Earlier this spring, in our post titled, The Supreme Court Ponders the Future of the Basic Presumption in Securities Litigation, we reported on the oral arguments before the Supreme Court in Halliburton Co. v. Erica P. John Fund, Inc., in which the high court considered whether to jettison the presumption of reliance in class action securities litigation. We reported that the justices indicated that they might adopt a “midway position,” which would uphold the plaintiff-friendly presumption of reliance created more than 25 years ago in Basic, Inc. v. Levinson, but would permit defendants to rebut this presumption at the class certification stage with evidence that the alleged fraud had no impact on stock price. Today, the Supreme Court issued its eagerly anticipated opinion in Halliburton Co. v. Erica P. John Fund, Inc., embracing the very “midway position” it foreshadowed at oral argument.
In Basic, the Supreme Court held that plaintiffs could satisfy the reliance element of the Rule 10b-5 cause of action by invoking a presumption that a public, material misrepresentation will distort the price of stock traded in an efficient market, and that anyone who purchases the stock at the market price may be considered to have done so in reliance on the alleged misrepresentation. Halliburton sought to overturn that holding or, in the alternative, to rein in plaintiffs’ use of the presumption of reliance by either requiring plaintiffs to affirmatively prove price impact at class certification in order to invoke the presumption, or at least allow defendants to rebut the presumption at class certification by proving lack of price impact. Any of these three results could help defendants fend off class action securities fraud claims before trial.
Writing for the majority, Chief Justice Roberts reasoned that Halliburton failed to show the requisite “special justification” that could warrant overturning long-settled precedent like Basic. Rather, according to the Court, Halliburton’s arguments against a presumption of reliance, and the efficient capital market theory on which it is based, were considered and rejected by a majority of the court when it decided Basic more than two decades ago. The Supreme Court also declined to impose a requirement that plaintiffs prove price impact directly in order to invoke the Basic presumption.
However, in a key win for securities class action defendants, the Supreme Court agreed with Halliburton that companies should at least be allowed to defeat the presumption of reliance at the class certification stage through evidence that the alleged misrepresentation did not in fact affect the stock price. The Court first explained Basic’s instruction that “‘[a]ny showing that severs the link between the alleged misrepresentation . . . and the price received (or paid) by the plaintiff . . . will be sufficient to rebut the presumption of reliance’ because ‘the basis for finding that that the fraud had been transmitted through market price would be gone.’” The Court then reasoned that without the presumption of reliance, a Rule 10b-5 suit cannot proceed as a class action because each plaintiff would have to prove reliance individually, causing such individual issues to predominate in contravention of Rule 23(b)(3). Accordingly, the Court held, “[p]rice impact is thus an essential precondition for any Rule 10b-5 class action.” The Supreme Court vacated the judgment of the Court of Appeals for the Fifth Circuit and remanded the case to allow Halliburton the opportunity prove lack of price impact at class certification.
Defendants now have another tool—the opportunity to establish lack of price impact at the class certification stage—to potentially put an early end to securities class action litigation.