Supreme Court’s Halliburton Decision May Significantly Impact Securities Litigation

What you need to know:

A current Supreme Court case has the potential to radically change the securities litigation landscape.  At issue is the continuing viability of the currently accepted fraud-on-the-market theory, which enables securities fraud allegations to be pursued as class actions without requiring that investors prove that they actually relied on the alleged misrepresentations.

What you need to do:

The Court’s decision may provide corporate defendants with a better opportunity to stop securities fraud cases before a class is certified.  Companies should consult with counsel to determine how Halliburton stands to impact any current securities fraud claims, as well as potential allegations going forward.

The Supreme Court recently held oral argument in Halliburton v. Erica P. John,with a decision expected before the end of June.  The case has attracted attention within the securities litigation bar because it has the potential to reshape the litigation landscape if the Supreme Court decides to set aside the currently accepted premise that loss causation need not be proved, and instead require proof that the investor relied on the misrepresentation at issue. 

Under the currently accepted fraud-on-the-market theory, investors do not have to show that they actually relied on alleged misrepresentations; instead, such reliance is presumed, provided a court is persuaded that the security at issue traded in an efficient market that reflected all available material information about the issuer, including material misrepresentations.  In the absence of this “Basic” presumption – so named because it was enshrined in the Court’s 1988 Basic Inc. v. Levinson decision – each allegedly defrauded investor would have to demonstrate that he or she relied on the misrepresentation.  Were the Basic presumption rejected, it is likely that more securities class actions would fail the class certification requirement that common, class-wide issues predominate over individual issues. 

While the Court could reject the Basic presumption, sending a crippling blow to the securities class action plaintiff’s bar, it is perhaps more likely that the Court will alter the Basic presumption in a manner that benefits corporate defendants.  For example, the Court may decide that plaintiffs must prove that the alleged misrepresentations moved the price of the stock before a class is certified.  Such an alteration would make event studies a routine part of the class certification process, giving corporate defendants a better shot at stopping these cases before a class is certified and the settlement pressure intensifies. 

Case Details and Background

Halliburton is a long-running case that is now before the Supreme Court for the second time.  Plaintiffs alleged that the company misled investors between 1999 and 2001 concerning its asbestos liabilities, revenue on construction contracts, and its merger in 1998 with Dresser Industries.  In its first decision on the Halliburton case, Erica P. John Fund, Inc. v. Halliburton, the Court held in June 2011 that securities fraud plaintiffs need not prove loss causation – which, like reliance, is an element of a federal securities fraud claim – in order to proceed as a class action.

This time around, the Court is being asked to answer the same question with respect to the element of reliance.  However, the unusual nature of the 1988 Basic decision – decided by a four-Justice court and premised on the Court’s embrace of the efficient market hypothesis then popular in the academic literature – coupled with recent indications that some on the Court might be interested in taking a second look at the presumption of reliance – has prompted practitioners and others to watch the case closely.

In Basic, Justice Blackmun’s decision for the Court noted that a presumption of reliance was supported by, among other things, “[r]ecent empirical studies [that had] tended to confirm Congress’ premise that the market price of shares traded on well-developed markets reflects all publicly available information and, hence, any material misrepresentations.”  Justice White concurred in part, but he dissented with respect to the application of the fraud-on-the-market theory, warning that the economic theories underpinning the presumption “may or may not prove accurate upon further consideration.”  Sure enough, since Basic, the academic literature on the efficient market theory has splintered – a fact seized upon by Halliburton and others who seek to overturn the presumption.

In the Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds decision last term, the Court held that plaintiffs need not prove the materiality of alleged misrepresentations before they could secure class certification.  In the context of their consideration of the Amgen case, several justices indicated that the academic literature since the Basic decision suggests that Basic may have rested on a faulty economic premise, and that they would be open to revisiting the precedent.  Halliburton has provided the opportunity for that second look, which is why many are eagerly awaiting the Court’s decision.