The U.S. Supreme Court heard oral argument yesterday in the closely watched Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317, which places in the Court’s crosshairs the continued viability of the fraud-on-the-market presumption of reliance first articulated by the Supreme Court in Basic Inc. v. Levinson. 485 U.S. 224 (1988). The fraud-on-the-market presumption of reliance posits that an investor’s reliance on any public misrepresentations may be presumed because publicly available information is reflected in the market price of stocks traded on efficient, well-developed markets. This presumption has been a driving force behind securities fraud class actions since its inception. The Supreme Court’s decision therefore has the potential to fundamentally change the future of securities fraud class actions.
Halliburton is asking the Supreme Court to overrule Basic, or to modify it so that plaintiffs would have to prove that an alleged misrepresentation affected a company’s stock price before gaining the benefit of the presumption. Alternatively, Halliburton asks that Basic’s fraud-on-the-market theory be pared down to require plaintiffs to prove that an alleged misrepresentation actually affected a company’s stock price before the fraud-on-the-market presumption can be invoked, or that defendants have a chance to rebut the presumption at the class certification stage.
Halliburton’s argument comes on the heels of the Supreme Court’s 2013 decision in Amgen Inc. v. Connecticut Ret. Plans & Trust Funds, 133 S.Ct. 1184 (2013), in which four Justices took the opportunity to question the continuing vitality of the fraud-on-the-market presumption in dissenting and concurring opinions. Even the majority opinion in Amgen recognized that modern economic research undercuts the premise of the fraud-on-the-market presumption: market efficiency is no longer believed to be a binary, yes or no question; rather, differences in efficiency can exist within a single market.
At oral argument, the Court did not focus on whether Basic should be overturned because it rests on an arguably faulty economic theory, despite the intimations in Amgen. Rather, the Court focused on a compromise position based on an argument that law professors made in an amicus curiae brief. The professors argued that plaintiffs should provide event studies analyzing whether a defendant’s alleged misrepresentation affected its stock price at the class certification stage. Justice Kennedy, who referred to the professors’ position as a “midway position,” asked both the Halliburton and respondent about the professors’ approach of requiring an event study at the class certification stage, and Justice Scalia asked respondent what the effect of adopting “Basic writ small” would be. At the close of argument, Justice Breyer, perhaps showing his hand, asked Halliburton what currently precluded a defendant from presenting an event study at the class certification stage to rebut fraud-on-the-market’s presumption of reliance, to which Halliburton responded, “that is what we’re asking this Court to hold.”
If the Court’s focus on the “midway position” is any indication, the Court is not prepared to overturn Basic, but seems willing to require plaintiffs to provide event studies tying a defendant’s misrepresentation to a price impact on their stock at the class certification stage. The significance of such a holding is manifest because, as Halliburton pointed out, nearly 75% of class certification motions are granted in securities cases, and only 7% of cases make it to the summary judgment stage after certification is granted. Were the Court to adopt “Basic writ small,” as coined by Justice Scalia, plaintiffs would no longer be able to avail themselves of Basic’s presumption without showing that a defendant’s alleged misrepresentation actually affected stock price, which would lead to fewer classes being certified and settled before price impact could be analyzed.