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.