Halliburton Co. v. Erica P. John Fund was finally decided this summer (for background on this case, including the issues, see my first two articles on the case here and here) and the presumption of reliance on the integrity of the stock price that was created in Basic v. Levinson was upheld. The fraud-on-the-market theory is alive and well. Halliburton (the petitioners to the Court and the defendants in the class action) also lost on their request to require that plaintiffs in securities class actions prove “price impact” at the class certification stage. They won a small victory by granting defendants in securities class actions the ability to rebut the presumption of an efficient market at the class certification stage so they will no longer have to wait until arguments are made on the merits of the case in order to address it.
To recap, in order to certify a class for a class action, common questions of law or fact must predominate over questions affecting only the individual members. In order to satisfy this requirement for Rule 10b-5 securities class actions, Basic includes the fraud-on-the-market doctrine. This satisfies the commonality and predominance requirements by providing a platform to show common reliance by all of the stock purchasers on the alleged misstatements by the company. Without this presumption, plaintiffs would have to show reliance on the misstatements individually which would lead to individual issues predominating and the class not being able to be certified.
The vote was 9-0 and the opinion was written by Chief Justice Roberts who was joined by Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan. There was also a short concurring opinion submitted by Ginsburg in which Breyer and Sotomayor joined. This concurrence indicated that their joining in the opinion was dependent on their interpretation that the burden of showing price impact was squarely on the defendant and that there would not be a “heavy toll on securities-fraud plaintiffs with tenable claims.” There was also a much longer concurring opinion filed by Thomas, in which Scalia and Alito joined. While concurring in the judgment, the three justices refused to join the opinion of the Court and instead promoted the abolishment of Basic’s presumption of reliance.
The reason that the court did not overturn Basic is because, under the doctrine of stare decisis, there needed to be a special justification in order to overturn the previous precedent. The Court found that Halliburton had not presented such a justification. In addition, given the number of times that Congress had considered the issue, most notably in 1995 with the passage of the Private Securities Litigation Reform Act (PSLRA), and had refused to eliminate the fraud on the market doctrine, stare decisis was especially appropriate
If you had been following the predictions of those writing about the case in the past few months, the opinion was not very surprising. They found a middle ground between the status quo, which is viewed as overly favorable to plaintiffs, and the extreme alternative of over-ruling Basic, which potentially kills the ability of plaintiffs to bring securities class actions.
So what effect will this opinion have? In most stages of the case, securities class actions will continue unchanged. The only real impact is at the class certification stage where defendants will be allowed to present evidence showing that the price of the company’s stock was not impacted by the alleged misrepresentations. While Halliburton is claiming victory given their ability to argue over stock price earlier, their victory is very limited. Ginsburg wrote in her concurring opinion, “the Court’s judgment, therefore, should impose no heavy toll on securities-fraud plaintiffs with tenable claims,” (page 29 of the pdf).
In post-Halliburton cases, the defense will be hiring experts to show that the price drop did not impact prices. They will be running event studies and use them to rebut the assumption of an efficient market. Plaintiffs will als0 have experts, but how much it costs and what lengths they will need to go through will be determined by how reticent courts are to find for the defense.
Rebutting price impact will likely be futile in cases where a company announces some bad news and the stock immediately and clearly drops. However, there will be other, less clear, cases where lots of bad news was bundled in one announcement, the market had a delayed reaction, or other situations occurred where the cause of the stock drop was much less clear. These cases are where this ruling will have an impact.
While the fraud-on-the-market theory lives on, don’t think that it got away completely free. Three justices, while supporting the court’s opinion that not enough new evidence was presented to overrule Basic in this case, still posited that the fraud-on-the-market theory may have outlived its usefulness. While that is still far from a majority, it is misguided to think that the argument against Basic fell on deaf ears. This likely won’t be the last time that the theory is litigated.