On March 5, the Supreme Court heard oral arguments in Halliburton v. The Erica P. John Fund. As discussed in previous blog posts, the United States Supreme Court agreed to consider Petitioner Halliburton’s argument to modify or overturn the fraud-on-the market presumption that the Court first articulated more than a quarter century ago in Basic v. Levinson, 485 U.S. 224, 243-50 (1988). As our readers know, the fraud-on-the market theory allows investors to bring securities class action suits under Section 10(b) of the 1934 Securities Exchange Act by using a rebuttable presumption that public information about a company is reflected in its stock price because of the efficient markets hypothesis. Basic significantly relaxes the burden on securities class action plaintiffs because they do not need to show actual reliance on a purported misstatement when deciding to buy or sell stock. Overturning or modifying Basic would significantly dampen shareholder litigation by making it more difficult to obtain class certification or to survive a motion to dismiss.
At oral argument, Halliburton’s counsel argued that the fraud-on-the-market presumption creates a “binary yes-or-no approach to market efficiency” with little consideration of whether the particular misstatement at issue actually affected the stock’s price in the market. According to Halliburton, this outcome is inconsistent with the Supreme Court’s otherwise narrow construction of Section 10(b), and the court generally disfavors presumption of classified issues. According to Halliburton, the Basic holding is an anomaly—“a sore thumb”—in the Supreme Court’s 10(b) jurisprudence.
Chief Justice Roberts, who may be a deciding factor in what appears to be a three-way split among the justices, suggested that Halliburton’s argument to “jettison” Basic asks the Court to accept or reject the efficient markets theory—an economic principle rather than a legal question. Moreover, the Court appeared reluctant to overturn Basic given that Congress did not expressly do so in the seminal Private Securities Litigation and Reformation Act of 1995 or the Securities Litigation Uniform Standards Act of 1998—although Justice Scalia noted that it doesn’t mean Basic cannot be overturned and Congress’s actions do not constitute a ratification of Basic.
Perhaps significantly, the Court spent most of its time on a potential compromise approach that would modify how Basic is applied. Referring to an idea suggested in an amici brief filed by a number of law professors, Justice Kennedy raised a “midway position” that proposes an event study during the class certification stage to determine whether stock price was in fact affected by the misstatement. The law professors’ position “shift[s] the focus of fraud on the market inquiries from a market’s overall efficiency to the question whether the alleged fraud affected market price.” Several justices, including Justices Alito and Roberts, inquired about the merits of event studies to examine market distortion, although Justice Kennedy was concerned about the resources and burden to conduct such a study. In contrast, Justice Sotomayor propounded that a study could “do away with market efficiency” or introduce merits arguments on loss causation at the certification stage. Finally, the Department of Justice (amicus curiae on behalf of the Respondent) agreed that an event study, i.e., moving away from the efficient markets theory, may not have a dramatic impact on shareholder litigation and could result in “a net gain” for plaintiffs because plaintiffs already have to prove price impact (though this generally occurs later in the litigation at the merits stage).
The Court’s opinion is expected this summer, but many observers believe that, whatever the decision may be, the Court must reconcile its Halliburton holding with its 2013 Amgen decision, which rejected a proposal to introduce a materiality requirement at the certification stage.