Supreme Court Preserves Fraud-on-the-Market Theory in Halliburton
June 23, 2014, the U.S. Supreme Court released its decision in Halliburton v. Erica P. John Fund, No. 13-317. As discussed in our previous alert, the decision was easily one of the most eagerly anticipated of the Court's current term and involved fundamental questions about the viability of securities fraud class action litigation. At issue was the so-called "fraud-on-the-market" presumption of reliance created by the Court in Basic v. Levinson some 25 years ago, which allows plaintiffs to obtain certification of securities fraud class actions without having to demonstrate each putative class member's individual reliance on an alleged misrepresentation. This plaintiff-friendly presumption rests on the "efficient market" theory – that is, the idea that the share price of a publicly traded security reflects all publicly available information about that security, including alleged misrepresentations. A showing of individual reliance, therefore, is unnecessary if the alleged misrepresentation was public since the average shareholder relies on a company's share price when buying or selling shares. The loss of the "fraud-on-the market" presumption would have made it much harder, if not impossible, for plaintiffs to pursue claims for securities fraud under § 10(b) of the 1934 Act and/or Rule 10b-5 as class actions – a major concern for law firms specializing in such work. As many predicted, however, such concerns were overblown. In its unanimous decision, the Supreme Court refused to overturn the "fraud-on-the-market" presumption.
The Supreme Court did, however, provide defendants with an important tool at the all-important class certification stage. Plaintiffs typically must introduce indirect evidence of price impact to establish entitlement to the presumption of reliance (via evidence of market efficiency and the public nature of an alleged misrepresentation). Now, defendants are allowed to rebut the presumption of reliance using evidence that no "price impact" had occurred. "Defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock." (Emphasis supplied).
This decision cements class certification as a key battleground for securities class actions (provided, of course, that the action survives a motion to dismiss) and will give economists and damage experts new work as defendants try to determine whether they can provide evidence to rebut the presumption of reliance.
Britt Latham was quoted in a piece for Law360 discussing the Halliburton case, which was published June 23, 2014.
Supreme Court Holds that a "Presumption of Prudence" Is No Longer Available to ERISA Fiduciaries Who Invest Plan Assets in Company Stock
On June 25, 2014, the U.S. Supreme Court released another much anticipated decision in Fifth Third Bancorp v. Dudenhoeffer, No. 12-751, 2014 U.S. LEXIS 4495. The decision, which was analyzed in a previous alert, unanimously overturned an important "presumption of prudence" that lower courts had for many years afforded ERISA fiduciaries in connection with a decision to buy, hold or offer employer stock as a part of a stand-alone employee stock ownership plan ("ESOP"), an ESOP component of a defined contribution plan or an employer stock fund offered under a 401(k) or profit sharing plan. As the name implies, such investment decisions previously had been viewed as presumptively prudent in all but the most exceptional circumstances, and the application of the presumption had been a powerful tool for defendants in seeking an early dismissal in ERISA stock-drop lawsuits.
The Supreme Court held that Section 404(a)(2) of ERISA does not create any special presumption favoring ESOP fiduciaries whether at the pleading stage or later in the proceedings as an evidentiary rule. Importantly, the Court explained that the instructions of a plan document - such as a provision requiring employer stock as an investment option - do not excuse fiduciaries from the duty of prudence with respect to the decision to include employer stock as a plan investment option. ESOP fiduciaries are now subject to the same standard of prudence that applies to all fiduciaries under ERISA with respect to decisions regarding plan investments, with the caveat that they are not bound by the same diversification requirements that ERISA imposes on fiduciaries who oversee investments of non-ESOP benefit plans. The loss of this defendant-friendly presumption could have significant ramifications for ESOP fiduciaries and could increase the number of ERISA-related actions that are filed. To address the concern that an ESOP fiduciary might find "himself between a rock and a hard place" when faced with competing obligations under ERISA and the federal securities laws, the Supreme Court decision does give lower courts some guidance as to how to use motions to dismiss to weed out meritless lawsuits.
Sixth Circuit Affirms Dismissal of Section 10(b) Claims on Loss Causation Grounds
In In re KBC Asset Mgmt. N.V., 2014 U.S. App. LEXIS 13489 (6th Cir. July 11, 2014), the Sixth Circuit affirmed the trial court's dismissal of a claim brought under the Securities Exchange Act of 1934 based on the plaintiff's failure to plead adequate loss causation. The case centered on allegedly fraudulent statements that defendant Eaton Corporation made in connection with a separate trade secrets lawsuit that it filed against a competitor. In rejecting the plaintiff's boilerplate loss causation allegations, the panel explained that "to plead loss causation adequately" a plaintiff must show that "'the act or omission of the defendant . . . caused the loss for which the plaintiff seeks to recover damages.'" Id. at *9 (citing 15 U.S.C. § 78u-4(b)(4)). Here, however, the Court parsed through the corrective disclosure at issue and determined that plaintiff's allegations did not amount to new information to the market. Instead, the alleged corrective disclosure was old news that the market should have already "absorbed long before." Id. at *11. Overall, this case underlines the importance of loss causation in the Sixth Circuit at the pleading stage of a securities fraud lawsuit and how the "failure to plead loss causation adequately is fatal to [a plaintiff's] § 10(b) claim." Id. at *17. Moreover, this case illustrates how courts in the Sixth Circuit consider the entire context in which an alleged "corrective disclosure" was made when considering whether a plaintiff has adequately stated a claim.
