As Basic hangs in the balance, next SCOTUS securities case looms
On Wednesday, the U.S. Supreme Court will hear oral arguments in Halliburton v. Erica P. John Fund, the most momentous securities case of the last quarter century. When this term ends in June, we’ll know whether the fraud-on-the-market theory that the Supreme Court codified in the 1988 case Basic v. Levinson will remain intact as the foundation of the securities class action industry or whether shareholders will lose the leverage of classwide damages claims for supposed fraud under the Exchange Act of 1934. I’ve been saying it for months: Untold billions of dollars hang on the justices’ determination in the Halliburton case.
The stakes are admittedly not quite as high in Omnicare v. Laborers District Council Construction Industry Pension, which the justices have just agreed to hear next term. Omnicare presents the question of whether plaintiffs asserting claims under Section 11 of the Securities Act of 1933 must only show that defendants made objectively false statements in offering documents – as the 6th Circuit Court of Appeals held in the Omnicare case – or must also show that defendants didn’t believe the supposedly false statements at the time they were made, as at least two other federal circuits have concluded. Section 11 class actions, as you know, aren’t historically as prevalent as Exchange Act fraud class actions. But if the Supreme Court overturns Basic v. Levinson, Securities Act claims will be one of the few remaining avenues for shareholders who want to sue through class actions. The justices’ reasoning on the standard of proof will go a long way toward determining how big a threat these cases present to issuers – and to their underwriters, auditors and lawyers.
To set that standard, the Supreme Court will have to resolve apparent tension between two of its own precedents. In the court’s 1991 ruling in Virginia Bancshares v. Sandberg, the majority considered “the actionability per se of statements of reasons, opinions or belief” under Section 14 of the Exchange Act. Because that sort of statement “purports to express what is consciously on the speaker’s mind,” the Supreme Court said, it made sense to limit any discussion of liability to misstatements that did not reflect the speakers’ true beliefs and opinions. According to Omnicare’s petition for certiorari, the 2nd, 3rd and 9th Circuits have all relied on that holding in Virginia Bancshares to conclude that even under Section 11 of the Securities Act – which calls for a more expansive view of liability than the Exchange Act provision at issue in the Virginia Bancshares case – defendants can only be sued for statements that depart from their actual opinions.
In its Omnicare opinion last October, the 6th Circuit explicitly acknowledged its split from the 2nd and 9th Circuit decisions on the same issue, but the three-judge panel said the other circuits had read too much into Virginia Bancshares. The laborers’ union, in its brief opposing Supreme Court review, agreed: Shareholders argued that the high court’s guiding precedent for strict liability claims under Section 11 is the 1983 case of Huddleston v. Herman & MacLean, in which the court said that “liability against the issuer of a security is virtually absolute, even for innocent misstatements.”
The union’s lawyers at Robbins Geller Rudman & Dowd had the unenviable job of trying to dissuade the Supreme Court from granting review of a case in which the 6th Circuit itself highlighted its divergence from other federal appeals courts. The firm argued without much credibility that there’s not really a significant circuit split, contending in particular that the 2nd Circuit’s “garbled” and “conceptually incoherent” 2011 decision in Fait v. Regions Financial is only rarely cited. Omnicare, which is represented by Winston & Strawn, countered in its reply brief that Fait has been the basis of dozens of rulings – so many that the 2nd Circuit itself has referred to the decision’s “frequent” citation. The union makes a better case on the merits, arguing that the 6th Circuit correctly interpreted its precedent and the statutory language of Section 11 when it determined that Virginia Bancshares cannot be read to undermine strict liability for misstatements in offering documents. (I think we can all agree that Virginia Bancshares is subject to varying interpretations; in a blog post at D&O Discourse after the 6th Circuit’s Omnicare decision, Claire Davis of Lane Powell said the Supreme Court’s 1991 decision is “anything but a paragon of clarity.”)
Section 11 liability, as you know, can extend beyond issuers to their underwriters and auditors and even to the law firms that approved offering materials, all of which are shielded from Exchange Act fraud class actions. Omnicare and Winston & Strawn have predicted dire consequences for corporate advisers if the Supreme Court adopts the 6th Circuit’s interpretation of what investors must show. “Many potential speakers – including issuers, officers, directors, auditors, lawyers and underwriters – may find themselves vulnerable to claims based on hindsight, as potential plaintiffs and class counsel focus their efforts on statements of opinion that, over time, turn out to be wrong,” the cert petition said. “It would serve as a powerful disincentive for corporations and their executives to disclose their honestly held opinions on subjects that investors may find important and useful.”
Robbins Geller, predictably, downplays the risk to defendants other than the issuer, pointing out that if the issuer deceived its advisers, they can rely on a due diligence defense. But it’s a good bet that this case is going to attract a lot of attention from friends of the court that aren’t involved in the Halliburton litigation because they’re not exposed to Exchange Act fraud class actions. Whatever happens in Halliburton, in other words, the Supreme Court battle over securities class actions won’t be over just yet.
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