At Halliburton argument, justices show little appetite for killing Basic
After oral arguments Wednesday morning at the U.S. Supreme Court in Halliburton v. Erica P. John Fund, I ran into a few securities class action plaintiffs lawyers in the court’s lobby, at the statue of Chief Justice John Marshall. They were looking jaunty indeed. The consensus in their little group was that the justices showed little inclination to toss out the 1988 precedent that has been the foundation of the megabillion-dollar securities class action industry. They regarded Wednesday’s argument as a hopeful portent that classwide securities fraud litigation is likely to survive the Supreme Court’s re-examination of Basic v. Levinson.
I have to agree. From the questions posed to Halliburton counsel Aaron Streett of Baker Botts and EPJ Fund lawyer David Boies of Boies, Schiller & Flexner, the Supreme Court seems to be searching for a way to require investors to demonstrate the price impact of alleged corporate misrepresentations in order to win class certification. That would be a new and different burden for the securities class action bar, which, under Basic’s fraud-on-the-market theory, simply had to show that shares traded in an efficient market in order to invoke the presumption that investors relied on corporate misstatements. To establish price impact, plaintiffs would have to hire experts to conduct event studies analyzing the market effect of particular misrepresentations. But such event studies are already common in securities class action litigation, as both sides acknowledged to the justices. So a new price impact requirement would leave the securities class action industry more or less intact. “We can live with that,” one plaintiffs lawyer told me.
If oral argument is a reliable predictor of the Supreme Court’s ultimate direction – a dicey proposition, of course – all of the lawyers and economic experts who worried they’d be scrabbling for work if the court overruled Basic can relax a bit. In fact, if the justices figure out some way to make price impact part of the class certification process, economics consultants could actually emerge from the Supreme Court’s scrutiny of Basic with more securities fraud business than ever.
Justice Anthony Kennedy was the first to raise the possibility of a compromise that would not entirely undermine Basic’s adoption of fraud-on-the-market theory, which assumes that market prices reflect all available public information. Well into Halliburton counsel Streett’s argument, after Justice Elena Kagan questioned him skeptically about why the court should even consider overturning Basic and Chief Justice John Roberts expressed reluctance to wade into the morass of economic literature on efficient market theory, Kennedy asked Streett to address “the midway position that says there should be an event study.” An analysis of price impact, he said, would seem to be “a substantial answer to…the challenge you make to the economic premises of the Basic decision.”
Kennedy noted that his question was based on an amicus brief by two law professors – he didn’t name them, but the brief is by John Elwood of Vinson & Elkins for Adam Pritchard of the University of Michigan and Todd Henderson of the University of Chicago – who argued that price impact is a cleaner, clearer test of whether market price is impacted by fraud than Basic’s efficient market framework. The brief advocates the use of event studies at the class certification stage of securities litigation to determine whether alleged misrepresentations truly distorted the market. Under this framework, investors could proceed as a class only if they could show evidence that the market has actually been defrauded.
As arguments continued Wednesday morning, the justices struggled to figure out exactly how the price impact requirement would work in practice, especially considering that just last term, in Amgen v. Connecticut Retirement Plans, the court said that it would not require shareholders to prove the materiality of alleged misstatements in order to be certified as a class. (As you probably recall, the court’s ruling in Amgen, in which four justices suggested that Basic’s presumption of reliance deserved re-examination, prompted Halliburton to ask that question in its certiorari petition.) Chief Justice Roberts wanted to know whether event studies to show price impact would be more expensive than market efficiency studies that securities class action plaintiffs now rely upon at the class certification stage. (Streett said not necessarily, Boies said yes.) Justice Breyer asked why defendants couldn’t already use event studies showing no price impact to oppose class certification motions; Halliburton counsel Streett pointed out that his client’s case was spurred by the 5th Circuit Court of Appeals’ refusal to consider exactly such evidence.
Justice Sotomayor was particularly uncomfortable with Kennedy’s suggested “midway” compromise. “I don’t see how this is a midpoint,” she said to Streett. “If you’re going to require proof of price, impact, why not do away with market efficiency?” Requiring proof of price impact at the class certification stage, Sotomayor said, would turn class certification into “a full-blown merits hearing.” Sotomayor later posed the same question to Boies: “If we believe price impact is necessary, why keep Basic if we’re going to put it in a class certification (hearing)?” Boies said price impact is a merits question, not a class certification question, which prompted Justice Kennedy to ask why price impact couldn’t be considered a class certification issue. “Even if Basic did not rely on economic theory, and there is a dispute on that…if later economic theories show that the market doesn’t react the way Basic assumed it automatically did, then certainly Congress would not wish to foreclose the court from considering that new evidence,” Kennedy said, in a question that implicitly noted that the certification process for securities fraud cases rests on Basic’s fraud-on-the-market theory.
The justices asked some questions, though fewer than I expected, about whether Congress has implicitly endorsed fraud-on-the-market theory by enacting legislation that assumes securities fraud class actions will continue. Boies argued that, in particular, the Securities Litigation Uniform Standards Act of 1998, which directed most securities class actions to federal court, makes no sense unless Congress had implicitly approved Basic v. Levinson. There was little discussion of the principle of stare decisis and only scant attention was paid to shareholders’ arguments that Basic’s fraud-on-the-market presumption is baked into the Securities and Exchange Commission’s enforcement regime. In fact, when Justice Kennedy asked Malcolm Stewart from the solicitor general’s office to predict the consequences of a new price impact requirement, Stewart said that he didn’t think they would be particularly dramatic. “If anything, that would be a net gain to plaintiffs, because plaintiffs already have to prove price impact at the end of the day,” he said.
After the argument, I called Michigan law professor Adam Pritchard, whose brief was such a hit with Justice Kennedy and seems to be the basis of a possible compromise on securities class actions. Pritchard, who skipped the oral argument for a weekend trip to Disney World, noted that Kennedy’s fondness for his theory is well founded: He structured the price impact test his brief advocates on Kennedy’s opinion in Central Bank of Denver v. First Interstate Bank. “Justice Kennedy is a fan of Justice Kennedy,” Pritchard joked. More seriously, he said that he doesn’t see why the Supreme Court can’t write an opinion that substitutes price impact for market efficiency as a condition for the presumption of classwide reliance on corporate misrepresentations.
“The justices should say Basic was wrong, abandon materiality and abandon efficiency,” Pritchard said. Price impact ought to be the focus of class certification, according to Pritchard, and if that test requires the court to tinker with its precedent in both Basic and in Amgen, so be it.
It could happen. But if you ask the securities bar, that would be a happy ending.
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