On Monday, the Halliburton case yielded its second significant U.S. Supreme Court decision, this time with more mixed results. On the one hand, this week’s decision, Halliburton Co. v. Erica P. John Fund, No. 13-317 (U.S. June 23, 2014) (“Halliburton II”), sided with plaintiffs and refused to overrule the fraud- on-the-market theory of reliance established in Basic Inc. v. Levinson, 485 U.S. 224 (1988). On the other hand, the Court held that defendants in securities class actions must be afforded an opportunity to rebut the fraud-on-the-market theory and its presumption of reliance with evidence of a lack of “price impact” before a class is certified.
There is little doubt that Halliburton II will provide defendants with an important tool to end some securities class actions before they are certified. However, in light of the Supreme Court’s recent trend of interjecting merits issues into the resolution of class certification issues — e.g., Wal-Mart Stores Inc. v. Dukes, 131 S. Ct. 2541 (2011), and Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013) — it is important to consider the consequences of adjudicating price impact early in a litigation.
For those who have not followed the Halliburton saga for the last 12 years, it is a classic price drop class action brought pursuant to Section 10(b) of the Securities Exchange Act of 1934. The plaintiffs alleged that Halliburton made certain misrepresentations which inflated the price of its stock until a number of corrective disclosures caused the company’s stock price to drop. Suit followed.
In order to succeed in Section 10(b) actions such as this, plaintiffs must ultimately prove that the class members relied on the defendants’ misrepresentations when they decided to buy or sell the company’s stock. Plaintiffs’ need to demonstrate “eyes and ears” reliance for thousands of investors would be nearly impossible, but since 1988, courts have allowed plaintiffs to satisfy the reliance requirement by invoking the Basic presumption that, in an efficient market, the price of the stock reflects all public, material information (including the alleged misrepresentations). In such cases, courts will presume that anyone who bought or sold the stock at market price relied on those misrepresentations. Thus, it has been defendants’ burden to rebut this presumption and show that the alleged misrepresentation did not actually affect the stock’s price, i.e., that it had no price impact. Before Halliburton II, that rebuttal was often foreclosed to defendants until summary judgment or trial.
The Defendants’ Attempt To Overturn Basic
Taking a cue from Justice Alito’s tantalizing comments in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184, 1204 (2013), Halliburton and business groups argued to the Supreme Court that the entirety of the Basic presumption should be abandoned because the economic theories concerning market efficiency and investor reliance on market price integrity were not supportable. The defense bar was particularly interested in these arguments because without the Basic presumption, plaintiffs would need to show that each investor did in fact rely on the alleged misrepresentations. As an investor-by-investor inquiry, common questions would not predominate and class certification would be all but impossible.
The unanimous Court refused to overrule Basic. In particular, Chief Justice Roberts, writing for the Court, held that there was no necessary “special justification” for overruling Basic and that “Halliburton ha[d] not identified the kind of fundamental shift in economic theory that could justify overruling a precedent on the ground that [Basic] misunderstood, or has since been overtaken by, economic realities.”
The Court’s Middle Ground
The defense bar did not receive the sweeping repudiation of Basic — and a death knell to class action price drop suits — it had hoped for. Nor did the Court adopt the defendants’ proposed alternative that plaintiffs should be required to prove that an alleged misrepresentation actually affected the stock price before invoking the Basic presumption.
However, the Court did arm defendants with another way to defeat these types of suits early on. The Court held that before a class is certified, defendants must be afforded the right to show through direct evidence that any alleged misrepresentation did not impact the price of the company’s stock as a way to rebut the fraud-on-the-market presumption.
This rebuttal might include the following arguments:
- The stock price did not react to the information because:
- The price simply did not move;
- The information was already publicly available, even if not touted in newspaper headlines; or
- There were concurrent causes of price impact — e.g., two pieces of information released at the same time, only one of which corrected the alleged misrepresentation — and it is impossible to attribute the price impact to one piece of information rather than the other.
- The stock is too thinly traded for the market to assimilate information efficiently.
- For dual-listed stock, the U.S. market price reflects foreign market movements more than assimilated information.
The Potential Impact Of Halliburton II: Will It “Raise The Ante” At Class Certification?
Defendants have already been raising reliance arguments after a class is certified, i.e., at summary judgment or trial, but this week’s decision allowing those argument to be litigated at the class certification stage will most likely have a significant impact. Indeed, the defendants in Halliburton II pointed out that while nearly 75% of class certification motions are granted in securities cases, only 7% of those cases make it to summary judgment — because a certified class puts undue pressure on defendants to settle. As a result, defendants who defeat class certification by demonstrating a lack of price impact connected to the alleged misrepresentation will most likely see an end to the pressure to settle, as well as avoid the expenses attached to discovery, summary judgment, or trial.
While defendants will welcome these savings when they are obtained, there are also reasons for defendants to be cautious. Continuing the Wal-Mart-Comcast trend, Halliburton II puts further focus on the class certification stage of securities litigation and will intensify a part of the case which, in recent years, has gone from rarely contested to one of a case’s most critical turning points. Thus, the costs of defending against class certification may increase, as implicitly noted in Justice Ginsburg’s concurrence: “[a]dvancing price impact consideration from the merits stage to the class certification stage may broaden the scope of discovery available at certification.”
Clearly the defense bar has been handed an important new tool to achieve the early resolution of some class action securities litigation — provided that the effort to defeat class certification is successful. However, failure may come at a price: if a defendant chooses to assert the price impact argument at the class certification stage, a ruling on that issue may touch upon other of the elements of a Section 10(b) cause of action. This could include materiality and loss causation. Careful consideration needs to be given to raising price impact at the class certification stage and thereby creating the risk that an adverse determination could potentially undermine other defenses that are typically raised at later stages of the litigation. While it remains to be seen how courts will deal with Halliburton II, it may be that raising price impact at the class certification stage is the Excalibur that will be unsheathed sparingly and only when the prospects for defeating class certification outweigh the possible negatives of a preliminary ruling that may set the tone for the case going forward.