On June 23, 2014, the U.S. Supreme Court released its decision in Halliburton v. Erica P. John Fund, No. 13-317. 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 that had many in the plaintiffs’ bar holding their breath about the future of that practice area.
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 individual reliance on an alleged misrepresentation by each member of the putative class. This plaintiff-friendly presumption rests on the “efficient market” theory – that is, 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 firms specializing in such work.
As many predicted, however, such concerns were overblown. In its unanimous decision, the Supreme Court effectively split the baby: refusing to overturn the “fraud-on-the-market” presumption, while at the same time clarifying that defendants should be allowed to rebut the presumption at the class certification stage using evidence of no price impact. The decision reverses earlier decisions in the case by both the district court and the U.S. Court of Appeals for the Fifth Circuit, which had ruled that defendants are not entitled to introduce evidence at the class certification stage intended to rebut the presumption of reliance.
According to the Supreme Court, this case presented no “special justification” to warrant “overturning a long-settled precedent” established in Basic. Specifically, the Court rejected the argument that Plaintiffs in securities fraud class actions should have to prove reliance on an individual basis, as well as the argument that the “efficient market” theory underlying Basic was no longer valid. The Court also saw no justification to require plaintiffs to affirmatively prove price impact, which the Court said “would radically alter the required showing” of reliance in a 10(b) / 10b-5 action.
The Supreme Court did, however, provide defendants with an important tool by affording them the chance to rebut the presumption of reliance at the all-important class certification stage using evidence that no “price impact” had occurred. Here, the Court seemed to undertake a “fair’s fair” analysis – because plaintiffs typically must introduce indirect evidence of price impact to establish entitlement to the presumption (via evidence of market efficiency and the public nature of an alleged misrepresentation), defendants should be allowed to fight back, especially where they may have direct evidence showing no price impact. “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).
Obviously, how defendants will use this new tool and how courts will receive it is still to be determined, but it will likely not change the landscape of securities class actions in dramatic fashion. It should, however, cement class certification as the primary battleground for these actions (following the motion to dismiss stage), as well as give economists and damage experts new work as defendants try to determine whether they can provide evidence to rebut the presumption. For those cases where such evidence is compelling, this new defense will certainly be dispositive. For others, it will be a non-factor.