Securities class action lawsuits have long been a fact of life for public companies traded on a U.S. exchange. Since 1997, plaintiffs have filed more than 3,200 securities fraud lawsuits1 that have resulted in approximately $75 billion in settlements.2 The threat posed by such suits has been cited as a major deterrent to listing on a U.S. stock market; indeed, the number of U.S. exchange-listed companies has declined by 46% since 1998.3 The prevalence of securities litigation under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) has been fueled in large part by the Supreme Court’s adoption in Basic Inc. v. Levinson, 485 U.S. 224 (1988), of the fraud-on-the-market presumption of reliance. However, the Supreme Court’s much anticipated decision in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 636 (2013) (“Halliburton”) (expected later this Spring) could fundamentally alter the securities litigation landscape depending on whether it reaffirms, reverses or modifies Basic. If the Court opts for a middle course—neither outright reversing nor affirming Basic (an outcome that appears quite possible based on the Justices’ questioning at the March 5 oral argument)—litigants may face a period of substantial uncertainty in the absence of a developed body of caselaw interpreting a new rule and in the face of novel theories and tactics from securities plaintiffs. This article explores these possibilities.
The fraud-on-the-market doctrine permits securities plaintiffs to side-step what previously had been a thorny issue: establishing for purposes of class certification under Fed. R. Civ. P. 23 that common issues predominate notwithstanding that actual reliance on allegedly false statements (typically an individual issue not susceptible to common proof) is an essential element of a Section 10(b) claim. Basic held that publicly available information, including an alleged misstatement, is generally reflected in a security’s market price. Given this presumed price impact, the Court likewise endorsed a presumption that an investor who buys or sells stock on an efficient market is relying on the integrity of that price, including public statements embedded in that price, rendering the issue of reliance common to the class. See Basic, 485 U.S. at 245-47.4 While the Basic presumption of reliance is nominally rebuttable, cases in which the presumption has been rebutted are, as one prominent observer noted, “as rare as hen’s teeth.”5
The fraud-on-the-market presumption was controversial from the outset, and now appears to be under full assault. In February 2013, the Supreme Court issued its decision in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 133 S. Ct. 1184 (2013), in which it found that securities fraud plaintiffs need not prove the materiality of the alleged misstatements at the class certification stage in order to invoke the fraud-on-the-market presumption.6 However, four Justices appeared to question the continuing vitality of Basic’s presumption of reliance altogether. In dissent, Justice Scalia referred to the “regrettable consequences of the four-Justice opinion in Basic.” 133 S. Ct. at 1206. In a three-sentence concurring opinion, Justice Alito observed that “recent evidence suggests that the [fraud-on-the-market] presumption may rest on a faulty economic premise,” and stated that “reconsideration of the Basic presumption may be appropriate.” Id. at 1204. Justice Thomas’s dissent, which was joined by Justice Kennedy, called Basic “questionable,” but indicated that, in the Amgen case, “the Court ha[d] not been asked to revisit Basic’s fraud-on-the-market presumption.” Id. at 1208 n.4.
Unlike in Amgen, the petitioners in Halliburton have specifically asked the Court to revisit the fraud-on-the-market presumption articulated in Basic.
THE HALLIBURTON CASE
Plaintiff Erica P. John Fund, Inc. (“Plaintiffs”) commenced a purported class action against Halliburton Company (“Halliburton” or the “Company”) and its Chief Executive Officer for alleged violations of Section 10(b). Plaintiffs alleged that defendants made false statements between 1999 and 2001 concerning: (i) Halliburton’s asbestos-related legal liability; (ii) Company revenues; and (iii) the cost savings Halliburton would derive from a 1998 merger. See Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423, 426 (5th Cir.), cert. granted, 134 S. Ct. 636 (2013).7
In opposing class certification, Halliburton argued that the “evidence revealed that [Halliburton’s] alleged fraud did not affect the market price of the stock; that is, its alleged misrepresentations did not cause ‘price impact’ or ‘price distortion.’” 718 F.3d at 427. As a result, according to Halliburton, plaintiff could not invoke the fraud-on-the-market presumption. The district court rejected this argument and certified the class. Id. The Fifth Circuit affirmed, and on November 15, 2013, the Supreme Court granted Halliburton’s petition for certiorari in which it seeks to overturn or substantially modify Basic. See Halliburton, 134 S. Ct. 636. The Court heard oral argument on March 5, 2014.
