On June 23, 2014, in Halliburton v. Erica P. John Fund, No. 13-317 (June 23, 2014) ("Halliburton II"), in an opinion authored by Justice Roberts, the Supreme Court unanimously declined to overturn its ruling in Basic v. Levinson, which created a presumption that investor plaintiffs rely on the market price of stock if the plaintiffs show that they traded securities in an efficient market. The Court further held, however, that company defendants may rebut this presumption by showing a lack of evidence that company stock prices were affected by alleged misrepresentations. Justices Ginsberg and Thomas filed concurring opinions.
While this decision is a victory for investors, it also provides company defendants a greater opportunity to defend against securities class action claims early on in the process. The following practice update summarizes the background of Halliburton II, the Court's analysis in Halliburton II itself and the effect the decision may have on future securities class actions.
Basic v. Levinson's "Presumption of Reliance" and Background of Halliburton II
Section 10(b) of the Securities and Exchange Act of 1934 requires a plaintiff to prove that the defendant intentionally made a material misstatement or omission regarding the purchase or sale of securities, with scienter, that the plaintiff reasonably relied on these misstatements or omissions and that the misstatement or omission proximately caused the plaintiff's injury. In Basic v. Levinson, 485 U.S. 224 (1988), the Supreme Court held that plaintiffs do not need to offer direct proof that they relied on alleged misstatements; rather, reliance is presumed if they can show "(1) that the alleged misrepresentations were publically known, (2) that they were material, (3) that the stock traded in an efficient market, and (4) that the plaintiff traded the stock between the time the misrepresentations were made and when the truth was revealed." This holding was premised on the "fraud-on-the-market" theory, which assumes that misrepresentations made in efficient markets will affect stock prices. After Basic, and absent the need to prove individual reliance, it became easier for plaintiffs pursuing claims under Section 10(b) to obtain certification as a class.
In Erica P. John Fund v. Halliburton, 131 S. Ct. 2179 (2011) (Halliburton I), Erica P. John Fund, Inc. ("Fund") moved to certify a class of investors in a suit against Halliburton Co. ("Halliburton"), claiming that Halliburton made a series of material misrepresentations to "inflate the price of its stock," followed by a drop in stock prices due to "corrective disclosures" that caused investors to lose money. The District Court denied class certification, finding that Fund failed to prove that the alleged misrepresentations caused the economic losses claimed, and the Fifth Circuit affirmed on the same grounds. The Supreme Court vacated the judgment and remanded the case, holding that plaintiffs are not required to prove loss causation to be entitled to Basic's presumption of reliance.
On remand, Halliburton asserted that the evidence it used to show lack of loss causation also rebutted Basic's reliance presumption because it showed that the alleged misrepresentations did not impact the price of Halliburton's stock. The District Court rejected this argument, however, holding that Basic's reliance presumption applied and certified the class. The Fifth Circuit affirmed the decision, finding that evidence of price impact is only relevant at the merits stage of a case, rather than at the class certification stage.
In the present case, Halliburton II, the Court granted certiorari to determine "whether securities fraud defendants may attempt to rebut the Basic presumption at the class certification stage with evidence of a lack of price impact" and whether Basic should be overruled.
Halliburton II: Upholding Basic but Allowing Defendants Greater Rebuttal Opportunities at the Class Certification Stage
The Court's recent decision in Halliburton II arguably is a greater victory for securities plaintiffs than defendants because the Court declined to overrule Basic's presumption of reliance. This holding, however, also gives defendants a greater opportunity to argue dismissal of securities cases at the class certification stage. The Court held that defendants may rebut Basic's presumption of reliance with evidence that the price of the securities was not impacted by the alleged misrepresentations even before the merits stage.
First, the Court rejected Halliburton's argument that Basic should be overruled and that securities fraud plaintiffs should always have to prove direct reliance, because Halliburton failed to show a "special justification" for overturning this prior holding. Quickly dismissing Halliburton's argument that congressional intent justified overruling Basic, the Court held that "[t]he academic debates discussed by Halliburton have not refuted the modest premise underlying the presumption of reliance" and that there is not enough of a "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." Further, it determined that the Basic Court did not assume that all investors rely on market price and that even those investors buying what they believe to be undervalued stock may not be "as indifferent to the integrity of market prices as Halliburton suggests." Additionally, the Court held that because Basic simply "sets forth what [plaintiffs] must prove" to show that class interests dominate over individual ones, it does not conflict with the Court's more recent class certification decisions. Further, it determined that any issues as to potential "serious and harmful consequences" from Basic are "more appropriately addressed to Congress."
Second, however, the Court provided some relief to the defendants by holding that while plaintiffs are not required to prove that a "misrepresentation actually affected the stock price," defendants may introduce evidence of lack of impact on the price at the class certification stage to rebut Basic's presumption of reliance. Given that defendants may present evidence of an absence of price impact at the merits stage and also at the class certification stage to show the market at issue was not efficient, the Court determined that it makes little sense to bar defendants from using such evidence to rebut Basic's reliance presumption for all purposes at the class certification stage.
Effect of Halliburton II
Because the Supreme Court refrained from overturning Basic, Halliburton II may have less of an effect on Securities Act litigation than initially predicted. Only three of the conservative Justices would have overturned Basic. Halliburton II may result in fewer successful class action suits, where it allows defendants to mount a greater defense at the class action stage. Corporate defendants may have a greater chance of succeeding if they can show that their stock prices did not fall subsequent to correction of a misstatement or that other factors may have affected the price of the stock rather than any alleged misstatement.
Perhaps the Court's assertion that overruling Basic is best left to Congress will prompt the legislative branch to take action. At present, however, it is likely that the decision will not have a significant impact on securities class.