The Supreme Court issued a decision on June 23rd in the closely watched case of Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. ___ (2014) (Halliburton II). A majority of the Court declined to overrule the fraud-on-the-market presumption of reliance, which makes it easier for plaintiffs in securities fraud class actions to prove reliance and obtain class certification. The Court did, however, give defendants additional ammunition to oppose class certification, holding that defendants may rebut the presumption of reliance at the class certification stage by showing that the alleged misrepresentations did not impact the stock price. The Court’s decision heightens the importance of the class certification stage, which will continue to be a major battleground in securities fraud cases.
Background and Procedural History
Plaintiff shareholders of Halliburton stock filed a putative class action suit alleging that Halliburton made false and misleading statements about various aspects of its business. The district court denied class certification in 2008 after finding that plaintiffs had not established loss causation, as required by then-binding Fifth Circuit authority. The Fifth Circuit affirmed on the same ground. However, the Supreme Court reversed and vacated the judgment, holding that securities fraud plaintiffs need not prove loss causation at the class certification stage. Erica P. John Fund, Inc. v. Halliburton Co., 563 U. S. ___ (2011) (Halliburton I).
On remand, the district court certified a class of shareholders after finding that plaintiffs had met the requirements for invoking the fraud-on-the-market theory of class-wide reliance. Halliburton appealed to the Fifth Circuit and argued that it should have been allowed to rebut the fraud-on-the-market presumption at class certification by showing that the alleged misrepresentations did not impact the price of Halliburton’s stock. The Fifth Circuit again affirmed the district court, rejecting price impact as an issue for consideration at class certification. Halliburton again appealed to the Supreme Court.
Halliburton II presented two questions to the Court: (1) whether the Court should overrule or substantially modify Basic’s fraud-on-the-market presumption of class-wide reliance; and (2) whether defendants may rebut the presumption at class certification by introducing evidence that the alleged misrepresentations did not distort the market price of the stock.
Supreme Court Upholds Basic and the Fraud-on-the-Market Presumption
With respect to the first question, the Court declined to overturn Basic or modify the prerequisites for invoking the fraud-on-the-market presumption. Justice Roberts, writing for the majority, noted that “overturning a long-settled precedent” requires “‘special justification,’ not just an argument that the precedent was wrongly decided.” The Court found that the criticisms of Basic and the presumption did not reach that standard. The Court further rejected Halliburton’s argument that plaintiffs should be required to show price impact to invoke the fraud-on-the-market presumption.
The Court’s refusal to overrule the fraud-on-the-market theory preserves the mechanism used by most plaintiffs to seek class certification in securities fraud suits.
Justice Thomas, who concurred in the judgment along with Justices Scalia and Alito, would have overruled Basic and eliminated any presumption of reliance in securities fraud suits.
Defendants May Rebut the Presumption at Class Certification By Showing Absence of Price Impact
The Court ruled in Halliburton’s favor with respect to the second question, holding that defendants may rebut the presumption of reliance at the class certification stage by showing that the alleged misrepresentations did not impact the stock price. Justice Roberts recognized that the prerequisites for invoking the fraud-on-the-market theory - namely, the alleged misrepresentations were publicly known and material, and the stock traded in an efficient market - serve as an indirect proxy for price impact. Under Basic, that indirect showing of price impact provides the requisite causal connection between the plaintiff’s transaction and the alleged misrepresentations. That presumed causal connection is severed where a defendant shows that the alleged misstatements did not actually impact the stock price. “In the absence of price impact, Basic’s fraud-on-the-market theory and presumption of reliance collapse,” and the “suit cannot proceed as a class action” because “[e]ach plaintiff would have to prove reliance individually.”
Implications of the Decision
A decision overruling Basic and the fraud-on-the-market presumption would have fundamentally undermined the ability to pursue securities fraud cases on a class action basis. Although the Supreme Court declined to take that step, Halliburton II nonetheless represents a significant victory for defendants in securities fraud suits. Some courts had refused to allow defendants to rebut the presumption at the class certification stage, making it far more difficult for defendants to oppose class certification. This decision preserves defendants’ ability to oppose certification where the economic evidence shows that reliance is not a common issue across the class. That issue won’t have to be deferred until later stages of the case, such as summary judgment or trial, which might never be reached. The decision is also consistent with the Court’s recent class action jurisprudence requiring that courts consider actual evidence from both sides before ruling on whether the requirements for class certification have been met.
Going forward, Halliburton II will heighten the importance of the class certification stage in putative securities fraud class actions. Defendants will be able to introduce expert testimony to show that, even if the market was efficient and might presumably be expected to quickly incorporate any material misstatements, the alleged misstatements did not actually impact the stock price. Plaintiffs will typically choose to present competing expert testimony, leaving the court to resolve the “battle of the experts.” This will in turn lead to an increased focus on Daubert motions challenging the admissibility of expert testimony.