Second Circuit Affirms Shareholder Opt-Out Requirements
On June 11, 2014, the Court of Appeals for the Second Circuit affirmed by summary order a lower court decision not to afford a member of a shareholder class more time to comply with the requirements for opting out of the settlement in a high-profile securities class action lawsuit. See Shumsker v. Citigroup Global Markets, Inc., No. 13-4581-cv, 2014 U.S. App. LEXIS 10806 (2d Cir. June 11, 2014). The class member had filed her opt-out request after the submission deadline and instituted a separate district court action to pursue her individual claims.
As support for her request for more time, the shareholder put forward two justifications. First, she argued that she "failed to understand" that she was required to opt-out of the class action settlement in order to maintain her individual claims. Second, she stated that she and her counsel each "genuinely believed the other was responsible for" sending the opt-out notice. The Second Circuit rejected both of these justifications as "unsatisfactory" and "contradictory." The Second Circuit also took note of the fact that the shareholder's request for more time to file her opt-out had not been made for several months after the opt-out deadline had run. According to the Court, to allow the shareholder more time after such a lengthy delay would prejudice defendants.
Taking all of this into consideration, the Court concluded that the district court's decision both to dismiss the shareholder's individual lawsuit and to deny her request for more time did not constitute an abuse of discretion. While lower courts are given a good deal of discretion in ruling on opt-outs, this decision highlights that courts are not likely to accept any claim that a class member "failed to understand" what he or she had to do in order to opt-out and pursue an individual action.
Joe Crace and Brant Phillips co-authored a piece for the ABA Section of Litigation – Commercial & Business discussing this case, which was published July 10, 2014.
Delaware Supreme Court Upholds Validity of Fee-Shifting Bylaws; Legislative Proposal to Restrict Such Bylaws Held Over Until Next Year
On May 8, 2014, the Delaware Supreme Court issued a decision in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), holding that a bylaw provision of a non-stock corporation shifting attorneys' fees and costs to unsuccessful plaintiffs in intra-corporate lawsuits was valid and enforceable under certain circumstances. The court found such bylaws permissible under Delaware's statutes when a plaintiff "does not obtain a judgment on the merits that substantially achieves, in substance and amount, the full remedy sought." Id. at 557. The Court did note that the enforceability of a fee-shifting bylaw depends on the manner in which it was adopted and the circumstances under which it was invoked. The Court said that it is "able to say only that a bylaw of the type at issue here is facially valid, in the sense that it is permissible under [Delaware's statutes], and that it may be enforceable if adopted by the appropriate corporate procedures and for a proper corporate purpose." Id. at 559.
This ruling generally upholds the facial validity of fee-shifting bylaws, and the Court's rationale seems to be equally applicable to stock corporations as well as to non-stock corporations. (Non-stock corporations are similar to limited liability companies, in that non-stock corporations are owned by members and not stockholders. Non-stock corporations are used primarily by non-profit entities.) As a result, this decision prompted discussion among businesses and attorneys alike, speculating whether to adopt such a provision in stock corporation bylaws along with other corporation-friendly bylaws, such as forum selection bylaws designating specific forums for shareholder disputes. As quickly as those talks began, the Delaware General Assembly scrambled to put together proposed legislation to restrict such fee-shifting bylaws to non-stock corporations.
Approximately a month after the proposed legislation was presented, it was withdrawn to allow a further study of the possible benefits and harm of using fee-shifting bylaws in stock corporations. The Delaware General Assembly likely will take up the issue again in 2015. In the meantime, the Delaware Supreme Court might get another look at this developing area of the law. A few stock corporations already have attempted to retroactively amend their bylaws with similar fee-shifting provisions, which might provide the Delaware Supreme Court with the opportunity to consider the issue with respect to stock corporations.
Whether or not directors of Delaware corporations should adopt a fee-shifting bylaw now before the Delaware General Assembly or the Delaware courts clarify the issue is a thorny question. Boards will need to consider specific company needs, the risk the company will be forced to revise bylaws yet again after any statutory amendments, likely investor opposition, and litigation risks.