Yesterday, the United States Supreme Court issued its much-anticipated decision in Halliburton Co. v. Erica P. John Fund, Inc. Halliburton called into question the very foundation of a securities class action—the presumption of class-wide reliance. A unanimous Court answered the question today, and the presumption of reliance lives. The Court's decision may, however, have given defendants new opportunities to rebut the presumption in the earlier stages of a case.
One of the elements a plaintiff must plead to state a federal securities fraud claim is reliance. In its 1988 decision in Basic Inc. v. Levinson, the Supreme Court held that investors could satisfy the reliance requirement by invoking a presumption that the price of stock traded in an efficient market reflects all public material information. The Halliburton Court revisited Basic at some length, and a brief summary of that case is useful context for an analysis of today's decision.
In Basic, the Court noted that requiring proof of direct reliance by every securities fraud plaintiff would eliminate the possibility of class relief because individual issues would necessarily overwhelm the common issues required for maintaining a class. Accordingly, the Basic Court created a rebuttable presumption of reliance premised upon the "fraud-on-the-market" economic theory. That theory maintains that the market price of shares impounds all publicly available information, including material misrepresentations. So, the Court held, when an investor buys or sells stock at the market price, his or her reliance may be presumed, assuming that he or she pleads that: (1) the alleged misrepresentations were publicly known, (2) they were material, (3) the stock was traded in an efficient market, and (4) the plaintiff traded in the stock in the relevant period. The Basic presumption is rebuttable. If the link between the misrepresentation and the price the plaintiff paid is severed, the presumption will not apply.
Petitioner Halliburton argued that Basic should be overruled. In the alternative, it argued that a plaintiff should be required to prove that a defendant's misrepresentation affected the stock price in order to obtain the presumption of reliance. Halliburton also argued that a defendant should be permitted to rebut the presumption of reliance with evidence of a lack of price impact prior to the class certification or merits stage of a class action.
The Supreme Court rejected Halliburton's argument for the elimination of Basic's presumption of reliance for several reasons. First, the standard for overruling Court precedent is high; a "special justification" is required, not just an argument that the decision is wrong. Second, the Court pushed aside arguments that the economic underpinnings of the Basic decision were wrong or outmoded by pointing out that the Basic Court understood and considered disagreements over the economic theory. Finally, the Court used the fact that the presumption is rebuttable to deflect Halliburton's arguments. Simply put, the Court said that Basic acknowledges the possibility that a misrepresentation may not impact a stock price by permitting defendants to rebut the presumption.
After declining to overrule Basic, the Court addressed the argument that a plaintiff should have to prove "price impact" to invoke the presumption of reliance. The Court treated this argument as a rehash of the attempt to overrule Basic as opposed to a modest refinement of the holding. The Court pointed out the Basic presumption is comprised of two distinct presumptions, the first of which is that price was impacted if the misrepresentation was public, material, and made in an efficient market. By arguing that a plaintiff should have to prove price impact, Halliburton was just restating its argument to jettison Basic, and the Court denied it for the same reasons.
Finally, the Court addressed when defendants may rebut the presumption of reliance. In its decision below, the Fifth Circuit had held that Halliburton could not introduce evidence of lack of price impact in connection with its opposition to class certification. The Court held that this restriction did not make any sense. It noted that while it is appropriate to allow plaintiffs to rely on an indirect proxy for price impact, that should not preclude direct evidence when it is available, stating that "[w]hile Basic allows plaintiffs to establish [price impact] indirectly, it does not require courts to ignore a defendant's direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock's market price and, consequently, that the Basic presumption does not apply."
Defense hopes that the presumption of reliance would be overruled have been dashed, and the world we live in still includes securities class actions. Nevertheless, the fact that the Supreme Court made clear that defendants can attempt to rebut the presumption of reliance at the class certification stage is a victory for defendants. How significant that victory ultimately will be may depend on the particular facts of each case, as well as how the courts address defense challenges to the applicability of the presumption of reliance. In the typical case—a positive announcement is followed by rise in the stock price, and a bad news announcement is followed by a sharp drop —Halliburton is not likely to change much. In other cases, in which the stock price movement is less clear, the decision may give rise to opportunities to narrow the class period or even defeat class certification entirely.