On June 23, 2014, the Supreme Court of the United States issued its much-anticipated decision in Halliburton Co., et al. v. Erica P. John Fund, Inc., No. 13-317 (2014). The Court vacated and remanded the decision of the United States Court of Appeals for the Fifth Circuit refusing to allow Halliburton to rebut the Basic Inc. v. Levinson, 485 U.S. 224 (1988), presumption of reliance at the class certification stage with evidence of a lack of price impact. In doing so, the Court rejected Halliburton’s invitation either to overturn the Basic presumption of reliance for securities fraud claims, or to require securities class action plaintiffs to prove price impact at the class certification stage. But the Court agreed with Halliburton that defendants should be permitted to provide evidence of the lack of price impact at the class certification stage, rather than putting off such proof to the merits stage.
The decision falls far short of the hopes of frequent targets of securities class actions of drastically changing the securities litigation landscape. The decision takes the least disruptive approach in eliminating the wholly inconsistent construct that allowed, in connection with class certification proceedings, plaintiffs to submit evidence that price impact exists; and defendants to submit evidence of price impact solely as evidence that the market is not efficient; but prevented defendants from submitting that same evidence of price impact to rebut the Basic presumption. And while the decision represents little change in the Second and Third Circuits—those courts already allowed defendants to rebut the presumption of reliance at the class certification stage by demonstrating that the alleged misrepresentation did not distort the market price—the decision will come as welcome relief in the Fifth and Seventh Circuits, which have until now held that price impact may not be considered at the class certification stage.
The Erica P. John Fund, Inc. (“Fund”) sued Halliburton under Section 10(b) and Rule 10b-5 of the Securities Exchange Act (“Act”). The Fund asserted that Halliburton issued several misrepresentations about certain liabilities, expected revenue, and the benefits of a merger, which it subsequently attempted to correct through a number of corrective disclosures. When the Fund sought to certify a class, the District Court concluded that, although the class had satisfied all of the requirements of Federal Rule of Civil Procedure 23(a), the Fund did not prove “loss causation” in order to invoke the presumption of reliance, as required by Fifth Circuit precedent. The District Court denied class certification and the Fifth Circuit affirmed. 597 F.3d 330 (2010). The Supreme Court granted certiorari and subsequently vacated the judgment. The Court “[found] nothing in ‘Basic or its logic’ to justify the Fifth Circuit’s requirement that securities fraud plaintiffs prove loss causation at the class certification stage in order to invoke Basic’s presumption of reliance.” Slip op., at 3.
On remand, Halliburton argued that it had demonstrated the lack of any “price impact”—i.e., that none of its alleged misrepresentations actually affected its stock price—and, therefore, it had rebutted the presumption of reliance. As a result, Halliburton argued, each member of the class would have to present individual proof that it relied on one or more alleged misrepresentations in connection with buying or selling Halliburton stock. As a result, Halliburton argued, because individual issues would predominate, class certification would be inappropriate. The District Court rejected Halliburton’s argument and certified a class, and the Fifth Circuit affirmed. 718 F.3d 423 (2013). In doing so, the Fifth Circuit held that Halliburton could not use its price impact evidence to rebut the presumption of reliance at the class certification stage. Halliburton again sought certiorari, arguing that securities fraud plaintiffs should always have to prove direct reliance, and raising two questions: Should the Court overturn twenty-five years of precedent established by Basic’s presumption of reliance for securities fraud claims and, if not, may securities fraud defendants attempt to rebut the Basic presumption at the class certification stage with evidence of lack of price impact?
The Basic Presumption Survives
The Supreme Court declined to overturn the Basic presumption. First, Halliburton argued that because the cause of action under Section 10(b) and Rule 10b-5 is an implied right of action—a “judicial construct”—the Court must ascertain and borrow from Section 18(a) of the Act, Section 18(a) being “‘the express provision that is “most analogous to the private 10b-5 right of action.”’” Slip op., at 8. That provision requires an investor to prove that he relied upon the defendant’s misrepresentation and, Halliburton argued, proof of actual reliance is thus required under Section 10(b) and Rule 10b-5, too. The Fund argued that the closest analog is Section 9 of the Act, which does not require actual reliance. The Court declined to settle the dispute, noting that the majority in Basic found unpersuasive an argument similar to Halliburton’s made by the dissenting justices, and “Halliburton gives us no new reason to endorse it now.” Slip op., at 8.
Second, Halliburton argued that the “efficient capital market hypothesis” underlying the presumption of reliance has been discredited by economic and statistical studies suggesting “that capital markets are not fundamentally efficient.” Slip op., at 9. The Court noted that this suggestion, too, had been rejected by the Basic majority, who instead “based the presumption on the fairly modest premise that ‘market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices,’” slip op., at 10, and rendered the presumption a matter of proof by making it a rebuttable presumption, thereby accommodating the lack of fundamental efficiency. “Halliburton has not identified the kind of fundamental shift in economic theory that could justify overruling a precedent on the ground that it misunderstood, or has since been overtaken by, economic realities.” Slip op., at 11.
