Corporations may have stronger defenses against shareholder suits for securities fraud, depending on how the Supreme Court decides Halliburton v. Erica P. John Fund. A decision is expected before the Court ends its term this summer.
The case involves a class of Halliburton shareholders who claim the company lied in its financial statements. When the truth came to light, the shareholders allege, Halliburton’s stock price dropped.
To win their case, the Halliburton shareholders must show not only that the company made a material misrepresentation, but also that they relied upon its misrepresentation in buying or selling the stock. One issue for the Court to decide is what, exactly, it means to “rely.”
Twenty-five years ago in Basic, Inc. v. Levinson, the Court held that a shareholder need not literally rely on statements in a company’s financial statements. Few shareholders have time to read those reports—and so they can seldom claim that they plucked a representation out of a company’s financial reports and relied upon it in making an investment decision. Basic gave shareholders an out, allowing them to prove reliance by merely showing a “fraud on the market.”
The idea is that the market efficiently incorporates all publicly available information into the share price. A misrepresentation in financial statements inflates the share price. And even if investors know nothing of the misrepresentation, they are still defrauded by the very act of purchasing at the inflated price.
Halliburton is asking the Court to overrule or modify Basic.
Naturally, Basic has been a boon to plaintiffs. Dispensing with the need to prove individual reliance on any given statement made it easier for shareholders to band together in a class action. The New York Times reports that corporations have paid $62 billion to settle claims brought by investors in the last decade alone—with plaintiffs’ attorney keeping about $10.5 billion for themselves.
Basic’s “fraud on the market” theory has come under fire from economists and even Supreme Court justices. Though some experts suggest the likelihood of the Court overruling Basic is slim, its application could be narrowed. For instance, the Court may allow defendants to disprove the “fraud on the market” before a class action is certified. That leaves corporations better positioned to reach favorable settlements.
The Halliburton decision is not expected to impact SEC’s ability to bring enforcement actions for misrepresentations made in financial statements, since the SEC is not required to prove reliance.
More information on Halliburton v. Erica P. John Fund, including the briefs filed and a transcript of the Supreme Court’s oral argument, may be found at http://www.scotusblog.com/case- files/cases/halliburton-co-v-erica-p-john-fund-inc.