On June 23, 2014, the U.S. Supreme Court issued its much anticipated decision in Halliburton Co. v. Erica P. John Fund, No. 13-317, 2014 WL 2807181. Although the Court declined to overrule the “fraud on the market” presumption of reliance adopted in Basic Inc. v. Levinson, 485 U.S. 224 (1988), it held that a defendant may rebut that presumption
at the class certification stage by introducing evidence that the alleged misrepresentation did not affect the stock price. The Halliburton decision does not fundamentally transform securities class action litigation, but it does arm defendants with a potentially important new weapon to defeat class certification in certain cases.
THE BASIC PRESUMPTION OF RELIANCE
In Basic v. Levinson, the Court held that plaintiffs asserting claims under Rule 10b-5 may – in most circumstances involving publicly traded securities – satisfy the reliance element of a Section 10(b) action by means of a rebuttable “fraud on the market” presumption.1 This presumption was predicated upon the “efficient capital markets hypothesis” – an economic theory positing that “the market price of shares traded on well-developed markets reflects all publicly available information,” including “any material misrepresentations,” and on the premise that an “investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price.” Basic, 485 U.S. at 246. According to Basic, “[b]ecause most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentations . . . may be presumed for purposes of a Rule 10b-5 action.” Id. at 247. This rebuttable presumption is crucial to a plaintiff’s ability to maintain a class action because, without it, each member of the purported class would have to offer proof of individualized reliance, and the requirement under Rule 23 that common issues of fact and law predominate over any questions affecting only individual members would not be satisfied. Plaintiffs invariably invoke the presumption of reliance in seeking to certify a class in securities fraud cases.2
THE HALLIBURTON DECISION
In Halliburton, the Court considered two related questions: First, whether Basic’s “fraud on the market” presumption of reliance should be overruled or substantially modified. Second, whether a defendant may rebut the presumption and defeat class certification by introducing evidence that the alleged misrepresentations did not distort the market price of defendant’s stock.
In an opinion by Chief Justice Roberts, joined by five other justices, the Court declined to overrule or modify the “fraud on the market” presumption. The Court considered and rejected Halliburton’s argument that numerous studies have cast doubt on the reliability of the “efficient capital markets hypothesis,” noting that “[e]ven the foremost critics of the efficient-capital-markets hypothesis acknowledge that public information generally affects stock prices.” Halliburton at 10. The Court stated that “Basic recognized that market efficiency is a matter of degree.” Id. The Court also rejected Halliburton’s argument that investors do not rely on the integrity of the market price when buying stock. Investors, Halliburton argued, frequently make investment decisions believing that shares are undervalued or overvalued and therefore present an opportunity to profit. The Court observed, however, that even such investors rely “on the fact that a stock’s market price will eventually reflect material information” – generating the market correction that eventually allows the investor to profit. Id. at 12. Having rejected these arguments, the Court concluded that Halliburton had not set forth the “special justification” necessary for the Court to overrule long-settled precedent, particularly in light of the fact that Congress has shown a willingness to address policy concerns in the area of securities litigation. Id. at 4, 12-16.
Justices Thomas, joined by Justices Scalia and Alito, argued in an opinion concurring in the judgment that Basic was wrongly decided and should be overruled – in particular because, in their view, the efficient capital markets hypothesis had been discredited by recent studies of economic behavior.
Although the Court rejected Halliburton’s frontal assault on Basic, it nevertheless agreed that a defendant should be allowed to rebut the presumption of reliance at the class certification stage by producing evidence that any alleged misrepresentations did not affect the stock price. Prior to Halliburton, a defendant was limited at the class certification stage to challenging the prerequisites for the presumption – usually whether the market for the shares was efficient – and could not directly address price impact until the merits stage. This restriction, the Court held, “makes no sense.” Id. at 19. “Under Basic’s fraud- on-the-market theory, market efficiency and the other prerequisites for invoking the presumption constitute an indirect way of showing price impact. . . . [I]t is appropriate to allow plaintiffs to rely on this indirect proxy for price impact . . . [b]ut an indirect proxy should not preclude direct evidence when such evidence is available.” Id. at 20.3
SIGNIFICANCE FOR SECURITIES LITIGATION
The Halliburton decision makes clear that defendants can attack class certification by offering evidence that an alleged misrepresentation did not actually affect the market price of the stock. As a result, the Halliburton decision is certain to increase defendants’ focus on class certification as a substantial obstacle for putative securities class actions. Moreover, because evidence relating to price impact will often include statistical analyses, such as “event studies,” class certification will likely involve expert opinions – increasing the costs of discovery in connection with class certification.
It remains to be seen whether this new basis for defendants to attack class certification will lead to a substantial increase in the frequency of defense victories at that stage. The decision is likely, however, to encourage more defendants to contest class certification vigorously rather than pursuing settlement when a complaint survives a motion to dismiss, particularly when defendants believe – based on statistical analysis or an events study – that their chances of rebutting the presumption of reliance are strong.