The Supreme Court recently heard oral argument in Halliburton Co. v. Erika P. John Fund, Inc. in advance of what could be the most important decision affecting securities litigation in recent history. The outcome of the Halliburton case will no doubt have a significant impact on the future of class action securities litigation. At issue is whether plaintiffs may benefit from a legal presumption that they relied on an issuer’s allegedly fraudulent disclosures, and be excused from proving actual reliance—a key element of a securities fraud claim. The Court hinted that it may take a “midway position,” which would permit companies to rebut the presumption of reliance at class certification.
Twenty six years ago, in Basic, Inc. v. Levinson, the Supreme Court endorsed the presumption that investors in an efficient capital market rely on the integrity of the market—that is, the notion that a stock’s market price reflects all publicly available information about the issuer, including any alleged misrepresentations by the issuer, which may distort market price. Dubbed the “Basic presumption,” this hybrid legal-economic theory allows securities-fraud plaintiffs to circumvent the requirement of proving actual, direct reliance on the issuer’s alleged misrepresentation and instead advance common proof of reliance on a class-wide basis. To successfully invoke the Basic presumption, plaintiffs need only show that there is an efficient market for the subject security—a nearly effortless showing when the security is publicly traded on a national exchange.
The Basic presumption paved the way for modern-day class action securities fraud plaintiffs to succeed at class certification, which has an in terrorem effect on defendants (due to potentially great exposure to a large number of plaintiffs) and therefore almost always results in a substantial settlement.
Halliburton is the defendant in a securities class action brought by lead plaintiff Erika P. John Fund, which alleged that Halliburton made misrepresentations about the adequacy of its reserves to cover asbestos-related liabilities. The case has returned to the U.S. Supreme Court for the second time on petition for writ of certiorari by Halliburton. On its first trip to the Supreme Court, the lead plaintiff successfully appealed a ruling by the U.S. Court of Appeals for the Fifth Circuit that securities class action plaintiffs are required to prove loss causation at class certification.
This time around, Halliburton appeals the Fifth Circuit’s subsequent ruling that Halliburton was not entitled to rebut the Basic presumption at class certification by showing that the alleged fraud had no impact on its stock price. The first question before the Supreme Court in Halliburton is whether to discard the Basic presumption as incorrect or outdated, and require securities plaintiffs to prove actual reliance just like plaintiffs in any other traditional fraud case. The second question presented is whether defendants are entitled to rebut the presumption of reliance at the class certification stage, before reaching a costly and risky trial on the merits. Successfully rebutting the presumption of reliance at class certification would effectively put an early end to the litigation because class plaintiffs would be forced to proceed individually, requiring each plaintiff to prove actual, direct reliance—a virtually impossible feat which would make litigation too costly for plaintiffs given the relatively small recovery available to an individual plaintiff.
Basic left defendants some room to defeat the presumption of reliance, explaining that “[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance.”
Accordingly, as an alternative to overturning Basic, Halliburton argues that, at class certification, defendants should be permitted to rebut the Basic presumption by showing that the alleged misrepresentation had no impact on the stock’s market price—that is, the stock price did not react negatively to the revelation of the fraud. This is typically done by providing an expert “event study” to show that the alleged fraud did not affect the market price, or that confounding factors—such as a market-wide decline or other bad news not related to the alleged fraud—actually caused the decline in price.
Early on at oral argument, Justices Kagan and Ginsburg honed in on a defendant’s right to rebut the Basic presumption and the timing of that rebuttal. Justice Kennedy then asked Halliburton to address the “midway position” advanced by a group of law professors who submitted a friend-of-the-court brief. The midway position is the right to rebut the Basic presumption at class certification. It is premised on a shift away from analyzing market efficiency and a focus on price impact. Justice Kennedy noted the inevitable need for expert event studies on price impact and commented: “And so then the question would be since you’re going to have it anyway, why not have it at the class certification stage.” In addition, Justice Scalia recognized that class certification is effectively the endpoint of a securities fraud case, noting that very few cases continue once a class is certified.
Questioning counsel for the lead plaintiff, Justice Ginsburg seemed to signal where the Court may be headed: “You agree that the Basic is a presumption and that it can be rebutted, but you say that’s a question for the merits. What difference does it make at what stage the rebuttal is allowed? What practical difference does it make if the inquiry is made at the certification stage rather than the merits stage?” The lead plaintiff’s counsel countered that requiring detailed event studies would “enormously” increase the costs and time delay associated with class certification and would result in a premature battle of the parties’ experts.
In arguing on behalf of the lead plaintiff, the U.S. Deputy Solicitor General ultimately conceded that if the Court were to accept the so-called midway position, “that would be a net gain to plaintiffs, because plaintiffs already have to prove price impact at the end of the day.”
While it is difficult to predict how the Court will rule, the questioning last week indicated some favor for the midway position which would give defendants the opportunity to rebut the Basic presumption at class certification. This approach could mitigate the coercive effect of class certification and provide a defense that could put an end to litigation before the costly summary judgment and trial stages. The Supreme Court is expected to issue its opinion by June 2014.