Halliburton’s Brief Asks The U.S. Supreme Court To Overturn The Not So Brief 25-Year-Old Fraud-On-The-Market Presumption

http://blogs.orrick.com/securities-litigation/files/2012/10/iStock_000001085149Large-200x150.jpgAs discussed in a previous December 3, 2013 post, the U.S. Supreme Court has agreed to hear Halliburton’s pitch to overrule or modify the decades old fraud-on-the-market presumption established in Basic Inc. v. Levinson, 485 U.S. 224, 243-50 (1988).  This theory effectively allows shareholders to bring class action suits under Section 10 of the 1934 Act by presuming that plaintiffs, in purchasing stock in an efficient market, relied on alleged material misstatements made by defendants because such public statements were reflected in the company’s stock prices.

Urging the reversal of Basic, Halliburton filed its opening brief on December 30, 2013, in Halliburton Co. v. Erica P. John Fund, No. 13-317.  Halliburton makes several arguments in its brief in support of overturning Basic, including many familiar legal arguments relating to statutory interpretation, congressional intent and public policy objectives.  Perhaps most interesting, however, is the brief’s focus on the academic literature regarding the economic assumptions underlying Basic that may not be as familiar to practitioners.  Specifically, Halliburton argues that academics have discredited and rejected Basic’s key premise that the market price of shares traded on well-developed markets reflects all publicly available information.  In particular, Halliburton argues that:

1)    Studies have shown that there are several types of investors with different strategies, including investors who attempt to locate undervalued stocks in an effort to beat the market, and therefore are betting on the inefficiency of the market.

2)    New empirical evidence suggests that capital markets are not fundamentally efficient as public information is not always immediately or rationally incorporated into the market price.  The brief cites examples of increases in stock prices after information that had already been in the market for months, appeared again in various articles and journals.

3)    Not only do less sophisticated investors make irrational decisions in purchasing stock, but more sophisticated investors may make money in the short term by exploiting the herd mentality of these less sophisticated investors, and therefore will also act irrationally.  Further, computerized trading programs that aim to beat the market execute trades based on metrics as opposed to public disclosures.

4)    Basic’s binary view of efficient markets is invalid – the same markets may be efficient at times and inefficient at other times.

As subsequent briefing is filed in this appeal, the arguments regarding the economic underpinnings of the Basic decision will doubtless provide unique insight into the intersection between economics and legal theories in the context of securities regulation.