In its long-awaited decision in Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), the US Supreme Court upheld the validity of the fraud-on-the-market presumption set forth in Basic Inc. v. Levinson, 485 US 224 (1988), while clarifying that a defendant in a securities fraud class action must be permitted to rebut Basic’s presumption of reliance at the class certification stage with evidence that alleged misrepresentations had no price impact at the time of investment. This ruling confirms the existence of an important defense against class certification in federal securities fraud class actions and raises significant new questions for consideration by the lower courts.
Plaintiff Erica P. John Fund, Inc. (the “EPJ Fund”) brought a putative class action against Halliburton Company and its CEO David Lesar (together, “Halliburton”) alleging that Halliburton violated Section 10(b) of the Securities Exchange Act of 1934 and
Rule 10b-5 by making misrepresentations in Halliburton’s SEC filings between June 1999 and December 2001. The EPJ Fund’s attempts to bring a viable suit and certify a class based on the fraud-on-the-market presumption have resulted in more than a decade of litigation and two significant Supreme Court decisions, including Halliburton II, which was issued on June 23, 2014.
The fraud-on-the market presumption was adopted by the Supreme Court in its landmark opinion in Basic. It established that plaintiffs may satisfy the reliance element of a claim under Rule 10b-5 without showing that they were actually aware of alleged misrepresentations if they can establish “(1) that the alleged misrepresentations were publicly known, (2) that they were material, (3) that the stock traded in an efficient market, and (4) that the plaintiff traded the stock between the time the misrepresentations were made and when the truth was revealed.”i The presumption, which is based on the efficient capital markets hypothesis (which, in simple terms, theorizes that the price of actively traded public securities will reflect all material public information), assumes that (a) material public information in an efficient market is reflected in a security’s price, and (b) investors therefore necessarily rely on all such information when they purchase or sell securities in an efficient market.ii The presumption is a key element in modern securities class action practice. Without it, plaintiffs would not be able to meet the predominance requirement of Federal Rule of Civil Procedure 23(b)(3), because individual questions—concerning which members of a purported class actually relied on which misrepresentations (and whether they did so reasonably)—would predominate over common questions and thereby preclude class certification.
In 2011, the Supreme Court reversed a prior decision of the US Court of Appeals for the Fifth Circuit in the Halliburton case by holding that plaintiffs need not establish loss causation (i.e., that the revelation of the “truth” actually caused an economic loss) to satisfy the fraud-on-the market presumption at the class certification stage because, the Court held, the presence or absence of loss causation is a merits issue that does not, in and of itself, implicate Rule 23 predominance issues.iii The Court remanded the case for further proceedings and, in 2012, the US District Court for the Northern District of Texas granted the EPJ Fund’s motion for class certification, notwithstanding Halliburton’s argument that it had rebutted the presumption of reliance with direct evidence that the alleged misrepresentations had not actually affected Halliburton’s stock price. In the District Court’s view, Halliburton could not use “price impact” evidence at the class certification stage to rebut the presumption of reliance because such evidence, like evidence of loss causation, has no bearing on whether common issues predominated under Rule 23(b)(3).iv In 2013, the Fifth Circuit affirmed that decision, relying heavily on Halliburton I and the US Supreme Court’s intervening 2013 decision in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds—which held that plaintiffs need not prove the materiality of the alleged misstatements to invoke Basic’s presumption of reliance at class certification.v Failure to prove materiality, according to the Amgen decision, did not mean individualized issues regarding materiality would predominate; rather, it meant the class as a whole could not recover at all.vi
In light of the Fifth Circuit’s ruling, Halliburton petitioned the Supreme Court to address two legal questions: (1) “Whether th[e] [Supreme] Court should overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 US 224 (1988), to the extent that it
recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory” and (2) “Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.”vii On November 15, 2013, the Supreme Court granted Halliburton’s certiorari petition.viii
Chief Justice John Roberts delivered the opinion of the Supreme Court, which Justices Anthony Kennedy, Ruth Bader Ginsburg, Stephen Breyer, Sonia Sotomayor, and Elena Kagan joined. As outlined in greater detail below, while the Court declined to overrule or substantially modify the Court’s prior holding in Basic, it accepted Halliburton’s argument that defendants must be afforded an opportunity before class certification to rebut the Basic presumption, including through evidence that an alleged misrepresentation did not actually affect the stock’s market price. The Fifth Circuit’s decision was vacated, and the case was remanded for further proceedings consistent with the Court’s opinion.
Justice Ginsburg filed a one-paragraph concurring opinion, which Justices Breyer and Sotomayor joined, to clarify that they joined in the Roberts’ opinion with the understanding that it should “impose no heavy toll on securities-fraud plaintiffs with tenable claims.”ix Justice Clarence Thomas filed an opinion concurring in the judgment, which Justices Antonin Scalia and Samuel Alito joined, to make plain their view that Basic was wrongly decided and should be overruled.
