Despite the urgent plea of business advocates, the U.S. Supreme Court on Wednesday appeared reluctant to completely overturn a key precedent that has made it easier for plaintiffs to sue companies for securities fraud.
Instead, during arguments in Halliburton v. Erica P. John Fund, several justices latched onto what they labeled “the law professors’ brief” filed in the case as a possible “midway position,” in the words of Justice Anthony Kennedy. The brief, authored by John Elwood of Vinson & Elkins, suggests that plaintiffs be required to conduct an “event study” at the class-certification stage showing that a company’s misstatements had a significant impact on share prices.
Kennedy, a crucial vote in this and most other cases, returned to the professors’ brief at least three times during argument, making it clear he saw it as a way to modestly increase the burden for plaintiffs in securities class actions—thereby updating but not overturning the 1988 precedent Basic Inc. v. Levinson.
That decision endorsed a “fraud on the market” theory holding that investors rely on an efficient market, and that share prices reflect information or misinformation that is available to the public. The theory has allowed plaintiffs to sue for securities fraud without the costly burden of having to prove specifically that individual investors read company statements and were misled and harmed by them.
By the end of the hourlong argument, Justice Antonin Scalia was referring to the brief’s compromise position as “Basic writ small,” and Justice Elena Kagan was asking advocates for their views on the impact “if the law professors’ position was adopted.” Neither side rejected the idea outright, though plaintiffs’ lawyer David Boies of Boies, Schiller & Flexner said event studies can become costly and complicated, especially if there are multiple events—company misstatements—whose price impact would have to be analyzed.
The Elwood brief was actually one of three amicus curiae briefs filed in the case on behalf of legal academics. Such briefs have proliferated at the Supreme Court in recent years, according to a 2012 study by Harvard Law School professor Richard Fallon. Kennedy did not mention which one he referred to, but it was clear to the advocates that it was Elwood’s.
On Wednesday, after the arguments, Elwood said, laughing, that it would have been nice if Kennedy had called it the “Elwood brief,” but thought the justice might have been reluctant to give one of his former law clerks a shout-out by name. Elwood clerked for Kennedy in 1996-97.
University of Michigan Law School professor Adam Pritchard, one of the law professors Elwood represented in the brief, said he has advanced the “event study” idea in two previous briefs in related Supreme Court cases.
“Finally, someone is paying attention, I hope,” Pritchard said. It could benefit plaintiffs in some cases, defendant companies in others, he said, making it a good foundation for a compromise. “Everyone has something to like or dislike,” he said.
The case before the court Wednesday was brought by investors who claim they were harmed by misleading statements from Halliburton Co. that underestimated the company’s exposure to asbestos liability claims and other business setbacks. Halliburton sought dismissal, and after a lengthy appeals process—including a previous decision by the Supreme Court—the U.S. Court of Appeals for the Fifth Circuit allowed certification of the class, with the help of the Basic presumption.
Basic was “wrong when it was decided and it is even more clearly erroneous today,” Halliburton’s lawyer and Baker Botts partner Aaron Streett told the justices Wednesday. He also said the ruling is “harming the very investors that it’s supposed to help. It is the small investors and the shareholders that are paying these judgments out of their own pocket, often to other shareholders, with a huge cut for both sides’ lawyers and insurance costs.”
But justices spent little time considering the costs or benefits of the presumption, instead focusing on how or whether it should be changed to reflect modern economic theories and market practices.
Asked about market efficiency, in the sense of investors responding to company information, Boies said “they are massively more efficient than they were in 1988,” making the Basic ruling more relevant than ever. “In 1988, people were still sitting home reading Barron’s to figure out what was happening in the stock market,” Boies added. “Today you have real-time information.”
Deputy Solicitor General Malcolm Stewart, arguing on the side of plaintiffs, also said that Basic is still important.
If Basic is overturned, Stewart said, Halliburton’s view is that the only investors who could sue would be “people who personally read, reviewed, and subjectively took account of the false information.” If Basic is upheld, by contrast, Stewart said, “any person who bought stock at the inflated price on the market, a price inflated by fraud, and subsequently lost money … would have a remedy.”
Contact Tony Mauro at email@example.com.