POTENTIAL OUTCOMES OF HALLIBURTON AND THEIR IMPACT
Corporate America, plaintiffs’ advocacy groups, the plaintiff and defense bars, and various other constituencies are intensely interested in the outcome of Halliburton. There are, potentially, several ways that the Supreme Court could rule.
Affirming the Fifth Circuit
The Supreme Court could decide that Basic has continued viability, rule in favor of the plaintiff-respondents and affirm the Fifth Circuit. This outcome would, of course, endorse the status quo.
A second potential outcome would be to reverse Basic entirely. Halliburton’s Petitioner’s Brief and the various amicus briefs supporting Halliburton’s cause lay out the rationales for such a result.8 Primarily, Halliburton and the amici assail the ECMH, arguing that “‘overwhelming empirical evidence’ now ‘suggests that capital markets are not fundamentally efficient.’” Brief for Petitioners, 2013 WL 6907610, at *16 (U.S. Dec. 30, 2013) (citation omitted). To drive this point home, Halliburton cites the “Black Monday” panic of 1987 and the dot-com bubble of 1998-2000 as evidence that robust markets experience price movements even in the absence of new information. Id. at *18. On the other hand, securities prices often have moved in response to articles published in prominent newspapers (such as the New York Times or Wall Street Journal), even when these articles merely repeated information contained in SEC filings disclosed weeks or months earlier. Id. at *17-18. Thus, markets undergo dramatic price changes without any new information and fail to respond rapidly to new public information. SIFMA contends that this is largely because “the market price of a security will not be uniformly efficient as to all types of information.” Brief of the Securities Industry and Financial Markets Association as Amicus Curiae, 2014 WL 60720, at *27 (U.S. Jan. 6, 2014) (“Brief of SIFMA”); see also Brief of Law Professors, 2014 WL 60721, at *14 (“Levels of efficiency vary even among the types of information within the same market”). In this reality of inefficient capital markets, Halliburton contends, courts should not assume that alleged misrepresentations are factored into market prices.9
Halliburton also contends that Basic is inconsistent with the Supreme Court’s repeated guidance on the certification of class actions: “‘actual, not presumed, conformance with Rule 23 remains . . . indispensable.’” Brief for Petitioners, 2013 WL 6907610, at *25 (quoting Gen. Tel. Co. of Sw. v. Falcon, 457 U.S. 147, 160 (1982)) (emphasis in original). Indeed, two recent Supreme Court decisions emphasized that class proponents must demonstrate at the class certification stage that the Rule 23 prerequisites to class certification are satisfied. Comcast Corp. v. Behrend, 133 S. Ct. 1426, 1432-33 (2013) (reversing grant of class certification where “[b]y refusing to entertain arguments against respondents’ damages model that bore on the propriety of class certification, simply because those arguments would also be pertinent to the merits determination, the Court of Appeals ran afoul of our precedents requiring precisely that inquiry”);10 Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2556-57 (2011) (reversing order granting class certification where the plaintiffs had failed to provide “convincing proof of a companywide discriminatory pay and promotion policy,” and therefore had failed to establish the predominance of common questions of law or fact). Halliburton asserts that the Basic presumption has now become an anomalous shortcut to class certification, since “nothing justifies insisting that all plaintiffs except securities plaintiffs must actually demonstrate predominance.” Brief for Petitioners, 2013 WL 6907610, at *26-27 (emphasis in original).
