On June 23, 2014, the Supreme Court issued its Decision in Halliburton v. Erica P. John Fund (“Halliburton II”). The decision upholds the Court’s prior Basic v. Levinson decision allowing the fraud on the market theory that presumes reliance, however; the Court agreed with Halliburton that defendants could rebut the presumption pre-class certification with evidence that an alleged misrepresentation did not actually affect the stock price. According to Law360, the decision “will likely make it somewhat more difficult for plaintiffs to bring securities class actions, but it stopped short of closing a major door.”

Chief Justice Roberts delivered the opinion of the Court, joined by Justices Kennedy, Ginsburg, Breyer, Sotomayor and Kagan.  Justice Ginsburg filed a concurring opinion, in which Justices Breyer and Sotomayer joined.  Justice Thomas filed an opinion concurring in the judgment, which Justices Scalia and Alito joined.

By way of background, Plaintiffs alleged that Halliburton “made a serious of misrepresentations regarding its potential liability in asbestos litigation, its expected revenue from certain construction contracts, and the anticipated benefits of its merger with another company – all in an attempt to inflate the price of its stock,” which dropped after Halliburton made a series of corrective disclosures.  Plaintiffs filed a motion to certify a class, which the District Court denied.  This District Court (which was affirmed by the Fifth Circuit) found that Plaintiffs must prove “loss causation,” that is, a “causal connection between the defendants’ alleged misrepresentations and the plaintiffs’ economic losses in order to invoke Basic [v. Levinson]’s presumption of reliance and obtain class certification.”  In its 2011 opinion, the Supreme Court vacated the judgment, finding that nothing in Basic justified the Fifth Circuit’s requirement that Plaintiffs prove loss causation at the class certification stage.  On remand, Halliburton argued that it had presented the absence of any price impact caused by its misrepresentations, and thus, investors would have to prove reliance on an individual basis rather than take advantage of Basic, which should defeat certification of the class.  The District Court rejected this argument, and the Fifth Circuit affirmed, finding that Halliburton’s price impact evidence could be used at trial on the merits, but that Halliburton could not use such evidence at the class certification stage.

In its 2014 Decision, the Supreme Court considered Halliburton’s request to overrule Basic’s presumption of reliance and “to instead require every securities fraud plaintiff to prove that he actually relied on the defendant’s misrepresentation in deciding to buy or sell a company’s stock.”  Halliburton advanced several arguments that Basic should be overruled, principal among them the “efficient capital markets hypothesis.” Essentially, Halliburton argued that Basic’s view of the market efficiency (that prices of shares traded on developed markets reflect all publicly available information, including any material misrepresentations) is “no longer tenable.”  According to Halliburton, empirical evidence suggests capital markets are not fundamentally efficient. This evidence, citing to recent crashes, suggests that information affecting a stock price is not immediately incorporated into stock price. The Supreme Court declined to disturb Basic, finding it rested on a “modest” premise.  As the Court held, “[e]ven the foremost critics of the efficient-capital markets hypothesis acknowledge that public information generally affects stock prices.”

While the Supreme Court kept the Basic presumption alive, it did give defendants a weapon.  Overruling the Fifth Circuit, the Supreme Court held that defendants should be able to defeat the presumption at the class certification stage through evidence that the alleged misrepresentation did not affect the stock price – so-called “price impact evidence.”  The Court held:

The fact that a misrepresentation “was reflected in the market price at the time of [the] transaction” – that it had price impact – is “Basic’s fundamental premise.”  Halliburton I, 563 U.S. at __ (slip op., at 7).  It thus has everything to do with the issue of predominance at the class certification stage.  That is why, if reliance is to be shown through the Basic presumption, the publicity and market efficiency prerequisites must be proved before class certification.  Without proof of these prerequisites, the fraud-on-the-market theory underlying the presumption completely collapses, rendering class certification inappropriate.  But as explained, publicity and market efficiency are nothing more than prerequisites for an indirect showing of price impace. There is no dispute that at least such indirect proof of price impact “is needed to ensure that the questions of law or fact common to the class will ‘predominate.’”  Amgen, 568 U.S. at __ (slip op., at 10) (emphasis deleted); see id., at __ (slip op., at 16-17).  That is so even though such proof is also highly relevant at the merits stage

Accordingly, the Court held that Defendants may introduce either “direct” or “indirect” price impact evidence at the class certification stage. Practicallly speaking, this means both sides will rely on experts and price impact studies, which will likely increase costs, and potentially serve as a deterrent to plaintiffs.  As Justice Ginsburg wrote in her concurring opinion, “[t]he Court’s judgment, therefore, should impose no heavy toll on securities-fraud plaintiffs with tenable claims.”  It may, however, result in fewer cases brought by plaintiffs with weaker claims.

In the few days since the decision came out, there has been significant commentary on its reasoning and likely effects.

While the Supreme Court took a “middle road,” many wonder if this created more confusion.  Professor Charles Korsmo of Case Western Reserve University School of Law told the Volokh Conspiracy that the decision “renders an already confused area of the law even more convoluted…”  Among other things, he observed that “[t]he dispute is almost never over whether there actually was a stock drop; it is over whether the company fraudulently concealed the negative information.”

Law 360 noted that the decision leaves open what exactly must be proven to show price impact or the lack thereof:

Price impact studies ultimately will be a tool defendants use to try to defeat claims at the class certification stage, so questions about what exactly defendants need to prove will have to be answered, according to Boris Feldman, a partner at Wilson Sonsini Goodrich & Rosati PC. Is it enough for the defendant to show no price impact followed the false statement? Or will they also have to show there was no impact when the corrective disclosure was made?

The real winners here may be the experts.  Costs will likely increase on both the plaintiff and defendant side to reflect the costs of preparing “price impact studies” at the pre-certification stage.  Beyond the costs of an expert price impact study, commentators also raised the spectre of increased discovery costs. Reuters columnist Alison Frankel, spoke to David Boies, attorney for the Halliburton II plaintiffs. She reported,

Moreover, Boies pointed out, defendants who decide to raise price impact arguments to oppose class certification will have to face shareholders’ discovery demands on the merits of their defenses. That’s going to expose defendants to depositions and documents requests they won’t welcome, he said. “Plaintiffs are going to get a whole lot more information at the class certification stage,” Boies said.

In anticipating of the decision, D&O insurers already began taking action.  As Law 360 reported,

Anticipating a so-called middle-of-the-road ruling in Halliburton, American International Group Inc. had already offered D&O policyholders an “event study endorsement” that will apply a $0 retention toward the cost of class certification event studies — critical tools used in securities litigation to measure an isolated stock price movement.

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A representative for AIG said the Halliburton ruling has not impacted the company’s new policy provision. The decision to provide full, upfront coverage for costs of a class certification event study can be seen as a bet on AIG’s part that the Supreme Court’s decision, though tempered, is likely to benefit at least a few defendants battling securities class actions, experts say.