On June 23, 2014, the Supreme Court of the United States rendered its opinion in Halliburton Co. v. Erica P. John Fund, No. 13-317, 134 S. Ct. 2398 (2014), unanimously declining to overturn a 26-year-old precedent that established the “fraud-on-the-market” presumption in securities litigation. The presumption, adopted in Basic v. Levinson, 485 U.S. 224 (1988), eliminates the need for plaintiffs in securities fraud cases to prove their reliance on alleged corporate misstatements in cases involving publicly traded securities. The premise of Basic, known as the “efficient market” theory, is that a publicly traded company’s stock price reflects all publicly available information about that company. The presumption that has arisen from this premise is that plaintiffs inherently rely on any alleged corporate misrepresentations when they purchase or sell stock because those misrepresentations are public information already reflected in the stock price.
Private plaintiffs must prove each element of securities fraud, namely, (1) a misstatement or omission (2) of a material fact (3) with scienter (i.e., fraudulent intent) (4) in connection with the purchase or sale of a security (5) on which the plaintiff reasonably relied and (6) which proximately caused the plaintiff’s loss. In order for a class action to be certified under Federal Civil Procedure Rule 23(b)(3), common questions must predominate over those of individual class members. The fraud-on-the-market presumption facilitates class certification by allowing courts to presume all class members inherently relied on the alleged misrepresentation when they bought or sold publicly traded securities. If this presumption did not exist, each member of the putative class would have the burden to prove they directly relied on an alleged corporate misrepresentation. Because this is not a “common question,” it is less likely the class can be certified.
Halliburton had asked the Court to completely do away with Basic and the fraud-on-the-market presumption, arguing this premise does not comport with reality. Although the Court declined to do so, Halliburton did win a small victory. The Court charted a middle ground by permitting corporate defendants to rebut the presumption at the class certification stage by introducing evidence that the alleged misrepresentation had no effect on the stock’s market price. Previously, corporate defendants were not permitted to rebut the presumption until after a class had been certified. Once a class is certified, corporate defendants overwhelmingly prefer to settle even what they believe to be meritless cases rather than assume the litigation risk they pose.
The decision failed to alter securities law in the fundamental way many hoped, instead by permitting defendants to rebut the presumption before class certification, the Court has set the stage for a war of experts. This will add to both the cost and complexity of these cases. While some claim a victory for investors, many in the securities industry bemoan what they describe as rigid adherence to principles of stare decisis. The Chief Justice wrote that the Court should not overturn precedent lightly, especially when interpreting statutes that Congress may revise if it sees fit. Justice Thomas, in his concurrence, responded “[w]hen we err in areas of judge-made law, we ought to presume that Congress expects us to correct our own mistakes—not the other way around.”
The full text of the Halliburton decision is here.