On June 23, 2014, the Supreme Court issued its long anticipated decision in Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317, 2014 WL 2807181 (June 23, 2014). The Court declined to overturn the 25 year-old decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), which established the “fraud-on-the-market” presumption of reliance1 in Section 10(b) class actions, but resolved a conflict among the circuits by confirming that under Basic, defendants can challenge and defeat the presumption of reliance at the class certification stage. This article discusses the opinion with a focus on how defendants in practice can successfully rebut the fraud-on-the-market presumption.2
The Halliburton action was initiated by the Erica P. John Fund, Inc. on behalf of a purported class consisting of shareholders in Halliburton Company (“Halliburton”) who purchased or sold stock between June 3, 1999 and December 7, 2001. Plaintiffs alleged that Halliburton made misrepresentations that artificially inflated Halliburton’s stock price, which caused injury to shareholders when corrective disclosure was publicly disseminated. Halliburton opposed class certification on the grounds that the Company’s alleged fraud did not affect the market price of its stock. The district court rejected this argument and certified the class. The Fifth Circuit affirmed, and in November 2013, the Supreme Court granted Halliburton’s petition for certiorari.3
THE COURT’S RULING
In the Court’s majority opinion, Chief Justice Roberts4 expressly declined to overrule Basic’s presumption of reliance and require each securities plaintiff to show actual reliance on the defendant’s misrepresentation. 2014 WL 2807181, at *6. The majority considered each of Halliburton’s arguments for overruling Basic in turn.
Halliburton argued that Basic was premised on the flawed assumption that market efficiency is a “‘binary, yes or no question.’” Id. at *9 (citation omitted). Rather, according to Halliburton, “a single market can process different kinds of information more or less efficiently, depending on how widely the information is disseminated and how easily it is understood.” Id. The majority rejected this assessment of Basic as overly narrow, noting that Halliburton had “fail[ed] to take Basic on its own terms.” Id. “Basic”, Chief Justice Roberts wrote, “d[id] not rest on a ‘binary’ view of market efficiency[:] in making the presumption rebuttable, Basic recognized that market efficiency is a matter of degree and accordingly made it a matter of proof.” Id.
The majority next addressed Halliburton’s assertion that current economic thinking rejects the efficient capital markets hypothesis, which provides the analytical justifications for Basic’s presumption of reliance on market prices. While conceding that the “efficient capital markets hypothesis may have ‘garnered substantial criticism since Basic’”, id. (citation omitted), the majority held that “Halliburton has not identified the kind of fundamental shift in economic theory that could justify overruling a precedent on the ground that it misunderstood, or has since been overtaken by, economic realities.” Id.5
The majority also observed that Congress has the power to overturn Basic but had declined to do so notwithstanding its adoption of legislation in this area, including statutes such as the Private Securities Litigation Reform Act (“PSLRA”), which the Court found addressed the “specific harmful consequences”6 arising out of the Basic decision cited by Halliburton and its amici.7
The Court also rejected as unpersuasive real-world examples offered by Halliburton when investors do not rely on the integrity of market prices. For instance, Halliburton pointed to “value investors” as a class of investors for whom “‘price integrity’ is . . . ‘marginal or irrelevant.’”8 The majority, however, held that even a value investor “implicitly relies on the fact that a stock’s market price will eventually reflect the material information [because] how else could the market correction on which his profit depends occur?”9
The majority opinion also considered Halliburton’s two proposed alternatives to overruling Basic: (1) requiring plaintiffs to prove that a defendant’s misrepresentation actually affected the stock price (i.e., “price impact”) in order to invoke Basic; or (2) allowing defendants to rebut the presumption of reliance with evidence of a “lack of price impact” at the class certification stage. Id. at *13.
The majority rejected the first alternative, finding that it would “radically alter the required showing for the reliance element of the Rule 10b-5 cause of action.” Id. at *14. Requiring plaintiffs to prove price impact directly would eviscerate the first constituent presumption of Basic—that public and material misrepresentations regarding a security traded on an efficient market are presumed to have affected the price of that security. Id. For all the reasons that the Court decided not to jettison Basic, the majority decided not to require plaintiffs to prove price impact. Id.
