Is the Fraud-on-the-Market Bubble About to Burst?

by Akin Gump Strauss Hauer & Feld LLP
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On November 25, the U.S. Supreme Court set oral argument for March 5, 2014, in Halliburton v. Erica P. John Fund (No. 13-317), a case that could significantly impact the costs of securities litigation in the United States. The case raises one central question: should plaintiffs be entitled to the fraud-on-the-market presumption of reliance, which allows plaintiffs to form a class of investors without first proving that those investors relied on the supposedly false or misleading information from the company?

The Court’s answer to this question could change the face of securities litigation in the United States. For years, securities class actions have been the textbook example of easy-to-certify classes. Under Rule 23(b)(3), proposed class plaintiffs must prove up the common class action elements: commonality, numerosity, adequacy, typicality and predominance.  Many proposed classes are never certified because of the predominance element—individual issues predominate over the common issues. In the case of securities class actions, the question revolves around whether investors actually relied on the alleged fraud and what it would take to prove that they did so.

In 1988, the Supreme Court made it so any plaintiff lawyer with a company misstatement and a stock drop could sue in a class action. In Basic, Inc. v. Levinson, 485 U.S. 224 (1988), the Court reasoned that under the efficient market theory, all publicly available information is reflected in the stock’s price instantaneously. In such cases, plaintiffs should not be required to prove one-by-one that they relied on a particular misstatement. Instead, since the information would already be reflected in the price of the stock, the investor would be entitled to a presumption that she relied on the misstatement. After all, the investor relied on the integrity of the market price and that price should reflect all publicly available material information.

That presumption held for nearly 15 years. Then, in the wake of market anomalies following the bursting of the Internet bubble and the market crash in 2008, defendants began fighting back and district courts began listening. Defendants would rebut the presumption of reliance by arguing that the market was not efficient. It became commonplace for both plaintiffs and defendants to hire experts at the class-certification stage to battle over whether the market was efficient or whether the misstatements were material. The parties appealed. In the precursor to the current Halliburton case, the Supreme Court held that plaintiffs were not required to prove loss causation at the class-certification stage. Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179, 2185 (2011).  And in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds (No. 11-1085) (Feb. 27, 2013), the Supreme Court ruled that materiality was not an issue for class certification. 

In both of these decisions, some justices have signaled that the fraud-on-the-market presumption may be overturned. In Amgen, Justice Thomas remarked, “Basic is a judicially invented doctrine based on an economic theory adopted to ease the burden on plaintiffs bringing claims under an implied cause of action.” Justice Alito further noted, “[M]ore recent evidence suggests that the presumption may rest on a faulty economic premise. In light of this development, reconsideration of the Basic presumption may be appropriate.”

After a series of wins for the plaintiffs at the Supreme Court, Halliburton II looks like it may burst the plaintiffs’ fraud-on-the-market bubble. Though the bursting of the bubble may look like a welcome change to defendants, it may simply result in more litigation expense to defendants in the form of extended class certification proceedings, splintered state court litigation, or endless costs of multi-district litigation in the federal courts. Only time will tell. We’ll update you in March.

 

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