On November 15, 2013, the U.S. Supreme Court announced that it would revisit the "fraud-on-the-market" presumption that it adopted 25 years ago, which substantially expanded securities fraud class actions. The appeal in which the Supreme Court granted certiorari — Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317 — will be watched closely because of the potential ramifications it has for shareholders, public companies, directors and officers.
Background on Section 10(b) Misrepresentation or Omission Cases
Under Section 10(b) of the Securities Exchange Act of 1934, an investor who believes he was deceived in connection with a securities purchase or sale may seek to recover his damages by bringing a lawsuit alleging securities fraud. To prevail, the investor must prove that, among other things, he relied on a misrepresentation, omission or deceptive practice.
In 1988, the Supreme Court decided in Basic Inc. v. Levinson, 485 U.S. 224 (1988) that in cases where a public company is alleged to have made a misrepresentation or omission, the reliance element of a Section 10(b) claim is presumed to be satisfied because, in an efficient stock market, all publicly available and material information about a public company should be reflected in the company's stock price. The fraud-on-the-market presumption, as it came to be known, greatly expanded the securities fraud litigation landscape by allowing a class of shareholders to be certified without requiring that each class member prove that he or she actually relied on the alleged misrepresentation or omission. The presumption is not absolute. In Basic, the Supreme Court held that a defendant can try to rebut the presumption by showing that the stock price was not affected by the misrepresentation or that the plaintiff did not trade in reliance on the integrity of the market price. As a practical matter, however, the rebuttal option did little to temper the growth of securities fraud class actions in the years after Basic was decided.
The Amgen Decision's Effect on Class Certification
In February 2013, the Supreme Court ruled in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184, that securities fraud plaintiffs need not prove the materiality of alleged misrepresentations in order to obtain class certification. (Materiality is another element of a Section 10(b) claim.) Several justices noted, however, that the petitioner in that appeal had not challenged the validity of the fraud-on-the-market presumption and some justices expressed doubts about the foundations for the presumption. Justice Alito remarked that "reconsideration of the Basic presumption may be appropriate."
The Halliburton Appeal Could Impact Federal Securities Fraud Class Actions
It did not take long for a litigant to accept Justice Alito's invitation. In September 2013, Halliburton Co. asked the Supreme Court to revisit its holding in Basic and the court agreed to do so. The first question presented in the Halliburton appeal is "[w]hether [the Supreme] Court should overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory." Oral argument is scheduled for March 2014, and a written decision is expected by July 2014.
If the Supreme Court eliminates or significantly curtails the fraud-on-the-market presumption, the ruling will substantially impact federal securities fraud class actions. If investors are required to plead individual reliance on alleged misrepresentations or omissions, it will be difficult to certify a class of shareholders because, in most cases, classwide issues will not outweigh individual issues. It is possible, however, that such a ruling could prompt Congress to reinstate through legislative means the fraud-on-the-market presumption or a similar mechanism. Absent congressional action, the elimination or curtailment of the fraud-on-the-market presumption would not impact the SEC's ability to pursue enforcement actions because, unlike private litigants, the SEC is not required to prove reliance under Section 10(b). Similarly, eliminating the Basic presumption would have little impact on the ability of investors to pursue class actions under Sections 11 and 12 of the Securities Act of 1933, which allows investors who purchase securities in public offerings to sue for damages without proving that they relied on an alleged misrepresentation or omission in the issuer's offering documents.