The Court also rejected Halliburton’s contention that some investors—e.g., value investors—purchase stocks without regard to price, so “courts should not presume that investors rely on the integrity of those prices and any misrepresentations incorporated into them.” Slip op., at 11. But Basic, according to the Court, found it reasonable to presume that “most”—not all—investors “will rely on the security’s market price as an unbiased assessment of the security’s value in light of all public information.” Slip op., at 12. And even value investors must have some faith that the market price will reflect material information in a reasonable time if they are to obtain the changes in market price upon which their hoped-for success depends. Id.
Finally, the Court rejected Halliburton’s contention that Basic is inconsistent with the Court’s more recent decisions in the securities class action context. Halliburton argued that Basic is inconsistent with the recent decisions concerning the Rule 10b-5 cause of action and class action certification under Federal Rule of Civil Procedure 23. The Court held that Basic neither expands the Rule 10b-5 cause of action (it “provides an alternative means of satisfying” the requirement that a plaintiff “prove that he relied on a misrepresentation made by the defendant”) nor relieves Rule 10b-5 plaintiffs from the burden of proving that the proposed class action satisfies the Rule 23 requirements (it “establishes that a plaintiff satisfies [the burden of proving the crucial requirement—predominance] by proving the prerequisites for invoking the presumption—namely, publicity, materiality, market efficiency, and market timing”). Slip op., at 13-14. And, the Court opined, it is Congress’ role—not the courts’—to address Halliburton’s other criticisms of securities class actions, such as the extortion of large settlements, punishing innocent shareholders who must pay settlement and judgments, excessive costs on businesses, and consuming judicial resources. Slip op., at 15-16.
Requiring Plaintiffs to Prove Price Impact is Inconsistent with the Basic Presumption, but Defendants May Rebut the Presumption at the Class Certification Stage
Halliburton offered two alternatives to overruling Basic. First, Halliburton argued that securities class action plaintiffs should be required to prove price impact. Slip op., at 16. According to Halliburton, “since the Basic presumption hinges on price impact, plaintiffs should be required to prove it directly in order to invoke the presumption.” Slip op., at 17. This was the so-called “midway” position that pervaded oral argument, but the Court decided such a requirement “would radically alter the required showing for the reliance element of the Rule 10b-5 cause of action.” Id. Because the Basic presumption is comprised of two “constituent presumptions”—“First, if a plaintiff shows that the defendant’s misrepresentation was public and material and that the stock traded in a generally efficient market, he is entitled to a presumption that the misrepresentation affected the stock price. Second, if the plaintiff also shows that he purchased the stock at the market price during the relevant period, he is entitled to a further presumption that he purchased the stock in reliance on the defendant’s misrepresentation.”—requiring a plaintiff to prove price impact would eliminate the first presumption. Slip op., at 17-18. Thus, held the Court, requiring plaintiffs to prove price impact as a gateway to invoking the presumption is inconsistent with the Basic presumption itself.
Second, Halliburton argued that “defendants should at least be allowed to defeat the presumption at the class certification stage through evidence that the misrepresentation did not in fact affect the stock price.” Slip op., at 18. The Court agreed. To proceed otherwise—i.e., to permit plaintiffs to submit, prior to class certification, evidence that price impact exists; and to permit defendants to submit, prior to class certification, price impact evidence so long as it is used only as evidence that the market is not efficient; but to prevent defendants from submitting, prior to class certification, price impact evidence to rebut the Basic presumption—“makes no sense, and can readily lead to bizarre results.” Slip op., at 18-19. Said otherwise, “[a]n indirect proxy should not preclude direct evidence when such evidence is available.” Slip op., at 20. “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.” Slip op., at 21.
In so holding, the Court rejected the Fund’s argument that proof of price impact is similar in many respects to the proof of materiality that the Court in Amgen, Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184 (2013), said should be left to the merits stage because it does not bear on the predominance requirement of Rule 23(b)(3). Price impact, the Court noted in distinguishing the concepts, is “‘Basic’s fundamental premise’” and “has everything to do with the issue of predominance at the class certification stage.” Slip op., at 22. Given the choice “between limiting the price impact inquiry before class certification to indirect evidence, or allowing consideration of direct evidence as well . . . we see no reason to artificially limit the inquiry at the class certification stage to indirect evidence of price impact.” Id.
Chief Justice Roberts delivered the opinion of the Court. Justice Ginsburg authored a concurring opinion, joined by Justice Breyer and Justice Sotomayor. Justice Thomas authored an opinion concurring in the judgment, joined by Justice Scalia and Justice Alito.