On June 23, 2014, the Supreme Court handed down its long-awaited decision in Halliburton Co. v. Erica P. John Fund, Inc. and issued a ruling that could dramatically alter the landscape of class action securities litigation. The question presented was whether or not to overrule Basic Inc. v. Levinson, 485 U.S. 224 (1988), which held that investor plaintiffs could invoke a presumption at class certification that a stock's price reflects all public, material information including material misstatements in order to demonstrate the plaintiffs' reliance on these misrepresentations.1 The Court also considered whether or not defendants should have the opportunity to rebut the presumption at class certification.2 While the high court declined to overturn Basic altogether, it also ruled that defendants should be able to introduce evidence at class certification demonstrating that the misstatements alleged had no effect on the stock’s price, one of the prerequisites necessary to invoke the Basic presumption.
Factual Background and Procedural History
The plaintiffs accused Halliburton and one of its executives of misrepresenting the company's potential liability in asbestos litigation, its expected revenue from construction contracts, and the anticipated benefits of a merger in an attempt to inflate the company's stock price in violation of,inter alia, Section 10(b) of the Securities Exchange Act.3 Halliburton made a number of corrective disclosures that plaintiffs argued caused the company's stock to drop at the investors' expense.4
Lead plaintiff Erica P. John Fund, Inc. moved to certify a class comprising all investors who purchased stock between the alleged misstatements and the corrective disclosures.5 After a lengthy legal battle, which included another appeal to the Supreme Court concerning a separate class certification issue, the district court certified the class, ignoring Halliburton's argument that the evidence it had submitted to disprove loss causation also showed "that none of its alleged misrepresentations had actually affected its stock price."6 The Fifth Circuit affirmed, ruling that such evidence could not be considered at the class certification stage.7
The Supreme Court granted certiorari "to resolve a conflict among the Circuits over whether securities fraud defendants may attempt to rebut the Basic presumption at the class certification stage with evidence of a lack of price impact."8 The Court also "accepted Halliburton's invitation to reconsider the presumption of reliance for securities fraud claims" adopted in Basic.9
The Court Declines to Overrule Basic, Keeping the Presumption Intact
The Court first considered whether or not to overrule the Basic presumption. Specifically, Halliburton argued "that securities fraud plaintiffs should always have to prove direct reliance and that the Basic Court erred in allowing them to invoke a presumption of reliance instead."10 After noting the increased burden for overturning a "long-settled precedent," the Court ruled that Halliburton had failed to make the required showing for the following reasons:
- Halliburton's contention that reading a presumption into a Section 10b-5 right of action contravenes Congress's express intent was simply a resubmission of an argument rejected by the Basic court lacking any "new reason to endorse it now," and need not be considered.11
- In arguing that recent studies had debunked the "efficient capital markets hypothesis" underlying Basic's holding, Halliburton failed "to take Basic on its own terms," noting that the modest premise adopted by the Basic court "that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices" was still valid.12
- Halliburton's argument that Basic's second premise for the presumption was not true (specifically, the notion that investors invest in reliance on the integrity of market price) was also unavailing, as even "value investors" who attempt to beat the market by buying misvalued stocks rely on the fact that the market price "will incorporate public information within a reasonable period."13
- Halliburton's contention that Basic was inconsistent with more recent decisions in which the Court emphasized the need to limit the reach of Section 10b-5 was unpersuasive, as those cases involved the proposed extension of liability to "new categories of defendants who themselves had not made any material, public misrepresentation."14
- The Basic presumption did not relieve Section 10b-5 plaintiffs of the burden to prove, rather than simply plead, the predominance prerequisite to class certification under Federal Rule of Civil Procedure 23(b)(3); rather, the presumption "establishes that a plaintiff satisfies that burden by proving the prerequisites for invoking the presumption," and also affords defendants the opportunity to rebut the presumption.15
The Court also noted that Halliburton's complaint that the Basic presumption had facilitated meritless class actions that imposed "excessive costs on businesses" and consumed "a disproportionately large share of judicial resources" was better addressed to Congress, which had in fact passed legislation addressed to that very issue.16
The Court Also Declines to Require Plaintiffs to Prove Price Impact at Class Certification
The Court next considered Halliburton's two proposed alternatives to overruling Basic: (1) requiring plaintiffs to prove that a defendant's misrepresentation actually affected the stock price in order to invoke the Basic presumption, also called "price impact"; and (2) allowing defendants to rebut the Basic presumption with evidence of a lack of price impact to defeat class certification.
