(Article from Securities Law Alert, September 2015)
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On September 8, 2015, the Fifth Circuit affirmed a Southern District of Texas decision denying certification to a proposed class of plaintiffs who alleged that BP had made misrepresentations concerning the safety procedures the company had in place prior to the 2010 Deepwater Horizon oil spill (the “Pre-Spill Class”). Ludlow v. BP, P.L.C., 2015 WL 5235010 (5th Cir. 2015) (Higginbotham, J.). Plaintiffs contended that BP’s statements “creat[ed] an impression that the risk of catastrophic failure was lower than it actually was.” Plaintiffs claimed that when the risk actually materialized in the form of the Deepwater spill, investors who were “defrauded into taking on that heightened risk” were entitled to recover their losses as damages. The Fifth Circuit agreed with the district court that damages based on plaintiffs’ “materialization of the risk” theory could not be measured on a class-wide basis, as required under the Supreme Court’s decision in Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013), because the model required an “individualized inquiry” into whether each investor would have purchased BP stock had that investor known of the true risk of a major spill.
The Fifth Circuit also affirmed the district court's decision certifying a class of plaintiffs who alleged that BP had misrepresented its internal estimates of the Deepwater spill rate.
Comcast: Damages Must Be Capable of Measurement on a Class-Wide Basis to Satisfy Rule 23(b)(3)’s Requirements
Rule 23(b)(3) provides, in relevant part, that “questions of law or fact common to class members [must] predominate over any questions affecting only individual members.” In Comcast, the Supreme Court held that “a model purporting to serve as evidence of damages in [a] class action must measure only those damages attributable to that theory” and must “establish that damages are susceptible of measurement across the entire class for purposes of Rule 23(b)(3).” 133 S. Ct. 1426. The Comcast Court emphasized that “any model supporting a plaintiff’s damages case must be consistent with its liability case, particularly with respect to the alleged . . . effect of the violation.” The Comcast Court further directed that “courts must conduct a rigorous analysis” to ensure that Rule 23(b)(3)’s requirements are met prior to certifying a class.
Fifth Circuit Finds the District Court Properly Declined to Certify the Pre-Spill Class Because the “Materialization of the Risk” Damages Model Required Individualized Inquiries as to Whether Each Plaintiff Would Have Purchased BP Stock Had It Known of the Allegedly Higher Risk of a Spill
The Pre-Spill Class sought damages based on a “materialization of the risk” theory. Plaintiffs claimed that “BP [had] allegedly misstated the efficacy of its safety procedures, creating an impression that the risk of a catastrophic failure was lower than it actually was.” According to plaintiffs, “[t]hese statements resulted in an ‘investor being defrauded into taking a greater risk than disclosed.’”
The Fifth Circuit found that the district court had not “abuse[d] its discretion in holding that the Pre-Spill damages theory was not capable of class-wide determination,” as required under Comcast. The Fifth Circuit explained that plaintiffs’ “materialization of the risk” “theory hinge[d] on a determination that each plaintiff would not have bought BP stock at all were it not for the alleged misrepresentations — a determination not derivable as a common question, but rather one requiring individualized inquiry.”
The court offered the example of two hypothetical pension fund investors, one that only invests in companies with a risk of catastrophic events of less than 1%, and another that has a higher 2% threshold for such risk. The court posited that if BP’s “true risk of a major spill was 2%, but BP’s statements had improperly represented the risk as 0.5%,” then the low-risk pension fund “would not have bought BP stock at all” but “the high-risk fund still might have purchased the stock.” The court explained that “[f]or the second type of plaintiff, full materialization-of-the-risk damages would prove a windfall.” Because plaintiffs’ damages model had no “mechanism for separating these two classes of plaintiffs,” the Fifth Circuit found that the model could not “provide an adequate measure of class-wide damages under Comcast.”
The Fifth Circuit rejected plaintiffs’ claim that under the fraud-on-the-market theory, the court had to “presume[ ] that the Pre-Spill Class relied on BP’s misrepresentations in purchasing the [stock] and the misrepresentations were a cause-in-fact of their losses.” The court explained that the fraud-on-the-market theory set forth in Basic Inc. v. Levinson, 485 U.S. 224 (1988), “does not provide any presumptions with regard to loss causation — whether the misstatement caused the loss.”
Moreover, the court pointed out that “the fraud-on-the-market presumption is rebuttable,” and found that “plaintiffs’ own model may well have rebutted it.” The court explained that the fraud-on-the-market theory “presume[s] reliance because (a) all information in an efficient market is priced into a security and (b) investors typically make investment decisions based on price and price alone.” Here, however, “plaintiffs’ own model assert[ed] that they [had] relied on something other than price: risk.” The Fifth Circuit found that “[b]y claiming that class members may have divested themselves of BP stock if they had known about the true risk of an accident in the Gulf — as distinguished from that risk’s impact on BP’s stock price,” plaintiffs were effectively “arguing that their investment decisions were based substantially on factors other than price.” The Fifth Circuit determined that “plaintiffs’ argument thus undercut[ ] one of the rationales for the Basic presumption of reliance.”
The Fifth Circuit therefore affirmed the district court’s decision denying certification as to the Pre-Spill Class.