If the Supreme Court completely overrules Basic, Section 10(b) class actions likely would become nearly impossible to certify. While the Plaintiffs’ bar has loudly protested that overruling Basic would leave the securities markets, in effect, unregulated, there are reasons to believe that those concerns are overblown. First, the Department of Justice and the Securities and Exchange Commission (“SEC”) would not be directly affected by a reversal. The SEC, for example, is not required to prove reliance, actual damages, or loss causation. See SEC v. Goble, 682 F.3d 934, 943 (11th Cir. 2012). Second, plaintiffs’ lawyers will adapt and find alternate means of pursuing alleged securities fraud. For example, large institutional investors that are able to show that they relied on alleged misrepresentations will still be able to press their claims on an individual basis without requiring the bundling-effect of the class action to cost-effectively pursue their rights.11 Plaintiffs’ lawyers may also elect to file mass individual actions (as opposed to class actions) if Halliburton were to make class certification unfeasible. Additionally, depending on the circumstances, plaintiffs may be able to file suit under Sections 11 and 12(a)(2) of the Securities Act of 1933 which, respectively, create liability for misstatements in a registration statement or a prospectus without any requirement to prove reliance. Third, Congress could act by effectively overruling a Supreme Court Halliburton decision that eviscerates Basic. Congress has had many opportunities since Basic was decided in 1988 to eliminate the fraud-on-the-market presumption but has never done so.12 If Congress believes that the Supreme Court has gone too far, it could enact legislation amending the securities laws to specifically include the Basic presumption.
Another option would be for the Supreme Court to modify Basic. Such an outcome could be accomplished in many ways, but Halliburton and the supporting amici primarily have focused on two potential modifications involving proof of price impact.
First, the Court could require plaintiffs to show at the class certification stage that the alleged misrepresentations actually affected the market price. See, e.g., Brief for Chamber et al., 2014 WL 108360, at *20-21 (arguing that the Court should require a determination that the market “actually incorporated the relevant misrepresentations into price” before concluding that the presumption is applied). As noted by Halliburton, Basic’s “‘fundamental premise [is] that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of [the] transaction.’” Brief for Petitioners, 2013 WL 6907610, at *37 (citation omitted; emphasis in original). If stockholder-plaintiffs are unable to show that the alleged misrepresentations were reflected in the market price, “there is ‘no grounding for any contention that investors indirectly relied on those misrepresentations through their reliance on the integrity of the market price.’” Id. (citation omitted). While this outcome would fall far short of requiring proof of actual reliance at class certification, it would still significantly raise the bar for plaintiffs to invoke the Basic presumption. Currently, plaintiffs must only show “market efficiency, publicity, and trade timing.” Id. at *38.
Second, the Supreme Court could modify Basic such that Section 10(b) defendants are permitted to rebut the fraud-on-the-market presumption at the class certification stage by showing the absence of price impact.13 With this modification, defendants who are able to show that the stock price has not been impacted by the alleged misrepresentations could defeat class certification. Such a modification would be significant: many courts will not permit rebuttal evidence until summary judgment or trial, at which point many class actions will have been settled.14
A “modification” may be an attractive option to the Court because it would allow for a material alteration of Basic without upending 25 years of precedent. At oral argument, several of the Justices seemed interested in a Basic modification—a “midway position” as Justice Kennedy described it—that could require securities plaintiffs to commission an “event study” to show price impact at class certification stage.15 However, as several of the amici have noted, half measures (such as requiring plaintiffs prove price impact or allowing defendants to rebut the presumption with the absence of price impact) will still result in meritless class actions. See, e.g., Brief of SIFMA, 2014 WL 60720, at *26 (“the presence or absence of price movement—whether at the time of the alleged misstatement or of the corrective disclosure—is a poor measure of market transmission of a false or misleading statement . . . [and] sets an unduly low and too easily satisfied threshold for invoking the Basic presumption”).16 Indeed, Basic’s very existence has conditioned the market to expect litigation whenever corrective information is announced, and thus markets drop on corrective information, not reflecting just the information disclosed, but also the issuer’s imminent litigation costs.
