In last term’s Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, four justices signaled an interest in overturning a 25-year-old precedent that makes it easier for shareholders to sue companies for securities fraud.
A petition in Halliburton v. Erica P. John Fund Inc. asks the Supreme Court to do just that. The case is scheduled for discussion at the court’s private conference Nov. 15, and only four votes are needed for certiorari to be granted.
The precedent Basic Inc. v. Levinson advances is what’s known as the “fraud-on-the-market” theory. It lets investors sue a company as a group without having to prove that they relied on corporate misstatements when purchasing its stocks.
An amicus brief by three former commissioners of the Securities and Exchange Commission and a handful of law professors calls this mechanism “the most powerful engine of civil liability ever established under American law.” In the years since Basic, shareholders have filed more than 3,000 class-action securities-fraud lawsuits, generating over $73.1 billion in settlements, the amici wrote on behalf of Halliburton.
Aaron Streett, an appellate litigation partner at Baker Botts in Houston, is counsel of record for Halliburton Co. on the petition pending in the high court court.
Under the fraud-on-the market theory, as he explains it, all public information about a company—including any falsehoods that corporate leaders may have told—is reflected in its stock price in well-developed markets. Therefore, shareholders seeking to obtain class certification do not need to prove that they relied on or even knew about misrepresentations when purchasing stocks. Instead, reliance is presumed.
Streett argues that current events and economic research have proved the fraud-on-the-market theory wrong.
“Basic’s naïve understanding of market efficiency and its simplistic view that market prices rationally convey information are at war with economic reality,” he wrote.
In Halliburton, a group of investors, led by the Erica P. John Fund, claim the Houston-based company made fraudulent statements from 1999 to 2001. They say the statements—about revenue, liability for asbestos claims, and the benefits of a merger with Dresser Industries—caused stock prices to artificially go up and then plummet. David Boies of Boies, Schiller & Flexner represents the shareholders, who are seeking class certification to sue under Section 10(b) of the Securities Exchange Act of 1934.
In 2011, the suit reached the Supreme Court, which vacated the U.S. Court of Appeals for the Fifth Circuit’s refusal to certify the investors as a class. The justices unanimously found that plaintiffs do not need to establish as a prerequisite for class certification that they lost money because of the alleged fraud. On remand, the Fifth Circuit allowed the class to go forward, and used Basic’s presumption of reliance to do so.
The Fifth Circuit’s ruling, Streett argues, also is at odds with recent high court precedent on class certification. In Wal-Mart v. Dukes and Comcast v. Behrend, the justices found that plaintiffs must affirmatively prove that common issues predominate amongst prospective class members. The same should be true of plaintiffs in securities cases, Streett says.
“There should be some requirement that common issues of reliance be shown, not just assumed away by a presumption that’s not supported by economists or the real world anymore,” Streett said.
Streett points to the technology bubble of 15 years ago and the economic crisis of 2008 to show that markets do not always act rationally, which is a key underpinning of the fraud-on-the-market theory.
In a dissent in Amgen, justices Clarence Thomas, Antonin Scalia and Anthony Kennedy called the Basic decision “questionable.” In a concurrence, Justice Samuel Alito wrote that recent evidence suggests that the theory may rely on a “faulty economic premise.”
If the justices do not want to get rid of Basic, Streett argues in the alternative that the court should let Halliburton rebut Erica P. John Fund’s presumption of reliance by introducing evidence that alleged misrepresentations did not distort stock prices. Some jurisdictions allow price-impact information at the class-certification stage, but the Fifth Circuit does not, Streett wrote.
Acceptance of this alternate argument, Streett said, “would at least restore some measure of balance to the playing field between plaintiffs and defendants in these cases.”
Jamie Schuman is a freelance writer and graduate of The George Washington University Law School.