(Photo by Diego M. Radzinschi)
The concern of the securities class action bar that the U.S. Supreme Court would issue yet another ruling to impede the pleading or proving of securities fraud cases has dissipated.
In Halliburton v. Erica P. John Fund, the court unanimously rejected an attack on its 25-year-old precedent, Basic v. Levinson, sustaining its fraud-on-the market presumption of reliance on misrepresentations at class certification. However, the court created the opportunity for the defendant to rebut that presumption at the certification hearing, by showing a lack of price impact.
As background, securities plaintiffs must satisfy Federal Rule of Civil Procedure 23 to obtain class certification and establish that the questions of law or fact common to class members, predominate over questions affecting only individual members as it pertains to satisfying the Rule 10b-5 reliance element. If the fraud-on-the market presumption does not exist for a securities plaintiff, each member of the putative class would be required to demonstrate that the member actually reviewed and believed the particular misrepresentation.
In Basic v. Levinson, the court recognized that an “unnecessarily unrealistic evidentiary burden” would exist if a plaintiff had to show how he would have acted but for the misrepresentation. The fraud-on-the-market theory means that: (i) in open and developed securities market, the price of a company’s stock is based upon whatever material information about the company is available for public review and (ii) thus, false or misleading statements will defraud stock purchasers, even if investors do not rely on the misstatements. Basic provides a presumption that class members relied upon the public material misrepresentations that are reflected in the defendant company’s stock market price, eliminating the requirement for each individual investor to prove reliance on the alleged misrepresentations.
Then, in Halliburton I, decided by the court in 2011, the court determined that securities fraud loss causation, meaning whether an investor lost money on a securities purchase because of an alleged misrepresentation, is different than the Basic fraud-on-the-market presumption. The court held class plaintiffs are not required to prove loss causation to obtain class certification and remanded for other certification issues. The case returned to the court with Halliburton challenging the concepts of Basic.
In Halliburton II, the plaintiff alleged the defendant inflated its stock price through misrepresentations related to its liability in asbestos litigation, revenue from certain contracts and benefits from a merger, and when these events did not occur and were publicly reported, Halliburton’s stock price dropped. Halliburton argued that Basic should be set aside because investors today neither make their investment decisions on an assumption of market efficiency or that a stock price is based upon all material, public information.
The court rejected this argument, but was swayed by amicus curaie briefs and a fallback position of Halliburton in reaching a middle ground approach. Instead, the court held that securities class defendants can rebut the fraud-on-the-market presumption of reliance at class certification, by showing a lack of stock price impact. This ruling hinged on Halliburton’s economic evidence used on its prior loss causation argument, involving expert testimony that there was no artificial stock inflation based upon the misrepresentations. Halliburton adjusted that same argument and applied it to Basic, in that if there is no artificial price inflation due to a misrepresentation, then investors are not entitled to the reliance presumption. Effectively, the court’s ruling allows defendants to rebut with price impact evidence prior to certification that defendants’ alleged misrepresentations did not inflate the stock price. Price impact evidence was already usable to prove or disprove market efficiency, so the court extended the use of this evidence to the issue of reliance, per Basic. Halliburton’s argument and the court’s holding suggests that securities class certifications could come down to a battle of the parties’ experts on price impact.
Halliburton II should not shut down securities fraud class action cases. While it may complicate certification, such securities plaintiffs already have the Basic burden to establish its presumption, being publicity, materiality, market efficiency and market timing. This means that financial and market experts will star in the class action evidentiary hearings. It is also possible with either a belief by the plaintiff’s bar that the case is more damaging to certification than presently appears, or if the immense cost attributable to trying to get certification becomes financially unrealistic, the public may see a rise in private single investor suits, dependent on perhaps, a particular state’s blue sky laws.