The significance of Basic to Section 10(b) class actions is difficult to overstate. Among other things, the decision fostered a cottage industry of securities fraud litigation propelled by an aggressive plaintiffs’ bar hungry for the quick settlements that typically follow a denial of a motion to dismiss and/or the certification of a securities fraud class. Conversely, corporate defendants often view the certification of a class as a cue to begin settlement negotiations even when confident in the merits in order to mitigate the inevitably substantial costs of discovery and the threat of an eight or nine figure judgment. Halliburton’s outcome, however, is difficult to predict. While Justice Kennedy dissented from the Amgen decision (and called Basic “questionable”), his statements at oral argument suggest an inclination to modify, rather than completely overrule, Basic. As many Court observers do not expect Justices Breyer, Ginsburg, Sotomayor or Kagan to join the concurring or dissenting Amgen Justices, the outcome may rest with Chief Justice Roberts (who did not reveal much at oral argument) and the extent of his concern for stare decisis in this situation.17
Notwithstanding its undeniable potential significance, the elimination or modification of the fraud-on-the-market presumption will not end criminal or regulatory enforcement of the securities laws, nor will it signal the demise of private civil securities fraud suits. Even in the absence of Congressional action or enhanced SEC enforcement, securities plaintiffs, like they did after the passage of the PSLRA, will adapt and find new and different ways to pursue redress for claimed injury. And, should the Court modify Basic, certain companies could even be more susceptible to Section 10(b) class actions.18 If the Court were to rule that a demonstrated price impact resulting from an alleged misstatement, and not an efficient market for the security, is the prerequisite to invoking a presumption of reliance, then smaller cap companies or those that trade over the counter (i.e., those that typically might not trade in an efficient market) may be newly vulnerable to Section 10(b) class actions as long plaintiff can show any required price impact. On the other hand, the Court’s adoption of such a rule would give companies that traditionally have been deemed to trade in an efficient market significantly enhanced opportunities to defeat class certification by focusing on the absence of a price effect.
1 Securities Class Action Filings: 2013 Year In Review (Cornerstone Research 2013) at 3, http://www.cornerstone.com/getattachment/d88bd527-25b5-4c54-8d40-2b13da0d0779/Securities-Class-Action-Filings%e2%80%942013-Year-in-Revie.aspx.
2 Joseph A. Grundfest, Damages and Reliance Under Section 10(b) of the Exchange Act at 47 (Rock Center for Corp. Governance Aug. 28, 2013) at 1, http://www.law.stanford.edu/sites/default/files/publication/442468/ doc/slspublic/SSRN-id2317537.pdf.
3 Id. at 12.
4 The fraud-on-the-market presumption articulated in Basic rests on an economic theory known as the Efficient Capital Markets Hypothesis (“ECMH”), which posits that securities prices rapidly adjust to reflect new public information impacting the underlying value of the securities being traded. In such an “efficient” market, investors are justified in relying on the market price as a substitute for investigating corporate reports—all that information should be accurately reflected in the market price. Any misrepresentation by the issuer would also be incorporated into the price until there is a corrective disclosure. Whether the capital markets are, in fact, “efficient,” is a question very much in dispute. As noted in the amicus brief filed by several former SEC Commissioners, “the Royal Swedish Academy of Sciences awarded the Nobel Memorial Prize in Economic Sciences to the ‘leading proponents of opposing views’ of that theory—one, the theory’s ‘author,’ the other, its ‘most influential critic.’” Brief for Former SEC Commissioners et al. as Amici Curiae, 2014 WL 69391, at *6 (U.S. Jan. 6, 2014) (citations & emphasis omitted). Additionally, while the fraud-on-the-market presumption is based on market efficiency, it need not be; “‘fraud can and does distort prevailing prices’ even in inefficient markets.” Brief of Law Professors as Amicus Curiae, 2014 WL 60721, at *7 (U.S. Jan. 6, 2014) (quoting Donald C. Langevoort, Basic at Twenty: Rethinking Fraud on the Market, 2009 Wis. L. Rev. 151, 161 (2009)).