The majority did, however, adopt Halliburton’s second proposed alternative permitting defendants to show lack of price impact at class certification. While it has long been accepted that Basic allowed defendants to introduce price impact evidence at the class certification stage to counter a plaintiff’s showing of market efficiency, in practice defendants rarely attempted to defeat the presumption of reliance on the basis of lack of market impact. Although Chief Justice Roberts contended that such an argument was always permissible under Basic, Halliburton effectively endorses and requires lower courts to consider arguments by defendants that there was no price impact with respect to the specific misrepresentation(s) at issue in the lawsuit, and therefore, that the presumption does not apply.10 Id. at *16 (Basic “does not require courts to ignore . . . direct . . . salient evidence showing that the alleged misrepresentation did not actually affect the stock’s market price and, consequently, that the Basic presumption does not apply”). The majority premised this holding on the idea that while market efficiency and other prerequisites for invoking the fraud-on-the-market theory have always constituted an “indirect way” of showing price impact, such an “indirect proxy” should not “preclude direct evidence when such evidence is available.” Id.11
THE CONCURRING OPINIONS
Justice Thomas12 wrote the primary concurring opinion, which reads more like a dissent. Justice Thomas begins by stating that “[l]ogic, economic realities, and our subsequent jurisprudence have undermined the foundations of the Basic presumption,” and therefore, “Basic should be overruled.” 2014 WL 2807181, at *18. Similar to his dissent in Amgen, Justice Thomas’ concurring opinion here posits that Basic was based on a “questionable understanding of disputed economic theory and flawed intuitions about investor behavior.” Id. at *20. Justice Thomas also states that Halliburton is inconsistent with the Court’s recent class action jurisprudence, noting that, in other cases, the Court has required “plaintiffs seeking class certification to ‘“affirmatively demonstrate”’ certification requirements like the predominance of common questions.” Id. (citation omitted).13 Halliburton, in contrast, retains a presumption that absolves plaintiffs of such a showing at the class certification stage. For these reasons, Justice Thomas contended that “Basic should be overruled in favor of the straightforward rule that . . . actual reliance, not the fictional ‘fraud-on-the-market’ version—‘is an essential element of the § 10(b) private cause of action.’” 2014 WL 2807181, at *26 (citation omitted). Justice Thomas’ concurrence does not describe which part of the majority’s decision he is concurring with, although presumably Justices Thomas, Scalia and Alito reluctantly agree with the Court’s alternative decision to allow defendants to introduce direct evidence of lack of price impact at the class certification stage in order to defeat the presumption.
Justice Ginsburg14 penned a brief, four-sentence concurrence recognizing that the majority’s opinion could “broaden the scope of discovery available at certification.” Id. at *18. Justice Ginsburg premised her concurrence in the outcome on the understanding that defendants bear the burden of showing the absence of price impact so as not to impose a “heavy toll on securities-fraud plaintiffs with tenable claims.” Id.
The impact of Halliburton for defendants is decidedly mixed. According to Chief Justice Roberts, nothing has changed. And it is undeniable that Halliburton is far from the outcome that corporate America had hoped for. In practice, however, defendants now have the ability to advance previously little used arguments for defeating class certification at a relatively early stage in the proceedings. In particular, defendants are now entitled to rebut a plaintiff’s indirect proof of price impact under the fraud-on-the-market theory by showing that the alleged misrepresentation did not impact the market price of the issuer’s stock at the time it was made. That timing provides defendants with a potentially potent weapon for defeating class actions rather than having to go through costly discovery and then settle in order to avoid an adverse summary judgment decision and/or trial.
Before Halliburton, as the majority and even plaintiffs acknowledged, there was no dispute that at the merits stage of the case, i.e., on summary judgment or rarely, at trial, defendants had the ability to show that alleged misstatements or omissions had no impact on a security’s market price. Such a showing would defeat Basic’s presumption of reliance. But by the time a defendant typically would be able to file a motion for summary judgment, fact and perhaps expert discovery would be complete and there would be mounting pressure to settle. See 2014 WL 2807181, at *25 n.7 (Thomas, J., concurring) (“The absence of postcertification rebuttal is likely attributable in part to the substantial in terrorem settlement pressure brought to bear by certification”).
Moreover, while Chief Justice Roberts suggested that under Basic courts always had the ability to consider arguments from defendants rebutting the presumption of reliance based on lack of price impact, the concurrence pointed out the reality that such arguments were by and large neither made nor decided at class certification. As Justice Thomas observed, “[o]ne search for rebuttals on individual-reliance grounds turned up only six cases out of the thousands of Rule 10b-5 actions brought since Basic.” Id. at *25.
