In what could result in the most significant change in class action securities law in decades, on November 15, 2013, the U.S. Supreme Court granted certiorari in Halliburton v. Erica P. John Fund, Inc. The Court is being asked to overturn its holding in Basic Inc. v. Levinson, 485 U.S. 224 (1988), which allows investors in securities-fraud cases to bring class actions even though they have not relied on the alleged false statements based on the fraud-on-the-market theory of reliance. This theory, which assumes that an efficient market absorbs information which in turn impacts stock price, allows class actions to be brought and certified without proof that the individual lead plaintiff or the class members individually relied on the company’s misleading statements. If Basic is overturned, investors would need to both plead and prove that they individually relied on the alleged false information in the market. This would make certification of securities class actions more difficult because, when individual issues predominate, a class action is not appropriate because it is not the superior method of resolving the claims. Nothing seems more fact specific than whether a member of a class has relied on the specific information alleged to have been false.
The Fraud-on-the-Market Theory
In Basic Inc. v. Levinson, the Court held that plaintiffs may use the fraud-on-the-market theory to invoke a presumption of reliance. In a 4–2 decision, the Court turned to the then-nascent economic theory of efficient markets. The theory states that the price of securities traded in an efficient market will incorporate all publicly available information. Under this theory, misrepresentations will therefore result in distorted market prices. The Court asserted that those who buy and sell securities rely on the integrity of market prices, justifying a presumption of reliance for securities traded in efficient markets. The Court noted that defendants could rebut this presumption through any showing that severs the link between the price paid for the security, or the decision to trade, and the misrepresentation.
Halliburton v. Erica P. John Fund, Inc.
The Erica P. John Fund, Inc. is the lead plaintiff in a class action 10b-5 securities-fraud case against Halliburton. The plaintiffs allege Halliburton made misrepresentations on three separate issues, and suffered a drop in stock price when the truth in those matters was disclosed. To meet the class certification requirement that common issues predominate over individual ones, the plaintiffs relied on Basic’s presumption of investor reliance on the integrity of Halliburton’s market price.
The Court had made a previous ruling in this case in Erica P. John Fund, Inc. v. Halliburton, 131 S.Ct. 2179 (2011). In that decision, the Court unanimously ruled that plaintiffs in federal securities actions do not need to prove loss causation at the class certification stage in order to invoke the fraud-on-the-market presumption established in Basic. On remand, the district court granted class certification. The Fifth Circuit upheld the certification in a 3–0 opinion, and subsequently denied the defendant’s petition for a rehearing en banc.
In the petition for certiorari, the defendant argued that the Court should overrule or substantially overturn its holding in Basic, or in the alternative, allow defendants to prevent class certifications by showing the alleged misrepresentations did not affect the market price of the stock.
Potential Impact on Securities-Fraud Litigation
If the Court chooses to overrule its holding in Basic, it will likely have a substantial impact on class action litigation because it will become far more difficult for plaintiffs to establish reliance through facts that are common to the class. This would preclude certification of the class, which in turn should result in fewer securities class actions.