On March 5, 2014, the U.S. Supreme Court heard argument in Halliburton v. Erica P. John Fund. The outcome of this case may change the landscape for securities class actions. The issue in Halliburton is whether the fraud on the market presumption of the Court's prior decision in Basic v. Levinson should be overturned.
Under Section 10 b5 of the Securities and Exchange Act of 1934 as interpreted by the courts, for a private investor to bring a case alleging that it was defrauded, it must state in the complaint what statements by the defendant it relied upon and how it relied upon those statements—for example, it read the statements in a newspaper and then decided to purchase. Since investors may rely on statements in various ways, or indeed may not rely on statements at all, for example, by buying on a tip or broker's advice, questions of reliance tend to be unique to each investor.
In turn, such unique questions would ordinarily prevent a securities plaintiff from bringing its case as a class action. This is because that type of case requires a predominance of common issues, and the reliance issue would overwhelm all other issues in the case, as the parties sought to demonstrate just how each investor did or did not rely. This would create thousands of mini-trials, which is just what the class action device was designed to avoid. Without the class action device, plaintiffs’ securities cases are far less threatening since each case is brought by one plaintiff instead of by all investors.
To combat this result, plaintiffs' counsel propounded the fraud on the market theory. This theory holds that because stocks trade on an efficient market that reflects all pertinent information in the price of the stock, one may presume reliance by investors because the price they pay for a stock is determined at least in part by the information in the market. Thus they have at least indirectly relied. This theory was first adopted by the Ninth Circuit in Blackie v. Barrack. In 1988 in the Basic case, four justices—three having recused—approved the theory as well.
Some 25 years later, Halliburton is challenging the Basic decision. It is doing so because of the opinions of the Court in a prior case, Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, decided last year. In Amgen, three justices suggested they would overrule Basic, and another one hinted that he would overrule Basic but the question had not been raised.
Halliburton's petition for certiorari quickly followed and was granted. The challenge is based on a number of arguments, including empirical research showing the premise of fraud on the market is wrong because price does not reflect all information, that the statute nowhere contemplates use of a presumption, and that markets are indeed inefficient rather than efficient processors of information.
If one can read anything from oral argument (always a dangerous bet), four justices on the Court’s liberal wing would vote to uphold Basic on the fundamental ground that Congress has revised the securities laws several times since the Basic decision and has not chosen to change the Basic presumption. Three justices appear ready to overrule Basic.
The Court's middle ground, seemingly held by Justice Anthony Kennedy and Chief Justice John Roberts, would be to modify Basic. The parameters of that modification are unclear but might include allowing a defendant to refute the presumption of fraud on the market at the pleading stage of a case. The defendant could do so by showing either that the market was inefficient or that statements regarding the particular stock in question did not affect the price of the stock, or perhaps through other means. Again, this is prediction based on the oral argument. The Court's actual decision, unless it is a straight-out affirmance of the Basic presumption, will dramatically change the landscape of securities class actions. We will of course keep you posted.