The highly anticipated U.S. Supreme Court ruling in Halliburton Co. v. Erica P. John Fund, Inc., 573 U. S. ____ (2014) (June 23, 2014) left intact the fraud-on-the-market theory established by the Supreme Court in Basic Inc. v. Levinson, 485 U. S. 224 (1988), which is the bedrock upon which securities class actions have rested for nearly thirty years. However, the Halliburton decision provided defendant companies with an avenue for early escape from the impending pressures to settle meritless class litigation by securing their right to rebut the Basic presumption of classwide reliance during the class certification phase. Although it was clear that Basic established a rebuttable presumption of classwide reliance, the U.S. Circuit Courts of Appeals were split on the issue of whether it was appropriate to allow rebuttal of the presumption during the class certification stage. We discussed Halliburton in a previous post, highlighting several of the key points of contention raised during the Supreme Court argument which probed what should become of Basic. We will highlight here why the Court let Basic stand, but did solidify for corporate defendants the middle-ground opportunity to rebut the presumption of classwide reliance prior to class certification.
Defendant Halliburton took the position that class certification was improperly granted in this case because it had introduced evidence that the alleged misrepresentations had no effect on the company’s stock price. In the absence of “price impact,” Halliburton argued that the presumption of classwide reliance (i.e., the presumption that the shareholders had relied on the misrepresentations by buying/selling stock at the market price) could not stand and reliance became an individualized issue that rendered class certification inappropriate. The District Court refused to consider the argument and the Fifth Circuit affirmed, holding that the evidence regarding price impact was only properly considered during the merits phase of the case after class certification. The Supreme Court took on this question regarding when defendants may rebut the presumption, and “also accepted Halliburton’s invitation to reconsider the presumption of reliance for securities fraud claims that we adopted in Basic.”
Basic Still Stands. The Supreme Court articulated several reasons why Halliburton failed to present the “special justification” required to reverse long-standing precedent established by Basic. Halliburton argued that the judicially-created presumption of reliance in Basic is contrary to Congressional intent based on an analysis of the direct reliance requirement imposed by the most analogous private right of action created by Congress under the Exchange Act. The Court dismissed this argument, which also was made by the dissenting Justices in Basic, stating “[t]he Basic majority did not find that argument persuasive then, and Halliburton has given us no new reason to endorse it now.” The Court further urged that Congress has the ability to modify or overturn the effects of Basic, therefore principles of stare decisis support maintaining the Basic presumption.
The Court also dismissed Halliburton’s attempt to discredit the economic theories and assumptions that underpinned the Basic presumption of reliance. The Basic presumption was grounded in efficient market theory and the premise that investors rely on the market integrity of stock prices, but these economic arguments no longer hold up, Halliburton argued. The Court clarified its position, explaining that by establishing the presumption of reliance the Court was not adopting any economic theory, but rather was “bas[ing] the presumption on the fairly modest premise that ‘market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.’” The Court argued that the rebuttable presumption takes into account “that market efficiency is a matter of degree and accordingly made it a matter of proof.”
The collateral consequences of Basic, in the form of meritless claims that result in large settlements or excessive costs for businesses and innocent shareholders, are better left to Congress to address, reasoned the Court. And Basic does not conflict with recent Supreme Court class action decisions that require proof that class certification requirements are met. Rather, the Court explained, “[t]he Basic presumption does not relieve plaintiffs of the burden of proving—before class certification—that this [predominance] requirement is met. Basic instead establishes that a plaintiff satisfies that burden by proving the prerequisites for invoking the presumption—namely, publicity, materiality, market efficiency, and market timing.”
The Alternative to Overruling Basic – Rebuttal at Class Certification. Halliburton requested that, if the Court maintained the Basic presumption, it provide safeguards to mitigate the consequences of the flawed decision. Halliburton proposed either requiring plaintiffs to prove that the alleged misrepresentations actually affected stock price as a prerequisite to invoking the presumption, or permitting defendants to rebut the presumption of reliance by showing a lack of price impact prior to class certification. The Court refused to require plaintiffs to prove price impact in order to invoke the Basic presumption, as requiring such proof would gut the premises underlying the presumption. The Court did, however, recognize that restricting the consideration of evidence of lack of price impact to the merits phase “makes no sense, and can readily lead to bizarre results,” especially since such evidence likely would be presented during class certification on the issue of market efficiency. The Court reasoned:
Such a result is inconsistent with Basic’s own logic. Under Basic’s fraud-on-the-market theory, market efficiency and the other prerequisites for invoking the presumption constitute an indirect way of showing price impact. As explained, it is appropriate to allow plaintiffs to rely on this indirect proxy for price impact, rather than requiring them to prove price impact directly, given Basic’s rationales for recognizing a presumption of reliance in the first place….But an indirect proxy should not preclude direct evidence when such evidence is available.
Our choice in this case, then, is not between allowing price impact evidence at the class certification stage or relegating it to the merits. Evidence of price impact will be before the court at the certification stage in any event. The choice, rather, is between limiting the price impact inquiry before class certification to indirect evidence, or allowing consideration of direct evidence as well. As explained, we see no reason to artificially limit the inquiry at the certification stage to indirect evidence of price impact.
The Court ultimately concluded that “to maintain the consistency of the presumption with the class certification requirements of Federal Rule of Civil Procedure 23, defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.”
While the result is somewhat positive for corporate defendants, plaintiffs still have the bigger benefit of the Basic presumption. Justice Thomas, along with Justices Scalia and Alito, found Halliburton’s arguments compelling. The three Justices concurred in judgment, but argued that Basic should have been overruled: “Logic, economic realities, and our subsequent jurisprudence have undermined the foundations of the Basic presumption, and stare decisis cannot prop up the façade that remains.” Yet, Basic remains.