Yesterday, the U.S. Supreme Court issued a unanimous¹ decision in the securities fraud case, Halliburton Co. v. Erica P. John Fund, which was highly anticipated by many who follow the federal securities laws, including D&O insurers. 573 U. S. ____ (June 23, 2014). Although Halliburton expressly upheld Basic’s “fraud-on-the-market” presumption in order to satisfy the reliance requirement for a class of investors, Halliburton also held that defendants will be able to rebut this presumption earlier – at the class certification stage – with evidence that the misrepresentation did not, in fact, affect stock price. Thus, while Halliburton does not scrap the fraud-on-the-market theory and its ability to satisfy reliance, as announced in Basic Inc. v. Levinson, 485 U. S. 224 (1988), Halliburton certainly changes the landscape as there likely will be additional costs incurred in connection with a defendant’s efforts to rebut the presumption of reliance at an earlier stage of the case; however, some classes may not be certified following those efforts. Both of these issues may have implications for D&O insurers.
In its decision, the Supreme Court addressed whether to continue to apply the Basic holding, which permits securities fraud plaintiffs to establish a presumption of class-wide reliance for alleged misrepresentations based on the fraud-on-the-market theory. Under this approach, plaintiffs are not required to demonstrate each class member’s individual reliance on the alleged misstatements, based on the theory that securities markets operate efficiently, and thus the price of publically traded securities accurately reflects all publically available information about the traded company – including the impact of the “public material misrepresentations.” Basic, therefore, enabled class plaintiffs to establish collective reliance on the misstatement(s) based on the market price of the security, and avoid individualized issues that could defeat class certification. Prior to Halliburton, defendants were allowed to rebut the presumption at trial, but not at the class certification stage.
Petitioner Halliburton, the defendant in the underlying securities action, challenged the economic assumptions of the efficient market theory, which it believes have been “widely rejected” by economists since the Basic decision. In its brief, Halliburton argued that Basic “was wrong when decided, and time has only made things worse.” Halliburton argued that a securities plaintiff should be required to demonstrate that the “alleged misrepresentations actually affected the stock price” in order for a presumption of reliance to apply or, at the very least, that defendants should be allowed to rebut the presumption at the class certification stage with evidence establishing that “the misrepresentation did not distort the market price[.]”
The respondents argued that Basic is “well-settled[,]” has been cited repeatedly and favorably in recent Supreme Court securities decisions, and is essential to maintain and supplement the enforcement of the federal securities laws. Respondents also contended that Congress considered, but flatly rejected, calls to overrule Basic when it enacted the PSLRA in 1995, and argued against an additional evidentiary step at the class certification stage, claiming that it would improperly and prematurely insert a merits inquiry into an otherwise preliminary stage of the litigation. Respondents characterized such a move as incompatible with federal class certification rules, and other Supreme Court decisions on class issues.
Ultimately, the Supreme Court took a measured approach in rejecting the defendant’s outright calls to overturn Basic’s presumption of reliance, finding that there has not been a “fundamental shift in economic theory” to overrule a signature doctrine in securities-fraud laws. However, the Halliburton Court seemingly agreed with Basic that the presumption was not conclusive, but rather rebuttable, in expressly empowering defendants with the ability to rebut plaintiff’s presumption of reliance at or before class certification. (Halliburton at 22.) (“[Price impact] thus has everything to do with the issue of predominance at the class certification stage. That is why, if reliance is to be shown through the Basic presumption, the publicity and market efficiency prerequisites must be proved before class certification. Without proof of those prerequisites, the fraud-on-the-market theory underlying the presumption completely collapses, rendering class certification inappropriate.”). As a result, when plaintiffs seek to rely on the presumption, defendants will seek to rebut the presumption earlier. We expect the class certification stage to be even more contentious, with increased briefing, evidentiary submissions, and expert testimony/analysis to the trial court on the issue of price impact.
Clearly, Halliburton’s continued affirmance of Basic’s fraud-on-the-market presumption of reliance, while somewhat unsurprising based on the line of questioning during oral arguments that were heard in March, is nonetheless disappointing for directors, officers, and entity defendants (and their insurers), because it makes it easier for a plaintiff to claim class-wide reliance based on alleged misrepresentations. The silver lining for defendants, however, is that they may now challenge the application of this presumption earlier, at the class certification stage. While this presents an opportunity for defendants potentially to avoid class-wide liability, and may cause some cases not to be certified (a benefit to D&O insurers), it also may increase the cost of defending such matters earlier in the process. Thus, Halliburton may create additional cost pressures for D&O insurers as there will be, among other things, additional expert and evidentiary efforts at the class certification stage to review the misrepresentations and any actual price impact. Along with the potential long-term implications of the decision, insurers should also be aware that a number of securities cases stayed, pending a decision in Halliburton, will recommence in the short-term.
¹ Roberts, delivered the opinion of the Court, in which Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan joined. Ginsburg, filed a concurring opinion, in which Breyer and Sotomayor, joined. Thomas, filed an opinion concurring in the judgment, in which Scalia and Alito, joined.