In a long-awaited ruling, today, the U.S. Supreme Court affirmed the validity of a “cornerstone” of private securities class actions: the fraud-on-the-market presumption. At the same time, the Court recognized the right of defendants to submit evidence to rebut that presumption at the class certification stage.
In its decision, Halliburton Co. v. Erica P. John Fund, Inc., authored by Chief Justice Roberts, the Court rejected Halliburton’s request that the Court overrule Basic v. Levinson, a 25-year-old precedent that adopted the fraud-on-the-market presumption. However, the Court also vacated the decision of the Fifth Circuit Court of Appeals, likely sending the case back to the lower courts to allow Halliburton an opportunity to rebut the presumption by showing that the alleged fraudulent statements did not have an impact on the price of Halliburton’s common stock.
The case centers on a fundamentally important element of securities fraud claims: reliance.
Investors can recover damages in private securities fraud actions only if they prove that they relied on a defendant’s alleged false or misleading statements. Recognizing that most investors rely on the integrity of the market price for securities, 25-years-ago, in Basic v. Levinson, the Supreme Court adopted a rebuttable presumption of reliance. The Basic Court held that, in an efficient market, stock prices reflect all publicly-known information and that shareholders, therefore, are presumed to have relied on such information when making a purchase. Without Basic’s “fraud-on-the-market presumption,” each individual class member would need to show that they relied on the specific allegedly false or misleading statements when they bought a company’s stock, a showing would be out of sync with the realities of how the U.S. securities markets function.
The current appeal was nothing short of a referendum on Basic. In fact, the “question presented” was whether to “overrule or substantially modify” Basic.
Basic survives.
Today’s ruling had three core components.
First, the Court affirmed Basic, noting that Halliburton had not shown a “special justification” for overruling the decision. Despite Halliburton’s attempts to re-package arguments that were presented and rejected by the Basic Court and to argue that the “efficient capital markets hypothesis,” cited in Basic, has faced criticism over the last 25 years, the Halliburton Court refused to overrule Basic.
Second, the Court refused to increase the burden on plaintiffs in invoking the Basic presumption. The Court rejected Halliburton’s argument that plaintiffs should be required to prove the “price impact” of specific statements directly at the class certification stage. Instead, the Court reiterated that plaintiffs can continue to meet their burden of establishing the fraud-on-the-market presumption at the class certification stage by establishing that (1) the alleged misrepresentations were publicly known; (2) the stock traded in an efficient market; and (3) the plaintiff traded the stock between the time the alleged misrepresentations were made and when the truth was revealed.
Finally, the Court agreed with Halliburton, however, that defendants must be afforded an opportunity to rebut the presumption of reliance before class certification with evidence of a lack of price impact. As the Court recognized, the presumption adopted in Basic was rebuttable – not conclusive. The Basic Court recognized that “[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance.” Halliburton argued that under that reasoning, it should be afforded the ability to defeat any presumption of reliance at the class certification stage through evidence that the alleged misrepresentations did not in fact affect the stock price. The Supreme Court agreed. The Court saw “no reason to artificially limit the inquiry at the class certification stage to indirect evidence of price impact.” Rather, “Defendants may seek to defeat the Basic presumption at that stage through direct as well as indirect price impact evidence.”
In conclusion, the Court noted:
“More than 25 years ago, we held that plaintiffs could satisfy the reliance element of the Rule 10b-5 cause of action by invoking a presumption that a public, material misrepresentation will distort the price of stock traded in an efficient market, and that anyone who purchases the stock at the market price may be considered to have done so in reliance on the misrepresentation. We adhere to that decision and decline to modify the prerequisites for invoking the presumption of reliance. But to maintain the consistency of the presumption with the class certification requirements of Federal Rule of Civil Procedure 23, defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.”
“Because the courts below denied Halliburton that opportunity, we vacate the judgment of the Court of Appeals for the Fifth Circuit and remand the case for further proceedings consistent with this opinion.”
The decision had something for both sides to cheer. Investors are relieved that the Court reaffirmed Basic, while defendants now unquestionably have an earlier opportunity to rebut the presumption of reliance. But the already intense battle ground over class certification will only become more intense and the real winners today just may be the experts. For years, class certification motions have turned into “battles of the experts,” and today’s decision will only magnify these battles. Also, the question of price impact often requires additional discovery, but class certification is often decided before formal discovery is completed. But as Justice Ginsburg noted in her concurring opinion, “[a]dvancing price impact consideration from the merits stage to the certification stage may broaden the scope of discovery available at certification.” While this decision will not result in a decrease in the filing of merited securities fraud cases, it essentially guarantees that the certification of a class will be a more time-intensive and expensive process for everyone and that the same factual issues may be resolved at multiple stages during the litigation.
Chief Justice Roberts was joined in the opinion by Justices Kennedy, Ginsburg, Breyer, Sotomayor and Kagan. Two concurring opinions were issued, but there was no dissent.
Justice Ginsburg wrote a very brief concurrence, joined by Justices Breyer and Sotomayor, to clarify her understanding that defendants must show the absence of price impact, which she viewed as “impos[ing] no heavy toll on securities-fraud plaintiffs with tenable claims.”
Justice Thomas wrote separately to concur in the judgment, joined by Justices Scalia and Alito, reaching the conclusion that “Basic should be overruled.” Justice Thomas did not agree with the Court’s majority that stare decisis required preserving Basic, and he would require investors to prove actual reliance. He also stated his view that requiring price impact is insufficient, as “the realities of class-action procedure make rebuttal based on an individual plaintiff’s lack of reliance virtually impossible.”