On Monday, the Supreme Court issues its heavily anticipated decision in Halliburton Co. v. Erica P. John Fund, Inc. As predicted in our prior alert about this case, the Court declined to overrule the "fraud on the market" theory that facilitates the certification of plaintiff classes in federal securities fraud lawsuits, but held that before deciding whether to certify a class, lower courts must give defendants the opportunity to present evidence rebutting the validity of the "fraud on the market" theory in a particular case.
The "fraud on the market" theory was endorsed by the Court in its 1988 decision in Basic, Inc. v. Levinson. It relieves plaintiffs in a securities fraud case from having to prove individual reliance on the alleged misrepresentation in purchasing or selling the security at issue. Instead, based on the "efficient capital markets hypothesis" supported by certain economists at the time, the Court found it reasonable to presume that if the security trades in an efficient market, any material public information will have been factored into the price of the security. An investor is therefore entitled (and presumed) to rely on the price of the security as accurately reflecting available information that might affect its price, including not only true information but any material misrepresentations that form the basis of a securities fraud claim. Whether the investor actually read, heard or knew about the alleged misrepresentation is irrelevant under the "fraud on the market" presumption, which allows the reliance question to be resolved on a class-wide basis for all investors, provided the plaintiff can meet the relatively light showing required to establish that an efficient market exists for the security.
In its release agreeing to hear the Halliburton case, the Supreme Court announced that it would revisit the continuing vitality of the "fraud on the market" theory, prompting widespread speculation whether the Court might overrule Basic and thereby dramatically curtail securities fraud class actions. The Court's 6-3 decision Monday refused to take that dramatic step. Justice Roberts, writing for the majority, rejected Halliburton's argument that the Basic Court had relied on a particularly "robust view of market efficiency" and that, therefore, more recent economic research "suggesting that capital markets are not fundamentally efficient" seriously undermined Basic's endorsement of the "fraud on the market" theory. Rather, the majority reasoned, "in making the presumption rebuttable, Basic recognized that market efficiency is a matter of degree and accordingly made it a matter of proof."
Consistent with the notion that the presumption is rebuttable, however, the Court ruled that at the class certification stage, the trial court must consider Halliburton's evidence that the alleged misrepresentation "did not in fact affect the stock price." That is, the "fraud on the market" presumption must be rebuttable by defendants not only for purposes of a decision on the merits of the fraud claims, but also for purposes of determining whether the matter should proceed as a class action.
Plaintiffs will continue to benefit from the presumptive availability of the "fraud on the market" doctrine to advance class-action securities fraud claims. Well-represented defendants, however, will adduce evidence to show that the misrepresentations plaintiffs allege had no significant impact on the company's share price, thereby increasing the probability of a decision to deny class certification.