On June 23, 2014, the Supreme Court issued its much-anticipated decision in Halliburton Co. v. Erica P. John Fund, Inc. The court upheld the fraud-on-the-market presumption as a means for securities-fraud plaintiffs to establish reliance on a class-wide basis – but gave securities-fraud defendants the ability to rebut the presumption at the class-certification stage.
The fraud-on-the-market presumption, originally articulated by the Supreme Court 26 years ago in Basic, Inc. v. Levinson, allows securities-fraud plaintiffs to establish reliance – an essential element of securities-fraud claims under Section 10(b) of the Securities and Exchange Act and SEC Rule 10b-5 – without resort to individualized proof that would defeat class certification. According to the court inBasic, the price of shares traded in an efficient market reflects all publicly available information; therefore, any person buying shares in an efficient market is presumptively relying on all public information about those shares, including any misrepresentations.
In Halliburton, shareholders sued Halliburton for securities-fraud, alleging the company and one of its executives made a series of misleading statements. In opposing the plaintiff’s motion for class certification, Halliburton tried to rebut the fraud-on-the-market presumption with evidence that the alleged misstatements did not affect the stock price and, therefore, the plaintiff could not have relied upon the statements simply by purchasing Halliburton’s stock. The trial court refused to consider this evidence at the class-certification stage and certified the class. The Fifth Circuit affirmed. After several justices indicated a willingness to reconsider the fraud-on-the-market presumption last term in Amgen, Inc. v. Conn. Ret. Plans & Trust Funds, Halliburton petitioned the Supreme Court to overturn, or at least modify, Basic’s presumption.
Halliburton’s primary argument for overturning the fraud-on-the-market presumption was that its underlying economic premise – particularly the premise that efficient markets promptly incorporate all publicly available information (also called the “efficient capital market hypothesis”) – had since been disproven. Halliburton argued that, since Basic was decided, economic evidence has demonstrated that markets are not efficient or inefficient in a binary sense; rather, certain markets incorporate some types of information better than other types of information and similarly incorporate information about some stocks better than information about others. Thus, according to Halliburton, a misrepresentation can distort a stock price even in an otherwise “inefficient” market but leave unaffected a stock price in an otherwise “efficient” market, rendering the fraud-on-the-market presumption invalid.
The court disagreed that Basic was so dependent on the efficient capital market hypothesis. As the court explained, the Basic opinion itself acknowledged disagreement over the efficient capital market hypothesis and explicitly stated that it was not adopting “any particular theory of how quickly and completely publicly available information is reflected in the market price.” Rather, Basic was based on “the fairly modest premise,” which has not been refuted by subsequent economic research, that “market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.”
Among its other arguments for overturning Basic, Halliburton argued that the fraud-on-the-market presumption was inconsistent with the Supreme Court’s decision in Wal-Mart Stores, Inc. v. Dukes, which held that plaintiffs seeking class certification must “actually prove – not simply plead – that their proposed class satisfies each requirement of Rule 23.” According to Halliburton, the fraud-on-the-market presumption eliminates the burden on plaintiffs to prove that common issues of reliance predominate over individual issues. Again, the court disagreed. As it explained, the presumption does not eliminate the burden on a plaintiff to prove that the predominance element of Rule 23 is satisfied; it simply sets forth one way a plaintiff may do so.
Halliburton also requested that if the court did not overturn Basic, the court should at the least modify the fraud-on-the-market presumption to either (i) require plaintiffs to prove that the alleged misstatement affected the stock price; or (ii) permit defendants to offer evidence at the class-certification stage regarding lack of price impact to rebut the presumption (as Halliburton had tried to do in the district court).
Halliburton’s arguments in favor of the first alternative were similar to its arguments for overturning Basic, and the court rejected them for the same reasons it declined to overturn Basic.
Regarding the second alternative, the court agreed with Halliburton that defendants should be permitted at class certification to provide evidence that the alleged misstatements did not affect the stock price in order to rebut the fraud-on-the-market presumption. The court noted that price-impact evidence already is provided to district courts at class certification: plaintiffs offer price-impact evidence in the form of event studies to prove that a market is “efficient,” and defendants may offer price-impact evidence to prove a market is not “efficient.” According to the court, “market efficiency and the other prerequisites for invoking the presumption constitute an indirect way of showing price impact.” For a trial court to consider price-impact evidence as to market efficiency, but not directly as to price impact itself, “makes no sense.” In short, “[w]hile Basic allows plaintiffs to establish [price impact] indirectly, it does not require courts to ignore a defendant’s direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock’s market price and, consequently, that the Basicpresumption does not apply.”
Because the lower courts denied Halliburton the opportunity to offer price-impact evidence to rebut the fraud-on-the-market presumption, the court vacated the decision of the Fifth Circuit and remanded the case for further proceedings.
In sum, and although some commentators predicted or speculated it might do so, the court’s much-anticipated decision in Halliburton is not likely to significantly restrict private securities litigation. The decision does provide securities-fraud defendants with additional ammunition to use in opposing class certification. But by leaving the fraud-on-the-market presumption in place, the court declined to significantly alter the current landscape. It seems unlikely that the decision will have much effect on the number of securities-fraud class actions filed going forward.
Chief Justice Roberts delivered the opinion of the court, joined by Justices Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan. Justices Scalia, Thomas, and Alito concurred in the judgment, but would have overturned Basic.