In Halliburton, however, Chief Justice Roberts made clear that defendants may rebut the presumption of reliance at class certification by demonstrating a lack of price impact, including through direct evidence severing the link between alleged misstatements and market price movements. In effect, the Court’s decision gives defendants a green light to make at the class certification stage arguments that otherwise had been relegated to late stage proceedings such as summary judgment. Defendants therefore appear to have substantial incentives to advocate for early class certification discovery and motion practice in the hope of defeating class certification before significant merits discovery occurs. Likewise, defendants need to marshal evidence supporting such arguments earlier. Defendants should consult with experts and begin preparing typical supporting evidence such as event studies almost from the outset of the case in order to be positioned to argue against price impact at the earliest point possible.
1 The fraud-on-the-market theory, established in Basic, presumes that publicly available information is generally reflected in a security’s market price. Given this presumed price impact, Basic also presumes that an investor who buys or sells stock on an efficient capital market is relying on the integrity of that price, including public statements embedded in that price. This renders the issue of reliance common to the class.
2 Several of the authors previously considered the various outcomes to Halliburton, and the implications for each. See Jason M. Halper, et al., Halliburton Co. v. Erica P. John Fund, Inc.: Assessing Possible Modifications to Basic and The Fraud-On-The-Market Theory, Fin. Fraud L. Rep. 405 (May 2014).
3 This is the second time that the dispute between Halliburton and plaintiffs reached the Supreme Court. In 2011, the Court issued a decision in Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011), holding that securities fraud plaintiffs need not prove loss causation at the class certification stage. Id. at 2186.
4 Joining the Chief Justice were Justices Kennedy, Ginsburg, Breyer, Sotomayor and Kagan.
5 Chief Justice Roberts also cited the Court’s deference to long-settled precedent, finding that a party must provide a “‘“special justification”’” for overturning a case such as Basic, rather than merely offering “an argument that the precedent was wrongly decided.” Id. at *6 (citation omitted).
6 Halliburton also argued that Basic has produced “serious and harmful consequences,” including the perpetuation of a system that encourages or permits large, extortionary settlements for meritless claims, excessive costs on businesses (and their shareholders) that are forced to defend against these claims, and the consumption of a disproportionately large share of judicial resources. Id. at *12. The majority found that “[t]hese concerns are more appropriately addressed to Congress,” citing Congress’s prior legislation in the securities area such as the PSLRA and the Securities Litigation Uniform Standards Act of 1998. Id. at **12-13.
7 In his concurrence, Justice Thomas (joined by Justices Alito and Scalia), disputed the inference that Congress’ silence with respect to the Basic presumption indicated approval. Id. at *27 (“it is inappropriate to give weight to ‘Congress’ unenacted opinion’ when construing judge-made doctrines, because doing so allows the Court to create law and then ‘effectively codify’ it ‘based only on Congress’ failure to address it’”) (citation omitted).
8 Id. at *10 (citation omitted). The opinion defines a value investor as one who “believes that certain stocks are undervalued or overvalued and attempts to ‘beat the market’ by buying the undervalued stocks and selling the overvalued ones.” Id.
10 The Court also acknowledged that a defendant could rebut the presumption of reliance by showing that a plaintiff “would have bought or sold the stock even had he been aware that the stock’s price was tainted by fraud.” Id. at *7. This suggests an argument that certain classes of investors (e.g., value investors and index funds) would not be suitable class representatives because the presumption of reliance would not apply to them.
11 The majority distinguished its decision in Halliburton from its 2013 holding in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184 (2013), where the Court found that securities plaintiffs need not prove materiality—itself a prerequisite for invoking the Basic presumption—at the class certification stage in order to show Rule 23(b) predominance. In Amgen, the Court held that the materiality determination is “an objective one,” in that the court’s determination of whether the alleged statements are material will by necessity apply to the entire class. Id. at 1195-96. The Halliburton majority found that price impact is “crucial[ly]” different: the common issue of materiality can be left to the merits stage without affecting whether individual issues will predominate over common ones, whereas “[t]here is no dispute that at least . . . indirect proof of price impact ‘is needed to ensure that the questions of law or fact common to the class will “predominate.”’” 2014 WL 2807181, at *16-17 (citation omitted).
12 Justice Thomas’ concurrence was joined by Justices Alito and Scalia.
13 See Comcast Corp. v. Behrend, 133 S. Ct. 1426, 1432 (2013).
14 Justice Ginsburg’s concurrence was joined by Justices Breyer and Sotomayor.
****Chao Huang, a litigation associate, assisted with the preparation of this memo.