5 See Grundfest, supra note 3, at 47.
6 The holding in Amgen was based on the Court’s finding that proof of materiality was not necessary to ensure the predominance of common questions of law or fact, and thus, need not be resolved prior to certifying a class, including because materiality is an essential element of a Section 10(b) claim and therefore the absence of materiality “end[s] the case for one and for all,” (i.e., on a common basis). Id. at 1196. For more on Amgen, see Jason M. Halper & Ryan J. Andreoli, Class Action Issues in Supreme Court: Assessing the Significance of ‘Amgen’, N.Y. L.J., Apr. 3, 2013, at 4.
7 When Plaintiffs initially moved to certify the class, the district court determined that the threshold requirements of Rule 23(a) had been satisfied, but found that Plaintiffs could not demonstrate “loss causation,” i.e., the direct causal link between the alleged misstatement and the claimant’s economic loss. Id. at 427. On appeal, the Fifth Circuit affirmed (Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330, 344 (5th Cir. 2010)), but a unanimous Supreme Court reversed, finding that proof of loss causation was not required for class certification. See Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179, 2187 (2011).
8 The individuals and entities filing amicus briefs in support of Halliburton’s position include: former members of Congress, former SEC commissioners and officials, various law professors, Vivendi, S.A., Amgen, Inc. the Washington Legal Foundation (“WLF”), the Committee on Capital Markets Regulation, the Securities Industry and Financial Markets Association (“SIFMA”) and the United States Chamber of Commerce (“Chamber”).
9 In fact, Halliburton asserts that investors do not rely on market price integrity: “many investors’ ‘strategies’ involve ‘attempting to locate undervalued stocks in an effort to “beat the market’”, meaning that they ‘are in essence betting that the market for the securities they are buying is in fact inefficient.’” Brief for Petitioners, 2013 WL 6907610, at *15-16 (emphasis in original; citations omitted); see also Brief for Chamber of Commerce et al. as Amici Curiae, 2014 WL 108360, at *12 (U.S. Jan. 6, 2014) (“Brief for Chamber et al.”) (“[M]any . . . buy or sell a security precisely because they believe the market price is wrong—buying when they assess the market has undervalued the stock and selling when the sock is overvalued”) (emphasis in original). In its amicus brief, Vivendi notes that entire classes of investors, such as volatility arbitragers, are indifferent to market efficiency. Brief for Vivendi S.A. as Amicus Curiae, 2014 WL 60716, at *4-5 (U.S. Jan. 6, 2014) (“Brief for Vivendi”).
10 For more on Comcast, see Jason M. Halper & Ryan J. Andreoli, Class-Action Issues in the Supreme Court: Comcast Corp. v. Behrend, 20 No. 4 Westlaw J. Class Action 1 (May 22, 2013).
11 Vivendi’s amicus brief observes that, in a recent securities class action settlement involving Vivendi, the “vast majority” of damages were claimed by a small number of institutional investors (approximately 2% of the class), i.e., “value investors” who “apply . . . sophisticated trading strategies that are not dependent on the integrity of market price.” Brief for Vivendi, 2014 WL 60716, at *8, *10 (“Unlike many retail investors, [large institutional investors] know why they determined that a security was a good investment when they purchased it. And if they did, in fact, rely on a particular public statement, they would be in a position to prove it”).
