Class Certification: Halliburton II and Basic

The predicate for many securities class actions is the fraud-on-the-market theory, adopted by the Supreme Court in Basic, Inc. v. Levinson, 485 U.S. 224 (1988). There the Court held that a securities law plaintiff could invoke a rebuttable presumption of reliance – a key element of an action for damages – where it can be demonstrated that the stock traded in an efficient market. The predicate for the decision is the theory that the price of a security reflects the available material information about the stock when it is traded in an efficient market. Investors are entitled to rely on the integrity of the share price for a stock trading in such a market. While the presumption is rebuttable it was not until Halliburton Co. v. Erica P. John Fund, Inc., 134 S.Ct. 2398 (2014)(Halliburton II) that the Court held that evidence demonstrating a lack of price impact could be introduced at the class certification hearing to address the point. That evidence, the Court noted, was typically developed through the use of economic event studies.

Two recent decisions illustrate the reach of Basic – Halliburton II. One is IBEW Local 98 Pension Fund v. Best Buy Co., Inc., No. 14-3178 (8th Cir. Filed April 12 2016). The case focused on two sets of statements, both made on September 14, 2010. The first set were in a Best Buy press release issued at 8::00 A. M. before the market open. The release announced an increase in full-year earnings per share guidance by 10 cents to $3.55-$3.70. The release cautioned that it contained forward looking information. The stock opened up 7.5% at $37.25.

The group of statements were made by Best Buy CFO Jim Muchlbauer in a 10:00 A.M. conference call the same day. During the call, which began with a reminder that there may be forward-looking statements, the executive told investors and the market that “looking at the results for the first half of fiscal 2011, while there are many moving pieces that we manage, like always, we are pleased that our earnings are essentially, in line with our original expectations for the year” and “Overall, we are pleased that we are on track to deliver and exceed our annual EPS guidance.” The stock closed at $36.73 on volume of 21.3 million shares.

Best Buy issued another press release on December 14. The release stated that the firm had a decline in fiscal third quarter sales and thus EPS guidance had been reduced to $3.20-$3.40. The release was discussed in a conference call later that day. The stock closed down 14.8% at $35.52, down from $41.70 at the close the day before.

This suit followed. The complaint alleged that the September statements were false, resulting in an artificial price which was corrected by the December statements. The District Court dismissed the claims based on the statements in the September press release, concluding that they were accompanied by meaningful cautionary language. The Court permitted the action to proceed based on the statements in the September press conference and certified the class. Plaintiffs’ economic expert supported the motion for certification by conducting an event study. Based on that study he concluded that the Best Buy stock price increased in reaction to the September 14 statements.

In contrast, an event study by defendants’ expert demonstrated that the price increase on September 14 occurred after the press release but before the call. Defendants’ expert went on to conclude that the statements at the press conference had no discernable impact on the stock price.

In rebuttal plaintiffs’ expert claimed that even if the September press release is not actionable, it does not mean that investors did not give it great weight. In addition, the conference call statements fraudulently maintained the share price until the corrective disclosure on December 14, the expert concluded. In certifying the class the District Court held that “price impact can be shown by a decrease in price following a revelation of the fraud.” The Court then found that defendants “have not offered evidence to show that Best Buy’s stock price did not decrease when the truth was revealed.”

The Eight Circuit reversed. The Court began by acknowledging that plaintiffs had presented a prima facie case that the Basic presumption applies. What the District Court ignored, however, was strong evidence that the presumption had been rebutted under Halliburton II by evidence presented by plaintiffs’ own expert. The expert opined that the economic substance of the non-fraudulent press release statements and the alleged misrepresentations “in the immediately following conference call was ‘virtually the same,’ and that the two ‘would have been expected to be interpreted similarly by investors.’” An event study confirmed the fact that the EPS guidance in the press release had an immediate impact on the share price but the confirming evidence in the conference call had no additional impact. Defendants’ expert agreed. This was “direct evidence that the investors did not rely on the executives’ confirming statements two hours later,” the Circuit Court stated.

