Risky Business

In the BP securities class action related to the 2010 Deepwater Horizon spill, the plaintiffs put forward two theories in an attempt to satisfy the class certification requirement that damages be susceptible to measurement across the entire class.

First, the plaintiffs argued that for investors who purchased BP stock before the spill (the “Pre-Spill” class), the company had understated the risk of a catastrophe when it made disclosures about its safety processes.  Under a materialization-of-risk theory, the plaintiffs claimed that the Pre-Spill class should be able to recover the decline in BP’s stock price after the spill occurred because the spill was a forseeable consequence of BP’s alleged inability to prevent and effectively respond to serious safety incidents.

Second, the plaintiffs argued that for investors who purchased stock after the spill (the “Post-Spill” class), the company had made affirmative misstatements concerning the spill rate.  Under an out-of-pocket theory, plaintiffs claimed that the Post-Spill class should be able to recover the difference between their purchase price of BP stock and the price (as determined by an event study) they would have paid had the relevant information been properly disclosed.

Based on the issue of damages, the district court agreed only to certify the Post-Spill class.  On appeal – Ludlow v. BP, P.L.C, 2015 WL 5235010 (5th Cir. Sept. 8, 2015) – the U.S. Court of Appeals for the Fifth Circuit has affirmed that decision.

In Ludlow, the court drew a sharp distinction between the proposed damages methodologies and whether they allowed damages to be measured across each proposed class.  Under the materialization-of-risk theory for the Pre-Spill class, the alleged false statements “resulted in an investor being defrauded into taking a greater risk than disclosed, taking away plaintiffs’ opportunity to decide whether to divest in light of the heightened risk.”  Therefore, the plaintiffs argued, the Pre-Spill class members should be able to recover the bulk of the stock price drop that occurred once that risk materialized in the form of the spill.  The court concluded, however, that the materialization-of-risk theory “was not capable of class-wide determination” because it “hinges on a determination that each plaintiff would not have bought BP stock at all were it not for the alleged misrepresentations.”  This determination was “not derivable as a common question,” but rather required “individualized inquiry.”

In contrast, the court found that the more common out-of-pocket damages theory used for the Post-Spill class was acceptable.  The defendants did raise a number of objections as to the damage calculations, including whether the corrective events relied on by the plaintiffs’ expert were adequately tied to the alleged misstatements.  The court held that resolving these objections at the class certification stage, however, would “vitiate Halliburton I’s requirement that loss causation need not be proved at this stage, since proving the quality of the fit at this stage would also require bringing forward the plaintiff’s proof of causation.”  Moreover, if “certain corrective events were later determined to be independent of the misrepresentations,” they could be removed from the damages measurement without impairing the ability to apply it across the Post-Spill class.

Holding: Affirming district court’s decision to certify only the Post-Spill class.

Quote of note: “To summarize, plaintiffs’ materialization-of-the-risk theory cannot support class certification for two reasons. Unlike the stock inflation model, the materialization-of-the-risk model cannot be applied uniformly across the class . . . because it lumps together those who would have bought the stock at the heightened risk with those who would not have. It also presumes substantial reliance on factors other than price, a theory not supported by Basic and the rationale for fraud-on-the-market theory.”

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