What you need to know:
The Supreme Court has declined to overturn a longstanding presumption that investors acquiring shares in an efficient market can be deemed to have relied on alleged misrepresentations. The so-called “Basic presumption” has been essential to the proliferation of securities fraud class actions since it was established by the Court in 1988 because it turned the otherwise individualized reliance inquiry into a common question for all members of a potential class of allegedly defrauded investors. Thus, the Supreme Court’s decision this week was a disappointment to corporations that had hoped the high court would deliver a knockout blow to their plaintiffs’ bar adversaries. However, the Court did make clear that defendants must be given a shot to rebut the presumption before a class can be certified, potentially giving defendants a chance to cut down securities fraud cases before certification of a class action greatly increases settlement pressure.
What you need to do:
Going forward, before a court can certify a class action, corporations (and individual defendants) will have a chance to rebut plaintiffs’ claims that alleged misrepresentations impacted the price of company stock, likely through event studies performed by economists. Since many defendants have used event studies to show that the market for their stock was not efficient (attacking one of the showings plaintiffs must make to invoke the Basic presumption), the Court’s decision effectively allows defendants to make the most of those studies at the earliest possible time.
Halliburton v. Erica P. John attracted attention within the securities litigation bar because it had the potential to reshape the litigation landscape if the Supreme Court decided to set aside the holding in the Court’s 1988 decision in Basic Inc. v. Levinson. In Basic, the Court established a presumption that where the stock at issue traded in an efficient market, anyone who bought or sold at the market price could be deemed to have relied on the alleged misstatements. Basic cleared the way for securities fraud class actions by treating reliance as an issue common to all class members, rather than the subject of an individualized inquiry that would defeat class certification. In so doing, it held that in order to invoke the presumption, plaintiffs must show:
That the alleged misrepresentations were publicly known;
That they were material;
That the stock traded in an efficient market; and
That the plaintiff traded the stock between the time the misrepresentations were made and when the truth was revealed.
The Basic presumption was rebuttable, however, by any showing that severed the link between the alleged misrepresentation and either the price received or paid by the plaintiff, or the plaintiff’s decision to trade at the market price. In other words, if the alleged misrepresentation lacked any impact on the price or the investor would have bought or sold the stock even if he or she had been aware of the alleged fraud, the presumption of reliance would be unavailable.
While Basic’s critics advanced a number of reasons why the decision was either wrong from the outset or outdated in light of changing thinking about investor behavior, the Supreme Court let Basic stand and offered only clarifying guidance about when the presumption can be rebutted. The Court noted that it needed “special justification” before it would overturn a precedent that is more than 25 years old. It brushed aside qualms about the accuracy of the efficient markets hypothesis by noting that Basic was premised not on the notion that markets are efficient with respect to all information about all issuers at all times. Instead, according to the Halliburton Court, Basic recognized that market efficiency is a matter of degree and is subject to proof in any given case.
Similarly, the Court rejected the notion that Basic was wrongly decided because for some investors, like value investors, “price integrity” is unimportant. Again, the Court said Basic’s critics had overstated its holding. While value investors may not believe that the current price of a stock that they are buying or selling currently reflects all material information, they presumably believe that the price will incorporate such information within a reasonable period. Basic merely held, according to Halliburton, that most investors rely on a security’s market price as an unbiased assessment of its value in light of all public information, therefore warranting a presumption.
The Court also held that the principle of stare decisis counseled against overturning Basic, particularly where Congress has had ample opportunity in the intervening period to write law addressing the issue if it felt the Basic presumption was inappropriate. Similarly, the Court suggested that concerns about whether Basic – by facilitating class actions – resulted in extortionate settlement demands were more appropriately addressed by Congress.
Defendants in Halliburton offered the Court two fallback positions in case the Court decided to let Basic stand. First, the defendants suggested that plaintiffs should be required to prove that alleged misrepresentations actually affected the stock price in order to invoke the Basic presumption. Alternatively, they suggested that defendants should at least have the opportunity to rebut price impact prior to class certification, not only at the merits stage (summary judgment or trial).
The Court declined the first proposal, but accepted the second. It did not require plaintiffs to prove price impact directly because to do so would have amounted to rejecting Basic altogether, which it declined to do for the reasons discussed already.
On the other hand, the Court held that defendants ought to be able to rebut price impact directly before class certification because defendants already routinely introduce evidence on that subject as part of attacks on market efficiency. Requiring courts to ignore that such evidence sometimes negates price impact could lead to potentially anomalous outcomes in which classes would be certified even though it had been shown that alleged misstatements had no price impact. As the Court explained, the presumption is an indirect proxy for price impact,
“[B]ut an indirect proxy should not preclude direct evidence when such evidence is available . . . . Price impact is . . . an essential precondition for any Rule 10b-5 class action. While Basic allows plaintiffs to establish that precondition 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.”
The Court also distinguished the issues in Halliburton from Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, in which it held last year that materiality was an issue that did not need to be proved at class certification and could be left to the merits stage. While materiality is an issue common to all potential class members and thus irrelevant to the predominance requirement of Rule 23(b)(3), the Court described “price impact” as having “everything to do with the issue of predominance at the class certification stage.”
While the Halliburton decision may usher in some changes in class certification procedure and perhaps increase the odds for defendants seeking to defeat certification, its most significant impact may be that it puts to rest questions about Basic’s continuing vitality. Corporations and the plaintiffs’ bar can now treat that question as settled. Recast by the Court as resting on a “fairly modest premise” about the behavior of “most” market participants, rather than a wholesale adoption of any particular version of the efficient markets hypothesis, Basic is presumptively here to stay.