Yesterday, the U.S. Supreme Court issued its long-awaited decision in Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), resulting in a partial win for defendants sued in putative securities fraud class actions.
One of the elements that a plaintiff alleging securities fraud must prove under the federal Securities Exchange Act of 1934 (under which most securities class actions are brought) is reliance on the alleged misstatement or omission.
Since the Supreme Court’s landmark 1988 ruling in Basic Inc. v. Levinson, 485 U.S. 224, securities class action plaintiffs have been entitled to a presumption of class-wide reliance as long as the market in which the plaintiff’s securities traded is “efficient” in the sense that information is immediately absorbed into and reflected in the security’s market price.
In Halliburton II, the Court held that defendants may try to rebut this presumption at the class certification stage of the case (and thus potentially defeat class certification and derail putative class actions at the outset) by showing that the alleged misstatement or omission had no impact on the security’s price.
The presumption of reliance is a judicially created doctrine adopted in Basic that allows securities cases to proceed as class actions with the presumption that class members transact in securities based upon the “integrity” of the market price. Halliburton II had the potential to overturn Basic, and had it done so likely would have eliminated most securities fraud class actions. That did not occur, however, although three Justices (Thomas, Scalia and Alito) argued that Basic was wrongly decided and should be overturned.
Plaintiffs can recover damages in a securities fraud action only if they can prove that they relied upon a defendant’s alleged misrepresentation in choosing to buy (or sell) a company’s securities. In Basic, the Supreme Court held that if a plaintiff could show that (i) the alleged misrepresentations were publicly known, (ii) and were material, (iii) and the security traded on an efficient market, (iv) and the relevant transaction occurred between the time the misrepresentations were made and the time the truth was revealed, then that plaintiff could benefit from the presumption that the transaction occurred based upon the “integrity” of the market price, which incorporated “all” or “most” of the publicly available information.
Accordingly, the Court in Basic held that a plaintiff who purchased (or sold) at the market price during the class period could be presumed to have relied upon the alleged misstatements, thereby satisfying the reliance element of a securities fraud class action, and the commonality requirement for class certification. The Basic Court also held, however, that the presumption was rebuttable, and in the 26 years since Basic was decided, much of the case law applying Basic has focused upon how and when defendants could attempt to rebut the presumption.
In Halliburton II, the Court ruled that a defendant may try to rebut the presumption by introducing evidence at the class certification stage to show that the alleged misstatement or omission did not affect the price of the security that the plaintiff then bought. Though the Court offered no guidance on what constitutes price impact, how long it takes for information to be impounded into price, or how a defendant may go about showing the absence of price impact, establishing price impact (or its absence) is often done through “event studies” where experts perform a regression analysis to eliminate other factors (such as a general rise or decline in security prices) to determine whether the particular misstatement or omission alleged caused the price to go up (or down).
Prior to Halliburton II, most courts had held that defendants could not seek to rebut the presumption of reliance until after a class had been certified, at the “merits” stage of the case. Halliburton II gives defendants the opportunity to present these issues at a preliminary stage of the case, giving defendants the opportunity to try to defeat class certification altogether by showing that the specific claimed misstatements or omissions in a case did not cause the price of the particular security to go up (or down).
Practical Takeaways From Halliburton II: Permitting a defendant to rebut the presumption of reliance at the class certification stage will increase early-stage defense costs for defendants (including expert fees, costs of motion practice, etc.) and raise the stakes based upon the outcomes. But should a defendant succeed in showing that the particular misstatement or omission had no impact on the security, as a practical matter the class action (and its potentially expansive exposure for the defendant) may be derailed and the potential settlement value of the case slashed. In short, Halliburton II gives defendants another potential early-stage defense strategy, and resets class certification analysis in a more defense-friendly posture.