Plaintiffs’ contention that the December 14 corrective disclosure was evidence of the requisite price impact not change these facts. The claimed “inflated price” was established by the non-fraudulent press release. Under these circumstances it is clear that “defendants rebutted the Basic presumption by submitting direct evidence (the opinions of both parties’ experts) that severed an link between the alleged conference call misrepresentations and the stock price at which plaintiffs purchased.”

The second is Todd Stanaford v. Genovese, Civil Action No. 13-cv-80923 (S.D. Fla. Opinion March 14, 2016). There plaintiffs claimed that defendant Robert Genovese, an activist investor, and his hedge fund, B. G. Capital and its affiliates, used a series of false statements and, in conjunction with boiler room tactics employed by a broker, fraudulently inflated the share price of silver mining company Liberty Silver, Inc. in the late summer and fall of 2012. A trading halt by the SEC in early October 2012 acted as a corrective disclosure. Liberty Silver’s shares were traded on the TSX in Toronto and on the OTC BB in the U.S. Following the denial of a motion to dismiss, settlement by certain defendants and the conclusion of fact and expert discovery, the Court denied plaintiffs’ request for class certification.

The fundamental question posed by the motion for class certification was if plaintiffs were entitled to invoke the Basic presumption – that is, was the market for Liberty Silver shares efficient. Neither the Supreme Court nor the Eleventh Circuit has defined a specific test or check list for deterring whether a market is efficient. The leading case on the point is Cammer v. Bloom, 711 S. Supp. 1264 (D. N.J. 1989). There the court stated that the central question is whether “the stock price . . . reflected misinformation alleged to have been disseminated. To determine whether a market is open and efficient, the court addressed the following factors: (1) the trading volume during the class period; (2) the number of securities analysts following and reporting on a company’s stock . . . (3) the existence of market makers; (4) whether the Company was required to file a S-3 Registration statement; and (5) [if there was] a cause and effect relationship between unexpected corporate events or financial releases and an immediate response to the stock price.”

An analysis of those factors supported the conclusion that Liberty Silver shares did not trade in an efficient market. For example, in considering the fifth factor – a cause and effect relationship – the Court found that there was none based on the testimony of defendants’ economic expert, Professor, and former SEC Chief Economist, Gregg Jarrell: “ ‘Liberty Silver’s stock returns were not correlated with any general market or industry indexes during the Class Period . . .” Specifically, Professor Jarrell examined each of the 11 disclosures that [were] alleged in the Complaint to contain fraudulent statements . . . [and based on event studies] found that none of the disclosures had a ‘corresponding, statistically-significant reaction to Liberty Silver’s stock price . . . Therefore, Professor Jarrell opined that ‘whether we examine non-fraud-related news or allegedly fraud-related news, there is no evidence whatsoever of any cause-and-effect relationship between news and Liberty Silver’s stock returns.’”

Professor Jarrell also analyzed a series of additional factors frequently considered in evaluating the question of market efficiency, in addition to the Cammer factors. Those included the market capitalization, public float, bid-ask spread, media coverage and institutional ownership. An analysis of each of these factors supported the conclusion that the shares of Liberty Silver did not trade in an efficient market.

Plaintiffs, in contrast, claimed that the market was efficient based on the testimony of Candace Preston. While Ms. Preston did not evaluate all of the Cammer factors or the additional points considered by Professor Jarrell, she opined that the market for Liberty Silver shares reflected available information for a small segment of the class period during which much of the trading in the case took place. In reaching her conclusion Ms. Preston relied on the results of a CMR test which measured the total price increase of the shares during the segment of the class period in comparison to earlier periods and three of the Cammer factors.

In its opinion the Court stated that it “rejects Ms. Preston’s conclusion, which claimed that Liberty Silver shares traded on an efficient market. The Court finds Professor Jarrell to be more credible.” Plaintiffs agreed to dismiss the action with prejudice.

Note: The author and his firm was counsel to the defendants.

Program: Key Issues in SEC Enforcement, webcast by the ABA Criminal Division, May 2, 2016 from 1:00 to 2:30 p.m. EST. Moderators: Thomas O. Gorman and Frank Razzano. Panelists: Stephen Cohen, Associate Director, SEC Division of Enforcement, Harry Weiss, partner, Wilmer Hale and Olga Greenberg, partner Southerland Asbil. Additional information and registration is available here.

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