysis is necessarily fact-specific, it provides a number of important reminders and takeaways for securities class action litigation.

Individualized damages issues can by themselves preclude class certification. To obtain certification of a class seeking damages, Federal Rule of Civil Procedure 23(b)(3) requires plaintiffs to show that “questions of law or fact common to class members predominate over any questions affecting only individual members, and that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy.” As is typical in securities class actions involving public companies, the liability issues in BP were considered to be common to the class.

The Fifth Circuit nonetheless affirmed the denial of certification of the Pre-Spill Class because the plaintiffs had not shown that damages were capable of class wide determination. In affirming the district court’s ruling, the Court rejected any suggestion that its 2014 decision in In re Deepwater Horizon, 739 F.3d 790 (5th Cir. 2014), changed Fifth Circuit law regarding the relevance of individualized damages questions to the issue of predominance under Rule 23(b)(3). This decision reinforces longstanding Fifth Circuit law holding that individualized damages issues can by themselves preclude class certification.

“Materialization of the risk” may not be an adequate measure of loss causation or damages in the Fifth Circuit, particularly after Comcast. One of the elements of a securities fraud claim is “loss causation,” which requires plaintiffs to show that they suffered economic losses that were caused by the defendants’ alleged fraud. With respect to the Pre-Spill Class, the plaintiffs in BP relied on a “materialization of the risk” theory of loss causation and damages. Under this theory, investors who purchased stock prior to the spill were allegedly defrauded by BP’s purported misstatements regarding its ability to prevent and contain safety events and were unable to make informed decisions regarding their willingness to take on those risks. Those understated risks then materialized and caused investors’ losses, the plaintiffs argued, after the spill when BP’s stock price dropped.

In affirming the district court’s decision not to certify the Pre-Spill Class, the Fifth Circuit analyzed the damages model submitted by the plaintiffs’ expert and found that it did not provide any mechanism for distinguishing between investors that would not have purchased BP stock in light of the allegedly understated risk and those that may have been willing to take that risk. Plaintiffs therefore failed to show that damages could be proven on a class wide basis.

In addition to holding that damages under a “materialization of the risk” theory could not be proven on a class-wide basis on the facts in BP, the Fifth Circuit also questioned whether “materialization of the risk” is an adequate theory of loss causation. Other courts have held that the theory is sufficient, the Court recognized, but “[w]e need not decide whether that holding is accurate – suffice to say that these cases did not directly address class certification in a post-Comcast world.” That language suggests that the Fifth Circuit may reach a different conclusion.

Investor’s reliance on risk instead of price alone may be inconsistent with the fraud-on-the-market theory. In arguing that their damages model for the Pre-Spill Class was adequate, the plaintiffs attempted to rely on the fraud-on-the-market theory. They argued that because they had proven the prerequisites of fraud-on-the-market, they were entitled to a presumption that the Pre-Spill Class relied on BP’s alleged misstatements and that the alleged misstatements were a cause in fact of the Pre-Spill Class’s losses.

The Court disagreed, recognizing that the fraud-on-the-market theory does not provide any presumptions related to whether the misstatements were the cause of an investor’s losses. In addition, the Court noted that the fraud-on-the-market presumption is rebuttable and the plaintiffs’ damages model itself may have rebutted the presumption. The Pre-Spill Class’s claims were based on allegations that investors relied on the risk of an accident in the Gulf rather than that risk’s impact on BP’s stock price. By arguing that investors relied on factors other than price, the Court viewed the plaintiffs’ own damages model as undercutting one of the rationales of the fraud-on-the-market theory.

A district court is not required to give the plaintiffs multiple bites at the class certification apple. As a final argument in support of the Pre-Spill Class, the plaintiffs asserted that the district court had erred in not permitting them to renew their motion for class certification based on a different theory of damages. Recognizing that the district court had issued “two thorough and well-reasoned” opinions, the Court declined to hold that the district court had erred in not allowing a renewed motion.

A district court may not be required to determine whether alleged corrective disclosures were indeed corrective of alleged misrepresentations at the class certification stage. In support of the Post-Spill Class, the plaintiffs offered an “out-of-pocket losses” theory of damage. Because BP’s stock price was inflated by BP’s alleged misstatements regarding the flow rate of oil into the Gulf, the plaintiffs argued, the plaintiffs were entitled to the difference between the inflated stock price and the true stock price – i.e., the price the stock would have been had BP disclosed the truth.

To measure damages, the plaintiffs’ expert proposed an event study which would evaluate the impact of corrective disclosures on BP’s stock price. More specifically, the plaintiffs’ expert identified six events that purportedly revealed to the public that the magnitude of the spill was greater than BP had initially disclosed and proposed to calculate the impact of those events on BP’s stock price.

The district court certified the class, and BP appealed. Among other things, BP took issue with the district court’s decision not to analyze whether the alleged corrective disclosures actually corrected the alleged misstatements. The Fifth Circuit was not persuaded. Attempting to harmonize Supreme Court decisions in Comcast, Halliburton I, and Amgen, the Court found that in this case the district court did not err by declining to determine whether some of the alleged corrective disclosures were in fact corrective. This is an emerging issue following the Supreme Court’s decision in Halliburton II that will likely continue to develop in the differing factual contexts of different cases.

A damages model that does not allow for certain adjustments could preclude class certification. In affirming certification of the Post-Spill Class, the court emphasized the ability of the plaintiffs’ expert to remove alleged corrective disclosures from his “out of pocket” damages model:

If certain corrective events were later determined to be independent of the misrepresentations, but those corrective events could not be disaggregated from the damages model, the plaintiffs would travel to a place forbidden by Comcast: they would recover damages other than those “resulting from the particular . . . injury on which [defendant’s] liability in this action is premised.”

The Court’s emphasis on the ability of the plaintiffs’ expert to make adjustments to the model could have significant consequences for other cases. Plaintiffs in securities class actions often submit damages models with no apparent means of adjustment if a judge or jury finds that certain alleged misstatements are not actionable or certain negative disclosures were not corrective of the actionable alleged misstatements. The Court’s reasoning in BP suggests that such models would not support class certification because they would run afoul of the Supreme Court’s holding in Comcast.

For additional information, please contact one of the lawyers listed below.

Daniel Gold
214.651.5154
daniel.gold@haynesboone.com

Thad Behrens
214.651.5668
thad.behrens@haynesboone.com

Carrie Huff
214.651.5509
carrie.huff@haynesboone.com

Odean Volker
713.547.2036
odean.volker@haynesboone.com

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