The first federal court of appeals decision interpreting Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (Halliburton II), was issued this month, involving the common fact pattern of an issuer that missed its earnings guidance. The court determined that the company had successfully shown that an analyst conference call in which management elaborated on its outlook had no impact on the market price of the stock. Although the Supreme Court’s Halliburton II decision declined to roll back the fraud on the market theory of reliance established in Basic Inc. v. Levinson, 485 U.S. 224 (1988), for 10b-5 class actions, the roadmap the Court established in that case for defendants to rebut the Basic presumption with evidence of lack of price impact enabled the defendants in IBEW Local 98 Pension Fund v. Best Buy Co., No. 14-3178 (8th Cir. Apr. 12, 2016), to defeat a motion for class certification and likely bring an end to a shareholder class action.
The Eighth Circuit in Best Buy held that the defendants rebutted the fraud on the market presumption by demonstrating a lack of “front-end” price impact – the alleged misrepresentations did not inflate the company’s stock price when made – and that the defendants were not required to disprove the allegation that a supposed corrective disclosure at a later time caused the stock price to decline at the back end. This result confirms early expectations in the wake of Halliburton II that class certification will continue to be a critical litigation stage where defendants may find opportunities to halt shareholder class actions. See Halliburton II: The Supreme Court Provides Defendants An Important Tool For An Early End To Securities Class Actions. But Has It Also “Raised The Ante” for Class Certification?
The court in Best Buy faced a very typical price drop securities litigation. Before the markets opened on September 14, 2010, Best Buy issued a press release announcing that it was increasing its 2011 earnings guidance. When the market opened, Best Buy’s stock traded up 7.5% over the previous day’s closing price. Later that day, Best Buy held an analyst conference call during which the CFO said the company’s “earnings [we]re essentially in line with [their] original expectations for the year” and that the company was “on track to deliver and exceed [its] annual [earnings per share] guidance.” The stock’s price closed the day slightly lower than its opening high.
Three months later, on December 14, 2010, Best Buy’s stock price dropped 14.8% when the company announced that its third quarter sales were “lower than expected” and that its 2011 earning guidance was being reduced. Unsurprisingly, plaintiffs filed a federal securities class action alleging that the September press release and conference call contained material misrepresentations that artificially inflated Best Buy’s stock price until the alleged truth was revealed in December.
The district court dismissed plaintiffs’ allegations related to the press release, finding that it contained only forward-looking statements protected by the “safe harbor” provision of the PSLRA. However, the district court sustained plaintiffs’ claims in connection with the CFO’s statements on the subsequent conference call that earnings were “in line” with expectations and that the company was “on track” to meet or exceed guidance. Those statements, the district court found (and the court of appeals was not called upon to decide), were representations of present fact, rather than forward–looking statements, and thus were not entitled to the safe harbor protection.
In support of their motion for class certification, plaintiffs submitted an event study showing – not surprisingly – that Best Buy’s stock price increased on September 14 as a result of the company’s improved forecast and, therefore, Basic’s fraud-on-the-market presumption was established. The defendants sought to rebut the presumption by using intra-day price data and demonstrating that while the stock price did increase on September 14, the price increase occurred after the inactionable press release but before the conference call, and the conference call did not further move the market. The plaintiffs’ expert conceded this intra-day analysis but claimed that while the conference call did not inflate the company’s stock price, it could have “maintained” the allegedly inflated price until the price dropped in the wake of bad news in December.
The district court agreed with the plaintiffs and held that “[e]ven though the stock price may have been inflated prior to the earnings phone conference, the alleged misrepresentations could have further inflated the price, prolonged the inflation of the price, or slowed the rate of fall.” Moreover, the district court held that the defendants not only needed to rebut “front-end” price impact but they were also required to show that the company’s stock price did not decrease upon the alleged corrective disclosure – i.e., that they needed to negate “back-end” price impact.
On appeal, the Eighth Circuit reversed in a 2-1 decision, finding that the back-end price drop related to loss causation, which is irrelevant to reliance and thus to the fraud on the market presumption. Rather, what mattered was just the front-end effect, and whether a trader who transacted in the stock presumptively could have relied on the market information assimilated into the stock price. The majority held that the defendants’ evidence, and the plaintiffs’ concession, that there was no statistically significant price increase following the conference call, which merely confirmed what was already known from the press release, “severed any link” between the alleged misstatements and the company’s stock price. The dissent adopted the plaintiffs’ price maintenance theory and would have held the defendants to a greater burden, and required them to demonstrate that the alleged misrepresentation did not counteract a price decline that would have happened “but for” the alleged misrepresentation.
While we await future decisions from the Second and Fifth Circuits in other pending appeals that are likely to address the application of Halliburton II, the Best Buy decision suggests that the class certification stage will remain a fertile ground for defendants seeking to dismiss at least routine “earnings miss” cases. In that regard, there are several points that defendants should note:
- Best Buy’s rejection of the supposition that the conference call statements “could have” caused maintenance of an inflated price makes clear that speculation by plaintiffs will not support class certification.
- Courts should be skeptical of price inflation claims based on mere reassurances about what the company is “on track” to do, or whose substance is otherwise “virtually the same” as what was previously disclosed. The appeals court here noted that the challenged statements in the conference call “added nothing to what was already public.”
- Plaintiffs seeking to pursue a price maintenance theory should have to produce real evidence that the stock price would have fallen in the absence of the challenged statement. Proving that a stock price would have trended downward in the absence of a statement is likely harder, as a practical matter, than showing a one-time bump upward in the wake a positive announcement.
- Once a defendant puts forth evidence to rebut a prima facie showing of price impact, plaintiffs should not be able to rely merely on evidence of back-end loss resulting from corrective disclosure to keep their case alive. That the price later dropped does not mean that the initial statement caused it to go up.
- While increasing the cost of defense relatively early in a litigation, careful expert analysis, including detailed event studies, may lead to the defeat of a class action before costly fact discovery, and thus could be worth the up-front expense.
While the plaintiffs’ bar is seeking to characterize Best Buy as a narrow case limited to its facts, its fact pattern is a common one. Many companies issue a press release with their earnings and then follow it up with an analyst call the same day or shortly thereafter. If subsequent events prove those forecasts to have been optimistic, the ability to obtain dismissal of shareholder litigation at the class certification stage on the ground that the conference call did not move the market beyond the effects of the press release itself is potentially a potent weapon in the defense arsenal. Moreover, if a plaintiff’s expert does not differentiate between the effect of a press release subject to the PSLRA safe harbor and the effect of a subsequent call potentially not subject to such protection, the expert’s report may additionally be subject to challenge under the Supreme Court’s decision in Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013), on the ground that a class cannot be certified – and correspondingly, classwide reliance cannot be presumed – if the predicate for the damages claimed impermissibly mixes actionable and non-actionable conduct or statements.