In Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317, __ S Ct. __, 2014 WL 2807181 (U.S. June 23, 2014), the United States Supreme Court refused to overturn the landmark decision Basic v. Levinson, but ruled that securities class action defendants may rebut the fraud-on-the-market presumption of investor reliance before the class certification stage by demonstrating lack of price impact.
Plaintiff alleged that Halliburton Co. (“Halliburton”) and its CEO made a series of public misstatements concerning the company’s liabilities and revenues and the cost savings expected from a recent merger. These misstatements purportedly inflated Halliburton’s stock price. According to plaintiff, when Halliburton eventually revealed the truth, the stock price fell, injuring plaintiff and other investors who purchased at the allegedly inflated prices. Plaintiff, on behalf of a putative class, asserted claims against Halliburton and its CEO for violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Securities & Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder.
Plaintiff moved for class certification under Rule 23 of the Federal Rules of Civil Procedure, seeking to satisfy Rule 23(b)(3)’s requirement that common questions predominate by invoking the fraud-on-the-market presumption of reliance. That presumption, when it applies, allows for common proof of reliance on the theory that investors rely upon the integrity of a stock’s trading price and, when the stock trades in an efficient market, such price reflects all public information, including any alleged material misstatements. See Basic, Inc. v. Levinson, 485 U.S. 224, 241-42 (1988).
The district court initially denied plaintiff’s class certification motion, and the Fifth Circuit affirmed. But the Supreme Court vacated that judgment, concluding that securities fraud plaintiffs need not prove loss causation – a causal connection between the defendants’ alleged misrepresentations and the plaintiffs’ economic losses – at the class certification stage in order to invoke Basic’s presumption of reliance.
On remand, Halliburton argued that class certification was nevertheless improper because the evidence presented also showed that the alleged misrepresentations did not actually affect its stock price. According to Halliburton, by demonstrating the absence of so-called “price impact,” it had rebutted the Basic presumption of investor reliance. The district court disagreed and certified the class. The Fifth Circuit affirmed, finding that Halliburton could use price impact evidence to rebut the Basic presumption only at trial, not at the class certification stage.
Two issues were presented to the Supreme Court the second time around. First, whether the Court should overrule or modify Basic’s presumption of reliance. And, second, if not, whether defendants should nonetheless be afforded an opportunity in securities class action cases to rebut the presumption at the class certification stage, by showing a lack of price impact.
With respect to the first issue, the Supreme Court declined to overturn or modify Basic. The Court found that none of the arguments that Halliburton presented so discredited the Basic decision to constitute a “special justification” for overruling it. The Court remarked that Basic’s presumption of reliance was not inconsistent with recent decisions more strictly construing the Rule 10b-5 cause of action, including Stoneridge Investment Partners, LLC v. Scientific Atlanta, Inc., 552 U.S. 148 (2008), or decisions governing class action certification, including Wal-Mart Stores, Inc. v. Dukes, 564 U.S. ___ (2011), which require plaintiffs to prove, not merely plead, that the proposed class satisfies each requirement of Rule 23.
The Court also declined to modify the prerequisites for invoking the fraud-on-the-market presumption by requiring plaintiffs to have to prove “price impact” at the class certification stage.
But, in the final part of its majority opinion, the Court dealt a blow to securities fraud class action lawsuits. The Court agreed with Halliburton that defendants must be afforded the opportunity to rebut the fraud-on-the-market presumption “before class certification” with evidence of a lack of price impact. The Court found there is no reason to prohibit a defendant from presenting evidence showing that an alleged misrepresentation did not actually affect the stock’s price and, consequently, that the Basic presumption does not apply.
Notably, Justice Thomas, submitted an opinion concurring in judgment (joined by Justices Scalia and Alito), but voicing the opinion that Basic should be overruled. The opinion suggested that economic realities and the Supreme Court’s subsequent jurisprudence have undermined the foundations of the Basic presumption, rendering it obsolete. Citing Stoneridge, Justice Thomas opined that “Basic should be overruled in favor of the straightforward rule that ‘[r]eliance by the plaintiff upon the defendant’s deceptive acts’—actual reliance, not the fictional ‘fraud-on-the-market’ version— ‘is an essential element of the §10(b) private cause of action.’”
While the majority Supreme Court opinion did not do away with the Basic presumption, it did open the door for securities fraud defendants to defeat class-wide showing of reliance at an earlier stage. That the Supreme Court ruled that defendants must be given an opportunity “before class certification” to defeat the presumption with evidence of lack of price impact, and did not say “at the class certification stage” is curious. Perhaps, going forward, defendants may be afforded the opportunity to demonstrate lack of price impact at the earliest stages of a case, including possibly the pleadings stage.