12 In their Respondents Brief, plaintiffs argue that the Basic presumption is well-settled precedent in a field that Congress has closely supervised. Plaintiffs further contend that Congress’ repeated inaction regarding Basic notwithstanding other aggressive reforms to the securities laws (including the passage of the Private Securities Litigation Reform Act of 1995 (“PSLRA”) and the Securities Litigation Uniform Standards Act) indicate Congress’ intent to leave Basic intact, an intent that the Court should respect. Brief for Respondent, 2014 WL 356636, at *5, *13-17 (U.S. Jan. 29, 2014). However, the former SEC Commissioners’ amicus brief responds to this line of reasoning as follows: “Instead of ‘reading the tea leaves of congressional inaction’ . . . the Court should apply what Congress expressly enacted into law: a requirement of actual reliance.” Brief for Former SEC Comm’rs et al., 2014 WL 69391, at *12; see also Brief for Former Members of Congress, Senior SEC Officials, and Congressional Counsel as Amici Curiae, 2014 WL 60715, at *2 (U.S. Jan. 6, 2014) (discussing the “mistaken notion that Congress endorsed the fraud-on-the-market theory in the PSLRA”).
13 As argued in the amicus curiae of DRI—The Voice of the Defense Bar, the “heart of the [ECMH] is that the stock price is impacted by (i.e., reflects) the alleged misrepresentations . . . [and] [a]ccordingly it is price impact that allows a presumption that market participants are indirectly relying on publicly available information.” Brief of DRI—The Voice of the Defense Bar as Amicus Curiae, 2014 WL 108362, at *6 (U.S. Jan. 6, 2014); see also Brief of the Washington Legal Foundation as Amicus Curiae, 2014 WL 60722, at *2 (U.S. Jan. 6, 2014) (“Price impact is a fundamental prerequisite for the application of the fraud-on-the-market presumption of reliance”).
14 At oral argument, Justices Scalia and Sotomayor pressed counsel on whether the certification of a class, for all intents and purposes, necessitated a quick settlement. See Transcript of Oral Argument at 23, Halliburton Co. et al. v. Erica P. John Fund, Inc., No.13-317 (Justice Scalia: “Once you get the class certified, the case is over, right?” Halliburton’s counsel: “Yes. And less than one third of one percent actually go to verdict”); id. at 39-40 (Justice Sotomayor: “[O]f cases that were certified as classes, how many go to trial . . . do you have a percentage for . . . that number?”).
15 See Oral Argument Transcript supra note 15 at 17. Justice Kennedy raised the question of requiring an event study with both Halliburton’s and Respondent’s counsel (see id. at 17 and 29-34), and then pressed the issue with the Deputy Solicitor General, who spoke on behalf of the United States and the SEC. Even Justice Scalia conceded that the Court might decide to modify Basic rather than overrule it. See id. at 41 (discussing the possibility that the Court would adopt a “Basic writ small”).
16 The SIFMA Brief also argued that modifying Basic to require proof of price impact, although “better than leaving Basic unchanged,” lacked a sound economic basis because it “would not reliably establish that any plaintiff relied on a distorted price at the time of the transaction.” Brief of SIFMA, 2014 WL 60720, at *3-4.
17 Halliburton and several amici argued that stare decisis does not preclude overruling Basic for a number of reasons, including that Basic is a four-Justice plurality (not a majority), the opinion was “badly reasoned,” it “cast aside” the text and structure of the securities laws, and sharply conflicts with the Supreme Court’s more recent decisions in Wal-Mart and Comcast. See, e.g., Brief for Former SEC Comm’rs et al., 2014 WL 69391, at *28.
18 While the Deputy Solicitor General (acting as amicus counsel for Respondents) noted that a full rejection of Basic could have “potentially dramatic” consequences, he stated that the “mid-way position” of interest to Justice Kennedy would not be “nearly [as] dramatic” a change and that “if anything, [might] be a net gain to plaintiffs, because plaintiffs already have to prove price impact at [the merits stage].” See Oral Argument Transcript supra note 15 at 48-50.