The securities class action industry was launched a quarter-century ago when the Supreme Court recognized the so-called “fraud-on-the-market” presumption of reliance in most putative securities class actions. The result has been that—despite Congressional efforts at securities litigation reform—most securities class actions that survive the pleadings stage are likely to achieve class certification, forcing defendants to settle. In the meantime, as explained in prior blog posts, the best economic thinking has shifted, calling the empirical assumptions underlying the fraud-on-the-market presumption into question.
In Halliburton Co. v. Erica P. John Fund, Inc. (pdf), decided today, the Supreme Court declined to abandon that presumption, instead largely maintaining the status quo. The Court did clarify one key aspect of how class certification works in the securities context, holding that defendants are now entitled to attempt to rebut the presumption by introducing evidence at the class certification stage that there was no “price impact”—i.e., that misrepresentation alleged in a particular lawsuit did not affect the stock’s price. This adjustment will make it possible for defendants to challenge class certification in a number of securities class actions, but is unlikely to alter the landscape of securities litigation significantly—a result that is troubling from a policy perspective because (for reasons we have previously stated) securities class actions generally benefit the lawyers who bring and defend them rather than the investors.
We provide more details about the decision below.
To prevail in a securities-fraud case under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), a plaintiff must establish—among other things—that the defendant made a false material representation in connection with the purchase or sale of securities, that the defendant acted either intentionally or recklessly, and that the plaintiff relied on the defendant’s misrepresentation. At common law, reliance requires proof that the defendant’s misstatement induced the plaintiff’s decision to engage in the transaction.
Application of the common-law reliance standard presented an obstacle to certification of securities fraud class actions, however, because a class action is permissible only if “the questions of law or fact common to class members predominate over any questions affecting only individual members.” Fed. R. Civ. P. 23(b)(3). If reliance had to be proven on an individual-by-individual basis, that would have tipped the overall balance toward individualized questions.
Twenty-five years ago, a four-Justice majority of the Supreme Court recognized a rebuttable presumption of class-wide reliance based on the “fraud on the market” economic theory. See Basic Inc. v. Levinson, 485 U.S. 224 (1988). That theory assumes that in an efficient market, all publicly available information about a stock is reflected in the stock’s price; and thus, purchases at that price are made in reliance on the information—including representations—known to the market.
The Supreme Court today rejected a challenge to the continuing validity of Basic’s presumption of class-wide reliance. The Court adopted a narrow adjustment to the presumption, however, holding that a defendant may rebut the presumption, and thereby prevent class certification, by establishing an absence of “price impact”—that the alleged misrepresentation did not affect the stock’s price.
The plaintiffs in Halliburton are shareholders who filed a class action alleging that their investments in that company’s stock lost money when the company issued corrective statements that allegedly caused the stock price to fall. In an earlier round of litigation, the Supreme Court had held that, in order to invoke Basic’s presumption, a securities-fraud plaintiff need not prove loss causation—i.e., that the corrective statement in fact caused the stock price to fall. See Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011). The Court specifically declined to address “any other question about Basic, its presumption, or how and when it may be rebutted.” Id. at 2187.
On remand, the district court certified the class without addressing Halliburton’s argument that it had rebutted the Basic presumption with price-impact evidence. Meanwhile, in a case involving proof of materiality in a fraud-on-the-market case, four justices questioned the economic premises of Basic’s presumption. See Amgen, Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184, 1204 (Alito, J., concurring); id. at 1208 n.4 (Thomas, J., dissenting, joined by Scalia and Kennedy, JJ.).
The Fifth Circuit then affirmed the order granting class certification in Halliburton, interpreting Amgen as focusing the Rule 23(b)(3) inquiry on whether all class members “will fail or succeed together.” 718 F.3d 423, 431 (5th Cir. 2013). The court of appeals noted that “price impact” rebuttal evidence may be established with proof common to the class, and that if the evidence successfully rebuts the presumption all class members’ claims will fail together. Accordingly, the court of appeals likened price-impact evidence to those issues that cannot be resolved at the class-certification stage (materiality), rather than those that can (trade timing, market efficiency, and publicity).
In an opinion by Chief Justice Roberts, the Supreme Court vacated the Fifth Circuit’s judgment and remanded. The Court rejected Halliburton’s challenge to the Basic presumption, holding that there was no “special justification” for overruling that decision.
First, the Court reasoned that the majority in Basic had considered but rejected Halliburton’s argument that the presumption was inconsistent with legislative intent. Next, it recognized that even when Basic was decided there were “academic debates” about the validity of the “efficient capital markets hypothesis”; as in Basic, the Court “declined to enter the fray” by taking a position on “the degree to which” a security’s market price reflects publicly available information. Finally, the Court stated that principles of stare decisis weighed against overruling Basic. Concerns about the economic irrationality of securities class actions were, the Court said, more appropriately addressed to Congress.
Having retained Basic’s presumption, the Court held that a defendant may seek to defeat that presumption at the class-certification stage by establishing the absence of price impact—that the alleged misrepresentations did not “affect the market price in the first place.” The Court declined to follow Halliburton’s suggestion that plaintiffs should bear the burden of affirmatively establishing price impact, because that would “effectively jettison half of” the Basic presumption. Instead, defendants may “defeat the presumption at the class certification stage through evidence that the misrepresentation did not in fact affect the stock price.”
Because the Fifth Circuit did not permit Halliburton to disprove price impact at the certification stage, the Court vacated and remanded.
Justice Ginsburg wrote a concurring opinion, joined by Justices Breyer and Sotomayor, emphasizing that the defendant bears the burden of disproving price impact at the certification stage. That approach, she explained, “should impose no heavy toll on securities-fraud plaintiffs with tenable claims.”
Justice Thomas concurred in the judgment, in an opinion joined by Justices Scalia and Alito, disagreeing with the Court’s conclusion that stare decisis warranted retaining Basic’s presumption. These Justices would have overruled Basic. Justice Thomas questioned the economic theory underlying the presumption, explained that the “presumption is at odds with” the Court’s class-action decisions, and contended that the presumption was rarely rebuttable in practice.
In practical terms, the Halliburton decision will not create a sea change in securities class action litigation. The most likely consequence is that, in a number of cases, defendants will be able to mount a substantial challenge to class certification, arguing that no price impact exists. As a result, a battle of the experts over price impact will become a standard feature of many securities class actions. But at most, Halliburton is only a small step towards ameliorating the significant costs that the securities class action system imposes on our markets.