Time to undo fraud-on-the-market presumption in securities class actions?
The U.S. Supreme Court created securities class actions as we now know them in 1987, when an unusual four-justice majority held in Basic v. Levinson that investors in securities fraud cases may be presumed to rely on public misrepresentations about stock trading in an efficient market. Basic’s fraud-on-the-market theory made it possible for shareholders to win class certification without proving that class members made investment decisions based on the defendants’ alleged misstatements – a momentum-shifting boon to shareholders. The ruling has become such an essential building block of securities fraud litigation that since 1987, according to Westlaw, Basic has been cited almost 17,000 times.
But now the Supreme Court is being asked to topple its own creation. In a petition for certiorari last month, Halliburton’s lawyers at Baker Botts argued that Basic’s “naive” and “simplistic” efficient-market theory has been repudiated by economists and is inconsistent with the court’s recent precedent in other sorts of class actions. The Halliburton petition capitalized on dissents in the Supreme Court decision last term in Amgen v. Connecticut Retirement Plans, in which the three justices in the minority – Clarence Thomas, Antonin Scalia and Anthony Kennedy - noted the “questionable” premise of fraud-on-the-market theory. Justice Samuel Alito, in a concurrence, specifically asked whether the court’s ruling in Basic should be reconsidered; Halliburton’s petition takes him up on the offer.
On Friday, class counsel at Boies, Schiller & Flexner shot back at Halliburton and Basic’s critics. In a brief opposing cert, Halliburton shareholders argued that Congress and the Supreme Court have had plenty of opportunities over the last 25 years to dismantle Basic’s fraud-on-the-market framework yet they have consistently refused to do so. According to the opposition brief, Basic remains good law, and even if the Supreme Court wanted to revisit efficient-market theory, the Halliburton case isn’t the right vehicle.
This is a hugely consequential cert petition. We already know from Amgen dissents that four justices have serious doubts about Basic. (Scalia said the majority’s holding in Amgen elevated Basic’s consequences from “arguably regrettable” to “unquestionably disastrous.”) If four members of the court decide reconsideration is ripe, shareholders should be very worried. To date, the Roberts court has spared investors from the obstacles to class certification it erected in Wal-Mart v. Dukes and Comcast v. Behrend. But if it does away with Basic’s efficient-market presumption, it will fundamentally remake securities fraud litigation.
The Halliburton case, as you may recall, has already been before the justices once before. The class action was initially filed way back in 2002 in federal district court in Dallas. Shareholders eventually alleged that the company and various executives made three different sorts of misrepresentations affecting the stock price, underplaying Halliburton’s exposure to asbestos liability and overestimating the potential benefits of its merger with Dresser Industries and of Halliburton’s ability to collect revenue for cost overruns on fixed-price construction contracts. Even though Halliburton conceded that its shares trade in an efficient market, in 2010 the 5th Circuit Court of Appeals affirmed denial of class certification because shareholders could not establish that Halliburton’s alleged misstatements caused their losses.
The Supreme Court reversed the 5th Circuit in 2012, ruling that shareholders do not have to prove loss causation to invoke Basic’s presumption of reliance on misrepresentations. The unanimous ruling, written by Chief Justice John Roberts, came as a huge relief to the securities class action bar, which had feared the Supreme Court might embrace the 5th Circuit’s outlier stance on loss causation as a way to undermine Basic. Instead, the justices implicitly endorsed the 1987 ruling’s fraud-on-the-market premise. Halliburton continued its relentless opposition to class certification when the case went back to the lower courts on remand from the Supreme Court, but despite the company’s claims that the alleged misrepresentations had no impact on its share price, the 5th Circuit certified the investor class in June.
Halliburton’s cert petition argued that the 5th Circuit’s class certification ruling is inconsistent with Supreme Court precedent in Dukes and Comcast – and that the justices should use this opportunity to align shareholder class certification requirements with those in other class actions. “Under Basic, putative plaintiff classes bringing Rule 10b-5 claims are given special solicitude available to no one else – immunity from the very Rule 23 principles articulated in cases like Wal-Mart and Comcast,” the brief said. “At the very least, Basic’s outdated economic theory should undergo the searching scrutiny given to the methodologies proffered to establish predominance in Wal-Mart and Comcast.”
The petition claimed that hundreds of empirical economics studies published since Basic have rebutted the premise that stock prices in an efficient market reflect all publicly available information. If that were true, the brief argued, share prices would move when companies disclosed information to the Securities and Exchange Commission, not days or even months later, when news outlets reported on SEC disclosures. According to Halliburton, stock traders and markets simply aren’t as efficient as Basic anticipated.
Boies Schiller’s new opposition brief posits several counterarguments, including Halliburton’s concession in the lower courts that its shares trade in an efficient market. The Supreme Court should not give Halliburton a chance to assert at this very late stage of the litigation a defense it raised for the first time on remand from the Supreme Court, investors said. And more fundamentally, they argued, “The fraud-on-the-market presumption, adopted by this court in Basic, has been repeatedly endorsed by this court, Congress, the SEC, and the (Justice Department) and enjoys widespread support among economists,” the opposition brief said. “This court should decline Halliburton’s invitation to abandon 25 years of established precedent and eliminate or hamstring the ability of private parties to bring securities fraud actions.” Congress specifically refused to undo Basic when it reformed securities class action rules in 1995, the brief said. The Supreme Court should defer to Congress and leave well enough alone.
Neither side disputes that securities class action defendants can rebut Basic’s presumption of reliance in a summary judgment motion or at trial. Basic applies only to class certification. But as the justices have discussed in their class action decisions in recent years, class certification is a crucial turning point in class action litigation. Blocking certification is just about the last chance defendants have to avert a settlement, since they’re almost never willing to risk class action trials.
Interestingly, the first amicus brief I’ve seen in the Halliburton case, filed Monday by DRI – The Voice of the Defense Bar, does not call for Basic to be undone. DRI argues instead that the 5th Circuit’s class certification ruling, which supposedly ignored Halliburton’s price impact evidence, would turn Basic’s rebuttable presumption of reliance into an irrebuttable presumption. I’m eager to see whether other amici go further than DRI and join Halliburton’s plea for the end of Basic.
(This post has been corrected. An earlier version incorrectly reported that Justice Samuel Alito dissented in Amgen.)