The Court rejected Halliburton’s numerous arguments for why Basic should be overruled, stating that Halliburton had not shown a “special justification,” Dickerson v. United States (530 US 428, 433 (2000)), for overruling Basic’s presumption of reliance.x
First, the Court rejected Halliburton’s contention that Basic should be overruled because it rests on two premises that no longer withstand scrutiny by distinguished economists and other academics: (i) that efficient markets automatically and accurately update stock prices to reflect all public information and (ii) that all investors rely on stock prices when transacting.xi The Court noted that the extent of the disagreement was more limited than Halliburton contended and stated that it was addressed through the Court’s clarification of defendants’ right to rebut the presumption and their ability to challenge specific plaintiffs on their use of the presumption.xii Second, the Court applied the deference of stare decisis to Basic and rejected Halliburton’s arguments that the Basic presumption produces a number of serious and harmful consequences for businesses and the courts and that the presumption is inconsistent with recent Supreme Court decisions narrowing the Rule 10b-5 cause of action and requiring that Rule 23 requirements be proved before a class is certified under Rule 23.xiii With respect to the significant consequences argument, the Court stated that such concerns are more appropriately addressed to
Congress and noted that Congress has passed legislation following Basic to curb the number of class actions filed by securities plaintiffs.xiv The Court also disagreed that the presumption violates recent Supreme Court precedent governing the scope of Rule 10b-5 liability and the requirements of Rule 23.xv Third, the Court rejected Halliburton’s argument that the Basic presumption is inconsistent with Congress’s intent in passing the Securities Exchange Act of 1934.xvi The Court reasoned that the same argument was raised and dealt with in Basic, and Halliburton provided no reason to accept the argument now.xvii Nearly all of these issues were strongly contested in the concurrence authored by Justice Thomas.
- The Court Permits Defendants to Rebut the Presumption with Price Impact Evidence at Class Certification Stage The Court allowed, however, that Basic’s fraud-on-the-market presumption could be rebutted “in a number of ways, including by showing that the alleged misrepresentation did not actually affect the stock’s price – that is, that the misrepresentation had no ‘price impact.’”xviii The Court further stated that “Basic recognized that market efficiency is a matter of degree and accordingly made it a matter of proof.”xix Basic thus “affords defendants an opportunity to rebut the presumption by showing, among other things, that the particular misrepresentation at issue did not affect the stock’s market price.”xx The Court accordingly held that defendants could make such a rebuttal at the class certification stage, including by introducing direct evidence (such as event studies, which we expect to be even more widely and consistently used at class certification) to show that defendants’ alleged misrepresentations had no impact on the price of the stock (and thus the Basic presumption did not apply).xxi The Court reasoned that such a showing was appropriate at the class certification stage in part because it is already undisputed that defendants can introduce price impact evidence at the class certification stage for purpose of rebutting plaintiffs’ claim of market efficiency, which is only part of an “indirect proxy” for showing price impact.xxii It would be nonsensical, therefore, to disallow such evidence to the extent it provided direct evidence of the same thing – i.e., evidence of price impact, or lack of price impact. Furthermore, the Court noted, plaintiffs must prove that the requirements of Rule 23 are met before a class can be certified. Distinguishing the need to prove price impact at the class certification stage from Amgen’s holding that there is no need to prove materiality at the class certification stage, the Court held that (unlike materiality) price impact cannot be disassociated from the issue of predominance.xxiii Indeed, “[t]he fact that a misrepresentation ‘was reflected in the market price at the time of [the] transaction’—that it had price impact—is ‘Basic’s fundamental premise.’”xxiv Accordingly, “defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.”xxv
The decision in Halliburton II continues to allow plaintiffs to meet their burden in establishing the fraud-on-the-market presumption through indirect methods such as by establishing general market efficiency (and the other Basic- presumption elements). Thus, plaintiffs may continue to rely on tests set forth in Cammer v. Bloomxxvi and Krogman v. Sterrittxxvii (which address whether market efficiency sufficient to invoke the fraud-on-the-market presumption has been shown) to bring their motions for certification. Halliburton II also makes clear, however, that defendants can rebut that presumption by focusing on the impact of specific, alleged misrepresentations rather than merely challenging the efficiency of the market for the securities more broadly.xxviii How that impact (or lack of impact) is to be analyzed is unclear. The Court clearly refers to and endorses the use of event studies.xxix But its reliance on the importance of actual price impact may well mean that in cases in which the price does not move in reaction to alleged misrepresentations, such as where the challenged statements merely confirm expectations, plaintiffs may have difficulty obtaining class certification. Plaintiffs can be expected to point to subsequent stock drops as evidence of price impact at the time of the alleged misrepresentation, and it remains to be seen whether, and to what extent, such arguments can succeed.
Halliburton II also raises new issues. The Supreme Court has clearly rejected an all-or-nothing view of efficiency in favor of a more nuanced and situational analysis.xxx This more rigorous and thoughtful approach may well affect the adjudication of other aspects of securities litigation—such as loss causation and the truth-on-the-market defense. Furthermore, the Court expressly noted that even material information disclosed in an efficient market might not affect a security’s price,xxxi and the Court reasoned that even investors who believe that information is not properly reflected in a security’s price when they invest in the security (such as so-called value investors) can be entitled to the presumption because they implicitly believe that the information will be fully incorporated at some point in the future.xxxii The added uncertainty created by such acknowledgments will raise issues that will be addressed again and at length in class certification litigation in the coming months and years.