In Halliburton v. Erica P. John Fund, the U.S. Supreme Court tackled two securities fraud class action issues: Whether the Basic v. Levinson, 485 U.S. 224 (1988), presumption of reliance on misrepresentation instead of actual reliance on misrepresentation should be overruled and whether defendants can rebut the presumption of reliance by showing lack of price impact at the class certification stage.
Securities class action cases are lucrative due in part to the judicially created “fraud-on-the-market” theory. This theory emanates from Basic’s holding that “the market price of shares traded on well-developed markets reflects all publicly available information and hence any material misrepresentations.”
In Basic, the court previously concluded that whoever buys or sells a company’s stock at the market price may be considered to have presumptively relied on all public material information or misinformation. However, Basic did not address whether this rebuttable presumption could be rebutted in a class certification proceeding. Armed with this presumptive reliance, investor plaintiffs did not have to prove actual reliance on misinformation.
In Halliburton, the court concluded that the presumption can be rebutted at the class certification stage. Additionally, the entire court without dissent refused to recede from Basic’s precedent. Though there were some grumblings in the concurring opinion, the votes reflect that Basic will remain intact well into the future.
Clearly the Supreme Court has ignored precedent when the majority had the votes. Recently, in Citizens United v. Fed. Election Commission, 558 U.S. 50 (2010), the majority eviscerated 20-year-old precedent (“no current support to suppress corporate political speech”). Austin v. Michigan Chamber of Commerce, 494 U.S. 652 (1990).
What’s the meaning for practitioners?
Class certification has always been a battleground for securities fraud class actions. Now defendants have a major defensive weapon: Halliburton’s mandate that defendants can rebut the presumption of reliance at the class certification stage.
Securities plaintiffs can no longer rest on the presumption of reliance to establish a required element for class certification. Now, if challenged, plaintiffs must establish actual reliance. That requires time and money including experts, statistics and a credible plaintiff.
The defense’s case fulcrum becomes rebutting the presumption of reliance at the class certification stage. If the defense is successful, the class action case evaporates. Consequently, an individual investor cannot finance a trial. Thus, settlements will hinge on who will likely prevail in pre-certification hearings.
What’s the meaning for trial judges?
Trial judges now face an additional level of scrutiny on class certification in securities cases. Previously, the presumption of reliance could be a non-issue at the class certification stage. Now evidentiary, procedural and substantive rulings will be evaluated for error resulting in another way to be reversed.
Also, because the stakes are so high, the trial judge will have to allot more pretrial time to the class certification proceedings and accommodate testimony on an issue that previously would have been presumed. This will no doubt tend to clog up the system for overworked judges trying to move cases. The problem would be obviated by more judges, but that is another discussion for another day.
What was the Supreme Court thinking?
The court clearly determined that refusing to allow Halliburton to rebut the presumption of reliance at the class certification stage, rather than at trial, “makes no sense and can readily lead to bizarre results.” Halliburton, No. 13-317, 2014 WL 2807181 (2014). As a result, defendants have the opportunity before class certification to defeat the presumption that an alleged misrepresentation did not affect a stock’s market price.
For over 25 years, plaintiffs could satisfy the reliance element of Rule 10b-5 actions by invoking the presumption. In Halliburton, the Supreme Court respected precedent over economic theory, social scientists and sophisticated statistics in 10b-5 class action cases.
The Supreme Court still adheres to Basic’s tenet of presumption of reliance but added a bright line: The presumption can be rebutted at the class certification stage. This decision is practical and will ultimately lead to more certainty in securities fraud class action cases.