With respect to the argument that plaintiffs should have to prove "price impact," the Court noted that "Halliburton's argument for doing so is the same as its primary argument for overruling theBasic presumption altogether: Because market efficiency is not a yes-or-no proposition, a public material misrepresentation might not affect a stock's price even in a generally efficient market."17Noting that the Basic Court "never suggested otherwise," the Court declined to require plaintiffs to prove "price impact" for "the same reasons we declined to completely jettison the Basicpresumption."18
The Court Permits Defendants to Introduce Evidence Disproving Price Impact to Defeat Class Certification
The Court did, however, agree with Halliburton that Section 10b-5 defendants should be allowed to defeat the Basic presumption at the class certification stage through evidence that the misrepresentation did not, in fact, affect the stock price.19 The Court was persuaded by the undisputed fact that defendants could already introduce evidence to rebut the presumption at the merit stages of litigation, and could introduce such evidence at class certification to counter a plaintiff's showing of market efficiency.20
The Court also found it significant that Section 10b-5 plaintiffs were already introducing evidence at class certification of price impact in connection with "event studies," which are "regression analyses that seek to show that the market price of the defendant's stock tends to respond to pertinent publicly reported events."21 For example, the plaintiffs in Halliburton "submitted an event study of various episodes that might have been expected to affect the price of Halliburton's stock, in order to demonstrate that the market for that stock takes account of material, public information about the company," even examining one of the alleged misrepresentations forming the basis for the suit.22 The Court reasoned that it made no sense to allow defendants to submit price impact evidence without allowing them to use it to rebut the presumption altogether.
The Court demonstrated the "bizarre" scenarios resulting from the Fifth Circuit's decision with a specific example:
Suppose a defendant at the certification stage submits an event study looking at the impact on the price of its stock from six discrete events, in an effort to refute the plaintiffs' claim of general market efficiency. All agree the defendant may do this. Suppose one of the six events is the specific misrepresentation asserted by the plaintiffs. All agree that this too is perfectly acceptable. Now suppose the district court determines that, despite the defendant's study, the plaintiff has carried its burden to prove market efficiency, but that the evidence shows no price impact with respect to the specific misrepresentation challenged in the suit. The evidence at the certification stage thus shows an efficient market, on which the alleged misrepresentation had no price impact. And yet under [the lead plaintiff's] view, the plaintiffs' action should be certified and proceed as a class action (with all that entails), even though the fraud-on-the-market theory does not apply and common reliance thus cannot be presumed.23
The Court concluded that, while the Basic Court's reasoning for allowing plaintiffs an indirect proxy for price impact was sound, that should not preclude the introduction of direct evidence when such evidence is available.24
The Court also addressed the Fifth Circuit's reliance on Amgen, in which the Supreme Court held that plaintiffs need not prove materiality of the alleged misstatement as a prerequisite to class certification, noting that materiality and price impact differed in a crucial respect, namely, that materiality was an objective issue subject to classwide proof, which would not require examination of each individual defendant's actions, as reliance would.25 The Court reasoned that "because materiality is a discrete issue that can be resolved in isolation from the other prerequisites, it can be wholly confined to the merits stage."26
Holding and Potential Impact of the Halliburton Decision
Ultimately, the Court decided to "adhere" to the Basic decision in declining "to modify the prerequisites for invoking the presumption of reliance."27 Even so, the Court held that, in order to "maintain the consistency of the presumption with the class certification requirements of Federal Rule of Civil Procedure 23, defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock."28 As such, the high court vacated the Fifth Circuit judgment and remanded the case to the district court.
The Halliburton decision will certainly have wide-ranging consequences for securities class actions. Section 10b-5 defendants are now armed with a new weapon to defeat class certification. While certification was already a hotly contested issue in Section 10b-5 cases, it is reasonable to expect even heavier litigation surrounding certification now. While eviscerating theBasic presumption altogether would have had more dramatic consequences for Section 10b-5 cases, there is no question that the Court's decision in Halliburton will benefit defendants in a meaningful way going forward.