The Supreme Court declined to scrap the way in which securities class actions are typically brought in Halliburton Co. v. Erica P. John Fund, No. 13-317 (Decided June 23, 2014). At the same time it may have rewritten the procedures regarding class certification more than may readily appear.
This is the second time the Supreme Court has considered Halliburton. The first time the case was before the High Court, the decision of the Fifth Circuit requiring that at class certification a securities law plaintiff establish loss causation was reversed. The Supreme Court concluding held that proof of loss causation is not necessary to invoke the fraud-on-the market presumption of reliance under Basic Inc. v,. Levinson, 485 U.S. 224 (1988). Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. — (2011)(“Halliburton I). On remand Halliburton argued that the Basic presumption had been rebutted by its evidence on a lack of price impact. The district court reject this conclusion and, in an opinion affirmed by the Fifth Circuit, certified the class.
The Supreme Court agreed to hear the case a second time. Plaintiffs argued that Basic should be overruled. Alternatively they contended that plaintiffs should be required to establish price impact at class certification. These issues are set against a complaint which claims that Halliburton made a series of misrepresentations regarding its potential liability in asbestos litigation, about its expected revenue from certain contracts and regarding the anticipated benefits of a merger. Those false statements inflated the stock price, according to plaintiffs. Later the company made a series of corrective disclosure which plaintiffs claim caused the stock price to drop. Investors suffered losses and are entitled to damages under Exchange Act Section 10(b) and Rule 10b-5, according to Erica John Fund.
The Court, in an opinion written by Chief Justice Roberts, and joined by Justices Kennedy, Ginsburg, Breyer, Sotomayor and Kagan, rejected the claim that Basic should be overruled. The Court also declined to require plaintiffs to prove price impact at class certification. Defendants may, however, in rebutting the Basic presumption use evidence demonstrating a lack of price impact, the Court ruled.
Before overruling a long-settled precedent such as Basic there must be “special justification,” Chief Justice Roberts wrote for the Court. Here plaintiffs have failed to make that showing.
Basic focuses on the key element of reliance which must be established to plead and prove a claim for securities fraud under Rule 10b-5. Reliance is the critical link between a claimed misrepresentation and plaintiff’s injury. It may be impracticable to prove individual reliance in actions where shares are bought and sold on an impersonal securities market. Using the fraud-on-the-market theory, it creates a substitute. The decision posits that in a well developed securities market the share price reflects the available material information, including misstatements. Based on this proposition Basic permits plaintiffs to invoke a rebuttable presumption of reliance after demonstrating that: 1) the alleged misrepresentations were publicly known; 2) they were material; 3) the stock traded in an efficient market; and 4) the plaintiff traded the stock between the time the misrepresentations were made and the truth was revealed. The presumption is rebuttable.
Halliburton claimed that the Basic presumption is inconsistent with the intent of Congress in passing the Exchange Act. This argument is predicated on a comparison to Exchange Act Section 18(a). That Section has an express private cause of action regarding misrepresentations tied to certain regulatory filings. Since it requires proof of reliance, Halliburton argued the same requirement should apply to the implied cause of action under Section 10(b). Thus the Basic presumption – a substitute for reliance – is contrary to the express provisions of the Exchange Act, according to Halliburton.
In contrast, the Fund argued that Section 9 of the Exchange Act, which also contains an express cause of action but omits reliance, is the better analogy. The Court declined to resolve this dispute, noting that a similar argument based on Section 18(a) was presented in the dissent in Basic.
Basic is also predicated on an erroneous view of the markets, according to Halliburton. While admitting that well developed securities markets do in fact reflect available information, Petitioners claim that Basic incorporates a “binary” view of the markets – either they incorporate the information or they don’t. This is incorrect as a number of recent studies confirm, according to plaintiffs.
The Court rejected this contention, noting that it misunderstands Basic. In that decision the Court only adopted the “fairly modest premise” that “’market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices,’” quoting Basic. Debates about the degree to which stock prices accurately reflect public information as in some studies cited by Halliburton are beside the point. And, in any event those studies are not an adequate basis for overruling Basic.
Likewise, Halliburton’s claim that Basic is at odds with the Court’s recent jurisprudence regarding class actions is incorrect. Those decisions establish that to secure class certification a plaintiff must not just plead but prove each of the requirements of Federal Rule of Civil Procedure 23. The crucial requirement for certification will be the predominance requirement. Basic does not relieve plaintiff of establishing that requirement. Rather, the case “sets forth what they [plaintiffs] must prove to demonstrate such predominance.”
Finally, Halliburton’s contention that Basic facilitates class actions which, once certified can force settlements in not a reason to overrule long established precedent. Rather, it is an issue for Congress. Accordingly, Halliburton failed to demonstrate that Basic should be overruled.
Alternatively, Halliburton claimed that plaintiffs should be required to prove price impact. This is not a “modest” modification as Halliburton claims, according to Chief Justice Roberts. Rather it, would “radically” rewrite the decision. The Court thus rejected the claim.
The Court agreed with Halliburton that a defendant should be permitted to offer evidence demonstrating a lack of price impact at certification. Indeed, to restrict defendants from offering such evidence would makes “no sense.” It would be “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. . . [therefore] it is appropriate to allow plaintiffs to rely on this indirect proxy for price impact, rather than requiring them to prove price impact directly. . .” At the same time since the presumption is a proxy for price, it can be rebutted with evidence of lack of price impact.
In sum, the Court rejected claims that Basic be overruled holding: “We adhere to that [Basic] decision and decline to modify the prerequisites for invoking the presumption of reliance. But 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.”
Justice Ginsburg filed a concurring opinion joined by Justices Breyer and Sotomayor. In her opinion Justice Ginsburg notes that while permitting evidence of price certification at certification may broaden discovery, it should not be a heavy burden on plaintiffs with tenable claims.
Justice Thomas filed an opinion concurring in the judgment. It was joined by Justices Scalia and Alito. Justice Thomas argues that the Court should not be endorsing an implied cause of action and crafting elements for such claims.
The plaintiffs bar may well be breathing a collective sigh of relief – or maybe not. If the Court had overruled Basic it would have rewritten the way in which securities class actions are brought. Plaintiffs might have shifted to using an omission theory under Affiliated Ute or focused on Securities Act claims which do not use Basic. It is problematic at best as to whether those options would prove to be an effective substitute for actions predicated on Exchange Act Section 10(b), Rule 10b-5 and Basic.
Likewise, rejecting Halliburton’s claim that a securities law plaintiff demonstrate price impact at class certification avoided substantially altering current practice. Basic is, as the Court noted, built on two presumptions, one that the claimed misrepresentations affected the stock price and the other that plaintiffs purchased the shares in reliance on the integrity of the price. Requiring plaintiffs to prove price impact would have rewritten those presumptions and added to the burned of the plaintiffs.
Before plaintiffs celebrate the dodging the bullet however, they should carefully consider the Court’s teachings on introducing evidence of lack of price impact. Now at class certification defendants can seek to rebut Basic by introducing evidence demonstrating a lack of price impact. While Justice Ginsburg correctly notes that permitting the introduction of that evidence at certification will increase discovery, it remains to be seen if her statement suggesting this will not significantly increase the burden for plaintiffs is correct. To be sure, evidence of price impact is being considered now at certification to some extent. At the same time Halliburton II will undoubtedly expand that practice and the related discovery. Certification may become a mini-trial centered on a battle of experts. Whether this will facilitate or impede class actions remains to be seen. The true impact of Halliburton II is thus a chapter in class action history yet to be written.