The Supreme Court has issued a key securities ruling that should come as welcome news to corporations and professional firms that find themselves in the crosshairs of private federal securities fraud class actions. In Halliburton v. Erica P. John Fund, No. 13-317, the Court had the opportunity to revisit Basic v. Levinson, one of the most important securities law precedents on the books. Basic adopted what is now known as the “fraud on the market” theory of reliance. It famously held that when a misrepresentation is made in an “efficient market”—that is, in a publicly traded market in which all material information is reflected in the market price— the law will presume that every purchaser who bought or sold at that price “relied” on the misrepresentation, at least indirectly. This is a critical presumption for plaintiffs, as the element of reliance would otherwise require individualized proof, which would effectively preclude litigating securities fraud claims on a class- wide basis. Although Halliburton declined to overrule Basic, it gives defendants the assurance that the Basic presumption can be rebutted at the class certification stage. In at least a subset of cases, this will give defendants an opportunity to stop plaintiffs from obtaining the disproportionate leverage that inevitably comes with a certified class.
This was the Halliburton parties’ second visit to the Supreme Court. The case began with a class action complaint against Halliburton and one of its executives. The complaint claimed that they had made material misrepresentations designed to inflate the company’s stock price in violation of Section 10(b) of the Exchange Act and SEC Rule 10b-5. The district court denied plaintiffs’ motion to certify the case as a class action, and the Fifth Circuit affirmed—on the ground that the defendants had shown that plaintiffs would not be able to establish “loss causation,” which, like reliance, is a fundamental element of a 10b-5 claim. The Supreme Court vacated that judgment, expressing concern about the extent to which a plaintiff can be required to prove the merits of the claim in order to obtain class certification (Halliburton I).
On remand, the defendants argued that class certification was still inappropriate because the evidence presented on the issue of loss causation also showed that the alleged misrepresentations had no “price impact” at all—a showing that rebutted the Basic presumption. The district court rejected that argument and certified the class. The Fifth Circuit affirmed, reading the first Halliburton decision to mean that the defendants could use their price impact evidence only on the merits, not at class certification.
The Supreme Court again granted certiorari. In a 9-0 ruling, the Court again vacated the Fifth Circuit’s decision.
The Court first considered whether to overrule Basic altogether. Supported by many amici, the defendants had argued that Basic was based on an economic theory of market efficiency that has since been discredited. A majority of the Court, however, was not willing to go that far. In a decision by Chief Justice Roberts, the majority invoked the doctrine of stare decisis and concluded that the defendants had not made the special showing required for overruling a prior decision. The Court noted in particular that Basic itself had acknowledged the debate over the efficient market theory and declined to endorse “any particular theory of how quickly and completely publicly available information is reflected in market price.” The fact that the question related to statutory interpretation was also significant; the Court explained that in the decades after Basic, Congress had done nothing to undermine the presumption or change the showing required for reliance (notwithstanding, among other things, its 1995 enactment of the Private Securities Litigation Reform Act).
At the same time, however, the Court made clear that defendants must be given a meaningful opportunity to rebut the presumption. And, critically, defendants must be given that opportunity in opposing class certification. Although the Court’s recent class action decisions have held that class certification generally should not be conflated with the merits, the mere fact that evidence may also be relevant on the merits does not mean that it cannot be presented on class certification. Halliburton’s evidence, for example, showed that the alleged misrepresentations had no price impact—a showing relevant to the applicability of the Basic presumption both on the merits and, critically, to satisfy the class action requirement of predominance.
Justice Thomas wrote separately, joined by Justices Scalia and Alito, to say that Basic should, in fact,be overruled. Justice Thomas described “Basic’s reimagined reliance requirement” as “a mistake” when it was issued—a mistake tied in part to the Court’s willingness to accept reliance that was merely “indirect.” He also explained that “the passage of time has compounded its failings,” surveying the literature that has criticized the efficient market presumption both as a theoretical matter and in terms of empirical evidence.
For the many who hoped that the Court would overrule Basic altogether, the decision is a disappointment at least to that extent. But Halliburton does give defendants the certainty that they will have a meaningful opportunity to rebut the presumption of reliance in order to defeat class certification. Viewed against the backdrop of some of the Court’s other recent jurisprudence in this area (including Halliburton I), that by itself is a significant victory. Courts and commentators have long recognized that the certification of a class action may create tremendous pressure on defendants to settle claims regardless of their merit, while its defeat most often sounds the death knell for the case. The latest Halliburton decision should prove to be an invaluable tool for defendants at this crucial stage.