The Supreme Court: Rewriting the Rules For Securities Class Actions?
rtiorari in Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317 (S.Ct.) for the second time the High Court will consider two key issues. The first is whether the Court’s decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), which adopted the fraud-on-the-market theory of reliance that many view as the foundation of securities class actions, should be overruled. The second is whether a defendant in a securities class action may rebut the Basic presumption at the class certification stage by introducing evidence that the alleged misrepresentations did not distort the market price of the stock.
This is the second time this case has been before the Supreme Court. The first time the Court considered Halliburton the question was whether the plaintiffs in a securities class action were required to prove loss causation at the class certification stage. In a narrow opinion written for a unanimous Court by Chief Justice Roberts the Court held that loss causation is a merits issue, not a Rule 23 class certification question. Indeed, Chief Justice Roberts held that since the district and circuit courts had previously concluded that the Rule 23 requirements had been met, the case was resolved. Erica P. John Fund, Inc. v. Halliburton Co., 131 S.Ct. 2179 (2011)(“Halliburton I”).
On remand the district court granted class certification where efficiency of the market had been conceded and based on a complaint alleging violations of Section 10(b) as a result of false statements made by the company and certain officers. The Fifth Circuit affirmed, rejecting claims that the defendants should be permitted to offer evidence demonstrating that there was no impact on price from the claimed statements based on Amgen, Inc., v. Connecticut Retirement Plans & Trust Funds, 133 S.Ct. 1184 (2013)(materiality need not be established at certification stage).
Noting that four justices in Amgen had signaled a willingness to reconsider Basic – Justices Alito, Thomas, Scalia and Kennedy – Petitioners advanced four key reasons for the Court to again review this case:
Economic theory: In adopting the Basic presumption, the four Justice majority focused on “considerations of fairness, public policy and probability, as well as judicial economy . . . [and] trusted in the accuracy of then [r]ecent empirical studies” . . . to engraft the efficient capital markets hypothesis into federal securities laws.” (internal quotes omitted). Now however “[a]cademics have largely given up on Basic’s economic premises . . . This efficient-market hypothesis showed early promise, but ‘empirical research became more specialized and sophisticated, and evidence of potential inefficiencies began to accumulate . . . There are now hundreds of papers documenting price anomalies, even for the most actively traded stocks.’”
Difficulty of application: Because Basic is built on a “binary” approach, the lower federal courts have struggled to apply it. State courts have rejected it.
Proper case: This case presents an ideal vehicle to review Basic. Although Halliburton’s shares are traded in an efficient market, that “hardly means that any particular misrepresentation will be efficiently incorporated into Halliburton’s stock price.” (emphasis original). Yet under the binary approach of Basic this is the result.
Alternative: Even if the Court is not inclined to overrule Basic, the decision should “be modified to require plaintiffs to prove price impact in order to invoke the presumption . . .”
Respondents opposed granting the petition, arguing three key points:
Importance: Basic and the “fraud-on-the-market presumption is critical to private securities actions, as this Court has repeatedly noted.” In addition, meritorious private securities actions are a necessary supplement to criminal prosecutions and civil enforcements as the Court and enforcement officials have repeatedly stated.
Congress: Congress had repeatedly amended and adjusted the federal securities laws since Basic was decided without altering it. Indeed, at the time the PSLRA was passed Congress considered and rejected calls to undo the fraud-on-the-market presumption as the Court acknowledged in Amgen.
Economic theory: The underpinnings to Basic have not been undercut. That decision is predicated in part on the same theory Congress “expressly relied on . . . [in the Exchange Act,] that securities markets are affected by information . . .” Furthermore although the economic theory regarding the efficiency of markets has evolved, “the semi-efficient market hypothesis continues to enjoy widespread support among economists.” The “Semi Strong Efficient Market Hypothesis . . . has been subjected to perhaps the most intensive and extensive testing of any hypothesis in all of the social sciences—and this extraordinary scrutiny has confirmed the strong empirical support for the theory.”
Calling the “fraud-on-the-market” theory the “most powerful engine of civil liability ever established in American law, a group of former SEC Commissioners and officials and law professors filed an amicus brief in support of Petitioners. That brief argues two key points:
Text of statute: While the text of Section 10(b) does not reveal how reliance should be established since the cause of action under it was implied by the courts, comparison to the nearest, most analogous statutory provision demonstrates that plaintiffs should be required to establish the element. This is illustrated by considering Exchange Act Section 18(a) where Congress required this approach.
Basic is inconsistent: The approach of Basic is “at war with itself . . .” While the case holds that there is a presumption, in fact it effectively can not be rebutted. Rebuttal requires “an individualized inquiry into the buying and selling decision of particular class members . . . And the cases in which such an individualized inquiry has rebutted the presumption after it has attached are . . . as rare as hen’s teeth.” (internal quotations omitted).
Revisiting Basic has the potential to rewrite the law applicable to federal securities class action litigation. Overruling the case could compel plaintiffs to prove reliance by the individual class members, something which may will be impossible. At the same time adopting the alternative approach suggested by Petitioners has the potential to intertwine the class certification requirements of Rule 23 with the merits of a fraud claim under Section 10(b), something the Court has repeatedly avoided. It also has the potential to turn the certification hearing into a min-trial. Yet many commentators argue that class certification is, for all practical purposes, the trial since certification virtually assures settlement in view of the potential liability defendants face.
To date four justices have indicated a willingness to revisit Basic. Four justices were required to vote for granting the petition. Whether there will be five votes to overrule or modify Basic, and perhaps Halliburton I and Amgen, will be determined later this term.