Back to Basic? Big Changes Could Be Coming to a Securities Class Action Near You

by Cozen O'Connor

Earlier this month, the Supreme Court heard the highly-anticipated oral argument in Hallburton Co. v. Erica P. John Fund, Inc.  Prior to the argument, there was a growing consensus that the Court was likely going to overturn Basic Inc. v. Levinson (1988), the groundbreaking case that adopted the “fraud-on-the-market” doctrine and allowed plaintiffs to proceed without a showing that they had actually relied on any particular alleged misrepresentation (reliance having been a bedrock requirement in fraud cases, dating back to the Garden of Eden).  But the tea leaves left over after the oral argument point to a different result—a compromise that would create additional significant hurdles for class plaintiffs but not eviscerate securities class actions.

Halliburton is the rare case where one of the parties has explicitly asked the Supreme Court to overrule one of its prior cases.  (This is the second time in the case that an issue has made its way to the Court; the Court in 2011 reversed the Fifth Circuit’s holding that proof of loss causation was required at the class certification stage.)  The argument was notable because of the prominent role that an amicus brief (written on behalf of a group of law professors) played and because of a key concession made by Deputy Solicitor General Malcolm Stewart, who argued on behalf of the SEC, ostensibly on the Respondent’s side.  

Basic’s fraud-on-the-market doctrine has been a critical aspect of securities class actions for the past 25 years.  In a nutshell, the fraud-on-the-market doctrine acts as a substitute for the reliance element of a securities fraud claim, and allows plaintiffs to get past the critical class certification stage without showing that any member of the class actually relied on any allegedly false statements.  The fraud-on-the-market doctrine was considered an adequate proxy for reliance, in large part, because of the “efficient market hypothesis,” which was in vogue at the time that Basic was decided.  The efficient market hypothesis, posits that financial markets rapidly take all publicly-available information into account, and the price of a security, therefore, has all material information baked into it.  So, according to the fraud-on-the-market doctrine, the buyer of a security is presumed to have relied on a particular public misrepresentation because the import of that misrepresentation was already reflected in the stock price at the time of the purchase.

In the years since Basic was decided, a class could avail itself of the presumption of reliance by demonstrating that (1) the alleged misstatement was made publicly; and (2) the market in which the security traded was “efficient.”  The key hurdle to invoking the fraud-on-the-market doctrine is the demonstration of market efficiency.  This is critical at the class certification stage because the presumption of reliance takes an issue that traditionally was a quintessentially individual issue (did Jane Doe rely on the misrepresentation?) and turns it into a common issue for the entire class (does Doe, Inc.’s stock trade in an efficient market?).  And, as it has turned out over the past quarter century, it is has not been particularly difficult for plaintiffs to demonstrate in most instances that the markets in which the subject securities traded (such as the New York Stock Exchange) were “efficient.”  At the same time, it has been difficult for defendants to rebut the reliance presumption.

The petitioner in Halliburton seeks to have the Court do away completely with the presumption of reliance, which would then require plaintiffs to demonstrate reliance in some other fashion.  Without the presumption, plaintiffs would, presumably, need to demonstrate reliance on an individual basis, which would then make it nearly impossible to certify a class.   In the alternative, the petitioner asks the Court to require plaintiffs to show that a particular “misrepresentation actually distorted the market price” in order to invoke the presumption of reliance. 

The oral argument offered significant insight into how the case may ultimately be decided.  On several occasions, the more conservative justices, in particular Justice Kennedy, asked about the “middle ground” suggested by the Petitioner and more forcefully (and persuasively) argued in the amicus curiae brief submitted on behalf of the group of law professors who specialize in corporate and federal securities law. 

The law professors argue that the fraud-on-the-market doctrine need not rely on the efficient market hypotheses, which has been both misunderstood and, to a large extent, discredited in the years since Basic was decided.  And, since the fraud-on-the-market doctrine and the efficient market hypothesis are independent of each other, one can jettison the efficient market hypothesis without killing the fraud-on-the-market doctrine—keeping the baby but not the bathwater. 

The alternative to the efficient market hypothesis that the law professors suggest is requiring a plaintiff at the class certification stage to show, with regard to each alleged misrepresentation, that the particular alleged misrepresentation in fact had an impact on the price of the security.  Price impact can be demonstrated by using event studies, which are commonly-used analyses often used in the later stages of securities litigation by parties trying to prove or disprove materiality or loss causation.  So, instead of requiring a plaintiff to show that a market is generally an efficient one, the professors argue that plaintiffs should be required to establish that the market was efficient in their particular case

During the argument, Petitioner’s counsel, Aaron Streett, quickly recognized that none of the justices (at least the eight who asked questions) seemed particularly inclined to overrule Basic in its entirety and spent most of his time supporting the law professors’ position that the fraud-on-the-market doctrine was still viable, but that the presumption should arise only if an event study demonstrates price impact.  And David Boies, who argued on behalf of the Respondent, also primarily answered questions about the law professors’ position. 

The justices seemed interested in how great a burden these event studies would be, and, while both Streett and Boies acknowledged that event studies would be sufficient to invoke the presumption and that the same event studies would, in any event, be required later in the case to prove loss causation, they differed on the alleged burden that the event study would impose on plaintiffs at the class certification stage.  Boies argued that requiring plaintiffs to demonstrate price impact can be a significant burden—especially in situations where there are multiple events and significant confounding effects affecting the security in question.  Streett, on the other hand, argued that there was little, if any, added burden since plaintiffs would need event studies later in the litigation.

Perhaps the most significant moment of the oral argument was when Justice Kennedy asked Deputy Solicitor General Malcolm Stewart about the law professors’ position.  Stewart, who argued on behalf of the SEC as amicus curiae on behalf of the respondent, said the following:

“I understand the professors … basically advocated a shift away from analyzing the general efficiency of the market and focusing only on the effect or lack of effect on the … particular stock.  I don’t think that the consequences would be nearly so dramatic.  In fact if anything that would be a net gain to plaintiffs because plaintiffs already have to prove price impact at the end of the day.”

With amici like that, who needs inimici?

At the end of the day, it appears likely that securities class actions will not go the way of the dodo bird.  At the same time, the burdens on plaintiffs seeking class certification will likely rise.  We will certainly get to see soon enough whether we have read these tea leaves correctly.  And we will report on what happens when the decision comes down.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Cozen O'Connor | Attorney Advertising

Written by:

Cozen O'Connor

Cozen O'Connor on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.