Given the opportunity to overrule its landmark 1988 decision in Basic v. Levinson, in which it created the fraud-on-the-market presumption, the Supreme Court declined. The Court found in its decision this week in Halliburton that, while it was not ready to dismiss the presumption altogether, it would allow defendants to offer rebuttal evidence at the class certification stage. Halliburton is another example, along with Wal-Mart and Amgen, of the Court’s recent trend toward expanding the scope of the class certification inquiry, thereby allowing defendants another option for defeating securities fraud actions prior to any discovery as to the merits in the case. While some plaintiffs are hailing the decision as a victory, the benefits the decision provides to the defense bar can not be overstated. The Justices' 9-0 opinion now will allow defendants to rebut the applicability of the presumption at the class certification stage. Basic may not have been overturned, but it is no longer the powerful plaintiffs’ tool it once was. The bottom line for defendants: “You can’t always get what you want, but sometimes you get what you need.”
The Path to the Supreme Court
Halliburton involved a claim under section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder brought by a class of Halliburton shareholders. After already making one trip up to the Supreme Court several years ago, the case had been remanded to the district court to determine whether a class should be certified. On remand, the district court granted class certification and Halliburton appealed, for a second time, arguing that plaintiffs were not entitled to the fraud-on-the-market presumption because the alleged misrepresentations had not impacted the stock price. Thus, the case eventually made its way back to the Supreme Court, which certified two questions: whether Basic should be overruled and the fraud-on-the-market presumption eliminated; and whether defendants should be allowed to present rebuttal evidence at the class certification stage.
Plaintiffs May Still Rely on the Fraud-on-the-Market Presumption
In Basic, the Court determined that securities fraud class plaintiffs did not need to demonstrate individual reliance on alleged misstatements. Instead, plaintiffs could rely on the “fraud-on-the-market presumption.” The presumption is based on the economic theory that all material information about a company is disseminated into and absorbed by the market place, and is reflected in the stock price. Thus, anyone who purchases the stock in the market essentially “relies” on the integrity of the market price. Halliburton asked the Court to overrule Basic and deny plaintiffs the benefit of the fraud-on-the-market presumption.
In a decision authored by Chief Justice John G. Roberts, Jr., in which all Justices joined, the Court rejected Halliburton’s invitation to overrule Basic. The Court did not reaffirm the correctness of its earlier ruling, but rather found only that there was no “special justification” that warranted overruling long-standing precedent. The Court recognized that “[a]lthough the presumption is a judicially created doctrine designed to implement a judicially created cause of action, we have described the doctrine as ‘a substantive doctrine of federal securities-fraud law.’” So, for the near future, the fraud-on-the-market presumption stands.
Defendants Can Rebut the Presumption at Class Certification
The second question the Court addressed was whether defendants can rebut the fraud-on-the-market presumption before a class is certified. The Court answered this question in the affirmative, giving defendants another weapon against certification.
In order to invoke the presumption, plaintiffs must demonstrate that the alleged misrepresentations were public and material and the defendant’s stock traded in an efficient market. Defendants may then rebut the presumption by proving that the misstatements did not in fact impact the price of the security. Thus, if the market price was not impacted, then plaintiffs cannot argue they “relied” on the misstatement when they “relied” on the market price. Defendants were already allowed to present this evidence at summary judgment and trial, but the issue before the Court was whether defendants were entitled to make the argument at class certification and before significant discovery costs and legal expenses were incurred.
Significantly, the Court held that defendants do have the right to present this evidence in opposition to class certification, reasoning that the evidence relates to the question of predominance. Plaintiffs must demonstrate that common questions predominate over individualized questions, which includes invoking the fraud-on-the-market presumption to avoid individual questions of reliance. District courts will now determine whether the presumption applies before granting class certification and, thus, should be allowed to consider arguments both for and against invoking the presumption. As the Court reasoned: “Price impact is . . . an essential precondition for any Rule 10b-5 class action. While Basic allows plaintiffs to establish that precondition indirectly, it does not require courts to ignore a defendant’s direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock’s market price and, consequently, that the Basic presumption does not apply.”
No matter the spin the plaintiffs’ bar puts on it, Halliburton is a win for defendants. It was hard to imagine the Court would overrule over 25 years of precedent in Basic and, in effect, eliminate class actions under section 10(b). The Court has, however, provided securities fraud class action defendants another out prior to class certification. This issue will likely play out as a battle of the experts as the parties argue over what caused movements in a stock’s price. As the Court has acknowledged, class certification is often the death knell of securities fraud class actions as it forces defendants into settlement. Once a class is certified, the potential damages increase so astronomically that defendants are often forced to settle. Defendants now have another argument against class certification, and one that will undoubtedly become a staple in opposing class certification.