On June 23 2014 the Supreme Court issued its ruling in Halliburton Co v Erica P John Fund, Inc (13-317 (US June 23 2014)), the most anticipated securities decision since its landmark ruling more than 25 years ago in Basic, Inc v Levinson (485 US 224 (1988)). Halliburton leaves intact the fraud-on-the-market presumption of reliance that the Basic court adopted. At the same time, the decision goes beyond Basic by forging new ground. Defendants may now seek to defeat Basic's fraud-on-the-market presumption by introducing evidence at the class certification stage of litigation showing that an allegedly fraudulent statement (or its correction) did not actually affect the stock price of the defendant corporation.
In Basic the court ruled that investors pursuing claims for securities fraud under Section 10(b) of the Securities Exchange Act of 1984 and SEC Rule 10b-5 could satisfy the element of reliance by revoking the fraud-on-the-market presumption of reliance in lieu of showing direct reliance on an alleged misrepresentation. The fraud-on-the-market presumption holds that a public, material misrepresentation will distort the price of stock trade in an efficient market, and that anyone who purchases stock at the market price may be considered to have done so in reliance on the misrepresentation. Without the benefit of that presumption, plaintiffs would have to prove reliance on an individual basis, meaning that individual issues would predominate over common ones and class certification would be inappropriate under Federal Rule of Civil Procedure 23(b)(3).
The Basic decision made the presumption of reliance rebuttable rather than conclusive:
"Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance."
In practice, however, defendants have seldom rebutted the presumption and have done so only late in the litigation.
In Halliburton the court was asked whether it should overrule or modify Basic's presumption of reliance and, if not, whether defendants should nonetheless be afforded an opportunity to rebut the presumption at the class certification stage by showing a lack of price impact. The court declined to overrule or modify Basic, finding no "special justification" for overruling the precedent set in Basic.
Nevertheless, the court ruled that consistent with Basic, defendants may introduce evidence of the lack of price impact at the class certification phase of litigation. Price impact evaluates whether an alleged misrepresentation actually affected the market price of a defendant corporation's stock. "In the absence of price impact, Basic's fraud-on-the-market theory and presumption of reliance collapse," concluded Chief Justice Roberts, who wrote the court's opinion, joined by five others. That is so because the "'fundamental premise' underlying the presumption is 'that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of this transaction". Without evidence of price impact, there is "no grounding for any contention that the investor indirectly relied on that misrepresentation through his reliance on the integrity of the market price."
Halliburton does not alter the framework established by Basic, which requires plaintiffs to introduce at least indirect evidence of price impact at class certification to invoke Basic's fraud-on-the-market presumption: "We adhere to that decision and decline to modify the prerequisites for invoking the presumption of reliance."
Thus, plaintiffs can still meet their burden by proving that:
- the stock traded in an efficient market;
- alleged misrepresentations were publicly known; and
- alleged misrepresentations are material.
All of these factors serve as an "indirect proxy for price impact".
However, that 'indirect' evidence may no longer carry the day for plaintiffs at the class certification stage after Halliburton. Now defendants "may seek to defeat the Basic presumption" at class certification, rather than waiting for summary judgment or trial, by seeking to introduce "direct as well as indirect price impact evidence". To do so, defendants can submit expert analyses, including event studies, which demonstrate that specific alleged misrepresentations did not affect the market price of a stock. The court reasoned that permitting this rebuttal by defendants at class certification was necessary "to maintain the consistency of the presumption with the class certification requirements of Federal Rule of Civil Procedure 23".
In light of the ruling, the court vacated class certification and remanded the case so that direct evidence of price impact may be considered. The decision keeps the 12-year-old case in class certification limbo, where it has been for more than six years. This is the second time that the Supreme Court has itself considered class certification in the case. Previously, in a unanimous opinion, also authored by Roberts, the Supreme Court held in Erica P John Fund, Inc v Halliburton Co (131 S Ct 2179 (2011)) that plaintiffs are not required to prove the element of loss causation at the class certification stage of a case. In the recent opinion, the court explained that that loss causation ruling addressed "a matter different from whether an investor relied on a misrepresentation, presumptively or otherwise, when buying or selling a stock". Nevertheless, in most cases the analysis of price impact will often overlap with the loss causation analysis.
Halliburton is unquestionably a win for securities class action defendants. By explicitly allowing defendants to rebut the presumption of reliance with evidence regarding price impact, it alters the status quo of securities litigation and is likely to breathe new life into the class certification stage of securities class actions.
It is possible that some plaintiffs will react to Halliburton by narrowing the scope of at least some of their cases, forgoing a 'shotgun' approach in which they challenge dozens of statements over long class periods. Nevertheless, the decision is unlikely to change the volume or frequency of securities litigation significantly. Instead, the decision may help to weed out weak cases, or weak parts of cases and may in some cases limit defendants' exposure.
Although all nine justices unanimously supported the outcome – vacating the class certification decision – three justices did not join the chief justice's opinion. Instead, they would have done away with the fraud-on-the-market presumption altogether and overruled Basic. Justice Thomas, joined by Justices Scalia and Alito, opined that "[l]ogic, economic realities, and out subsequent jurisprudence have undermined the foundations of the Basic presumption, and stare decisis cannot prop up the façade that remains".
Justices Ginsburg, Breyer and Kagan joined the chief justice's opinion, but also joined a separate concurrence by Ginsburg, who emphasised that it is "incumbent upon the defendant to show the absence of price impact". They concluded that permitting defendants to do so "should impose no heavy toll on securities-fraud plaintiffs with tenable claims".
Halliburton has led to unprecedented expectations for those involved in securities litigation. Some predicted the end of securities class actions, particularly after Thomas, Kennedy, Scalia and Alito issued concurring and dissenting opinions last year in Amgen, Inc v Connecticut Retirement Plans and Trust Funds (133 S Ct 1184 (2013)), explicitly calling into question the viability of the fraud-on-the-market presumption.
Instead of bringing an end to securities class actions, Halliburton will enable securities class actions to continue, but with an additional check in the form of rigorous price-impact review at class certification. That check bears the hallmark of securities decisions issued by the Roberts court: an attempt to achieve equilibrium. The court's securities opinions consistently seek to preserve the ability of investors to pursue cases, while providing defendants with meaningful tools to defeat them. The court leaves to Congress any significant changes to the framework that governs securities class actions.
For further information on this topic please contact Jordan Eth or Mark RS Foster at Morrison & Foerster LLP by telephone (+1 415 268 7000), fax (+1 415 268 7522) or email (email@example.com or firstname.lastname@example.org). The Morrison & Foerster website can be accessed at www.mofo.com.