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October Term, 2010

June 6, 2011

Today the Supreme Court issued two decisions, described below, of interest to the business community.

Securities Exchange Act of 1934—Class Certification—Loss Causation

Erica P. John Fund, Inc. v. Halliburton Co., No. 09-1403 (previously discussed in the January 10, 2011 Docket Report)

SEC Rule 10b-5, which implements Section 10(b) of the Securities and Exchange Act of 1934, makes it unlawful for any person, in connection with the purchase or sale of a security, “[t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” 17 C.F.R. § 240.10b-5(b). A private right of action to enforce Rule 10b-5 has been judicially inferred. The elements of the claim include (1) the plaintiff’s reliance on the alleged misrepresentation or omission and (2) loss causation—i.e., that the defendant’s misrepresentation or omission caused the plaintiff’s loss. In a class action, securities-fraud plaintiffs may establish a rebuttable presumption of reliance based on the “fraud on the market” theory, according to which the price of stock in an efficient market reflects publicly available information, including material misrepresentations, such that an investor buying or selling stock at the price set by the market does so in reliance on the integrity of that price. Today, in Erica P. John Fund, Inc. v. Halliburton Co., No. 09-1403, the Supreme Court held that plaintiffs that invoke the fraud-on-the-market presumption of reliance are not required to establish loss causation in order to maintain a securities-fraud suit as a class action.

Petitioner in the case, the plaintiff below, filed a putative class action alleging that respondents Halliburton Company and its CEO, the defendants below, violated Rule 10b-5 by falsifying the company’s financial results and misleading the public about its financial condition with respect to (1) the scope of Halliburton’s potential liability in asbestos litigation; (2) Halliburton’s expected revenue from specific construction contracts; and (3) the benefits of Halliburton’s merger with another company. The district court denied class certification, relying on the Fifth Circuit’s decision in Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007), which required plaintiffs to establish loss causation at the class-certification stage. The Fifth Circuit affirmed. In a unanimous opinion by Chief Justice Roberts, the Supreme Court reversed. It rejected the Fifth Circuit’s conclusion that petitioner “had to prove the separate element of loss causation in order to establish that reliance was capable of resolution on a common, classwide basis.” Slip op. 4.

In so holding, the Court contrasted the element of reliance, also known as “transaction causation,” which “focus[es] on facts surrounding the investor’s decision to engage in the transaction,” slip op. 6-7, with loss causation, which “requires a plaintiff to show that a misrepresentation that affected the integrity of the market price also caused a subsequent economic loss” and “has no logical connection to the facts necessary to establish the efficient market predicate to the fraud-on-the-market theory,” id. at 7-8. Requiring plaintiffs to prove loss causation in order to invoke the rebuttable presumption of reliance, the Court explained, would contravene the fundamental principle that “an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction.” Id. at 7. “The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation,” the Court observed, “has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory.” Id.   

Respondents did not contend otherwise in the Supreme Court. Instead, they defended the decision below on the ground that the Fifth Circuit’s reference to “loss causation” was mere “shorthand” for a “price impact” analysis, which addresses “whether the alleged misrepresentations affected the market price in the first place.” Slip op. 8. The Court rejected that position. “Whatever Halliburton [thought] the Court of Appeals meant to say,” the Supreme Court explained, “what it said was loss causation” and “[b]ased on those words, the decision below cannot stand.” Id. at 9.

Bayh-Dole Act—Agreements to Assign Patent Rights

Board of Trustees of the Leland Stanford Junior University v. Roche Molecular Systems, Inc., No. 09-1159 (previously discussed in the November 1, 2010 docket report).

In a decision that could affect the numerous recipients of federal funding for research, the Supreme Court today addressed the proper interpretation of the Bayh-Dole Act, 35 U.S.C. §§ 200 et seq., which allocates rights in inventions developed with federal funds. The Act allows recipients of federal research funding to retain title to inventions developed with that funding, provided certain conditions are met. The question presented in Board of Trustees of the Leland Stanford Junior University v. Roche Molecular Systems, Inc. was whether the Bayh-Dole Act automatically vested the recipient of federal funding with the rights to an invention developed by one of its employees using that funding. In a 7-2 decision today, the Court held that the Act does not automatically vest title to such inventions with the recipient of federal funding and that title instead remains with the original inventor.

The case stemmed from a dispute between Stanford University and Roche Molecular Systems over the patent for an HIV testing kit. The technology behind the kit was developed by a team including Dr. Holodniy, a Stanford researcher. As part of his research, Dr. Holodniy visited Cetus to learn about a technique Cetus developed known as “PCR.” PCR became an integral part of the HIV testing kit Dr. Holodniy developed.  As a condition of his visit, Dr. Holodniy assigned to Cetus his rights to any inventions developed from knowledge he gained at Cetus. Cetus subsequently sold those rights to Roche. After Stanford secured three patents relating to the HIV testing kit, Stanford sued Roche for violation of the patents. Roche argued that, as a result of Dr. Holodniy’s assignment, it had a right to develop and market the HIV testing kits. 

Chief Justice Roberts, writing for the majority, rejected Stanford’s argument that the Bayh-Dole Act trumped Dr. Holodniy’s assignment of rights to Cetus. The Court focused on the statute’s use of the word “retain,” see 35 U.S.C. § 202(a) (providing that a contractor may “elect to retain title” to an invention), and found such usage incompatible with an implicit vesting of rights. The Court noted that the statutory text also referred to an “invention of the contractor,” see id. (emphasis added), a qualifier which would be surplussage in the presence of an automatic vesting of title. Rejecting Stanford’s arguments, the Court held that the Bayh-Dole Act assumed (as is the common practice) that the federal funding recipient would include in its employment contracts an assignment of rights in inventions to the employer. But, where such an assignment is lacking, long-established background principles of patent law require that the patent rights revert to the individual inventor. Although Stanford had attempted to include such an assignment in its employment contract with Dr. Holodniy, the Federal Circuit previously held that this assignment was ineffective.

In dissent, Justice Breyer, joined by Justice Ginsberg, argued that the Court should have remanded the case to the Federal Circuit for additional development. Justice Breyer outlined two arguments which he felt warranted further briefing in the lower court, before the Supreme Court should pass on the case. First, Justice Breyer strongly criticized the Federal Circuit’s rule which invalidated Stanford’s attempted assignment agreement with Dr. Holodniy. Second, Justice Breyer argued that equitable principles and the goals of the Bayh-Dole Act required a rule that Dr. Holodniy was legally obligated to assign to Stanford his rights in the invention, independent of other agreements with third parties.

Justice Sotomayor wrote a separate concurring opinion, noting her agreement with Justice Breyer’s criticism of the Federal Circuit’s invalidation of Stanford’s assignment agreement. However, she wrote that, because the issue had not been appealed by Stanford, she joined the majority’s affirmance of the Federal Circuit’s decision.

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