Can this brief save securities fraud class actions?

By Alison Frankel
January 30, 2014

There is an awful lot of weight on David Boies‘s shoulders in the U.S. Supreme Court case known as Halliburton v. Erica P.John Fund. The renowned litigator and his partners at Boies, Schiller & Flexner represent the EPJ Fund, but in a larger sense, they represent everyone who invests in shares listed on U.S. exchanges. If Boies and his firm can’t persuade the justices of the Supreme Court to leave intact the court’s 1988 precedent in Basic v. Levinson, securities fraud class actions will be decimated. Small investors without the resources to bring their own fraud claims will be stranded – as will all of the lawyers, economists, academics and consultants who make a living in the multibillion-dollar securities class action industry.

So how does Boies Schiller intend to convince the Supreme Court not to meddle with private securities litigation? Based on the firm’s newly filed merits brief, by appealing to the court’s respect for its own precedent and deference to Congress and regulators.

As you would expect, Boies Schiller’s 85-page filing offers a long list of arguments to counter Halliburton and the many pro-business organizations urging the Supreme Court to overturn Basic’s holding that investors trading in an efficient market can be presumed to have relied on alleged corporate misstatements. (That presumption of reliance, as you know, is what permits investors to band together as a class to pursue securities fraud claims; without the presumption, individual investors would be forced to prove that they relied on misinformation when they made trading decisions.) Some of the new brief’s points are technical, such as its discussion of whether defendants should be permitted to rebut the presumption of reliance by offering evidence that the supposed misrepresentations had no impact on share price. Some are political, emphasizing defendants’ success in fending off unwarranted fraud class actions. Boies Schiller also dedicates several pages to defending what the brief calls “the simple economic truth” at the heart of Basic v. Levinson. Regardless of debate among economists about the mechanisms of market efficiency, the brief argues, there’s no controversy around “the proposition that developed markets generally respond to material information.”

The overarching theme of the brief, however, is that the presumption of investor reliance on market prices is rooted in the history of U.S. securities laws. Moreover, according to Boies Schiller, that presumption has become inextricably entwined with enforcement of those laws, as both Congress and the Executive Branch have acknowledged time and again in the 25 years since Basic v. Levinson came down. If the Supreme Court overturns Basic, the brief says, it will not only be reversing its own statutory precedent – an occurrence so rare, according to Boies Schiller, that it has been more than 50 years since the justice last repudiated a previous court’s statutory interpretation, in James v. United States – but will also implicitly override Congress, which has had several opportunities to undo Basic v. Levinson and has repeatedly declined to do so.

Halliburton and its supporters anticipated precisely these arguments in their merits briefs earlier this month. Those filings offered the Supreme Court a plethora of explanations for why the principle of stare decisis – or deference to the court’s precedent – should not apply to Basic, which Halliburton and its supporters portray as a fundamentally misguided decision that rested on a flawed economic theory, codified a right that doesn’t exist in the securities fraud statutes and was endorsed by only four justices. (Those four constituted a majority because only six justices heard Basic v. Levinson). Nor does Team Halliburton agree that Congress has implicitly approved Basic by failing to pass legislation overturning it. One of the briefs before the Supreme Court is from former Republican lawmakers who argue that political expedience, rather than philosophical agreement with Basic, explains Congress’s failure to overturn the presumption of classwide reliance.

Both sides, in other words, seem to be betting that the biggest obstacles to overturning Basic will be stare decisis and congressional acquiescence. Boies Schiller’s priority in the newly filed brief seems to have been to characterize Basic v. Levinson not as an outlier decision but as a case that rests on a foundation of precedent and has, in turn, provided so strong a base for additional enforcement that Congress has not dared to assail it.

That context, according to Boies Schiller, dates back to the 1930s, when future Supreme Court Justice William Douglas (then a professor involved in the drafting of securities laws intended to prevent future stock market crashes) touted the notion that the market price for a security reflects corporate statements that might never reach the attention of individual investors. Fraud-on-the-market reliance theory, in Boies Schiller’s telling, informed Congress in both the Securities Act of 1933 and the Exchange Act of 1934. The Supreme Court acknowledged as much, according to the new brief, when it discussed reliance in two major securities fraud cases that preceded Basic v. Levinson: Mills v. Electric Auto-Lite in 1970 and Affiliated Ute v. United States in 1972. And since Basic came down in 1988, the brief says, the Supreme Court itself has endorsed its fraud-on-the-market holding in several cases, including five in the last 10 years. (One of those, the brief points out, was a previous trip to the high court in this very litigation; in 2011, the court sided with the Erica P. John Fund on the standard for certification of a shareholder class.)

Basic has also shaped securities enforcement by the Securities and Exchange Commission and the Department of Justice, according to Boies Schiller. Both agencies have acknowledged that private litigation is essential to deterring market fraud, the brief says, but perhaps more importantly, they also rely on fraud-on-the-market theory in their own cases. “Modern enforcement of the securities laws, both by public and private actors, has grown up around Basic’s fraud-on-the-market presumption,” the brief says. “Adopting Halliburton’s position would disrupt broad swaths of the enforcement regime…. The SEC might have to adopt substantially more onerous disclosure or substantive requirements. Further, in pursuing criminal and civil violations of federal securities laws, the Department of Justice and the SEC regularly rely on the assumption that information is generally incorporated into the market price of stocks, including through the use of ‘event studies’ that parallel those used in private suits under Basic.”

Notwithstanding the amicus brief by onetime Republican lawmakers, Boies Schiller says, Congress knew full well the significance of Basic’s presumption of reliance when it rewrote the rules for securities fraud class actions in the Private Securities Litigation Reform Act of 1995. Rather than tamper with fraud-on-the-market theory, the House and Senate took other measures to rein in supposedly unfounded class actions. In fact, according to the Boies brief, the lawmakers’ amicus filing actually bolsters the argument that the Supreme Court should defer to a Congress that considered overturning Basic but didn’t do so.

There’s simply no compelling reason for the justices to change the status quo, the brief contends – and very good reasons to leave Basic alone. “If this court were to eliminate the fraud-on-the-market presumption, most defrauded investors would be left without any legal recourse from fraud,” Boies Schiller says. “The legal landscape would be worse for the change.”

Amicus briefs supporting the Erica P. John Fund are due next week. The case will be argued on March 5.

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