By S. Douglas Bunch
Associate, Cohen Milstein
On June 23, 2014, the U.S. Supreme Court issued its decision in Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”). In rejecting Halliburton’s attempt to radically restrict the rights of investors, the Supreme Court affirmed the principles it announced over a quarter century ago in Basic v. Levinson, a decision that ensures investors have the opportunity to prove their claims—and those of other investors—in a class action.
Halliburton II had generated much anticipation and commentary due to its potential to threaten the continued viability of the fraud-on-the-market presumption of reliance recognized by the Court in Basic v. Levinson, 485 U.S. 224 (1988). Under the fraud-on-the-market presumption, publicly available information is assumed to be reflected in the market price of a stock, and, in turn, investors can be presumed to have relied on the information because their purchasing and sales decisions account for the price of the security. This eases the burden on investors, who need not show reliance on a defendant’s misrepresentations when bringing suits for securities fraud.
The presumption is crucial in class actions. Justice Thomas, joined by Justices Scalia and Alito, wrote an acrimonious concurrence to the Court’s opinion, in which he argued that Basic should have been overruled because “[l]ogic, economic realities, and our subsequent jurisprudence have undermined the foundations of the Basic presumption, and stare decisis cannot prop up the façade that remains.” Had Justice Thomas’s viewpoint prevailed, it might have meant the end of securities fraud class actions altogether, because without the Basic presumption, each individual investor in the class would have needed to demonstrate that he or she directly relied on the alleged misstatements when deciding to purchase or sell stock, making class certification in securities fraud cases nearly impossible.
However, in an important victory for investors, the Supreme Court in Halliburton II declined to overrule Basic and instead reaffirmed the principles underlying that decision. The Court rejected the arguments advanced by Halliburton that the fraud-on-the-market presumption is inconsistent with congressional intent, that the presumption is no longer justified by economic theory, and that the presumption is undermined by the notion that some investors do not rely on the integrity of the stock’s market price.
The Court also squarely rejected Halliburton’s policy arguments contending that Basic should have been overturned because of the supposed “harmful consequences” of securities class actions. The Court properly noted that the forum for addressing such concerns is Congress, not the courts. This portion of the Court’s ruling will hopefully put an end to the repeated and baseless anti-investor policy arguments raised by defendants during litigation in an attempt to curtail investor rights.
The Court did adopt one of Halliburton’s proposed alternatives to overruling Basic: defendants will now be allowed to attempt to rebut the presumption of reliance at the class certification stage by trying to present evidence that the misrepresentations did not affect the stock price. Defendants were already permitted to introduce such “price impact” evidence at the class certification stage to rebut a plaintiff’s showing that the stock at issue traded in an efficient market, and could even introduce such evidence, at the merits stage, to defeat the presumption of reliance itself. All the Supreme Court’s ruling in Halliburton II means is that defendants may now attack the presumption of reliance earlier, by submitting such evidence at class certification.
This changes very little. In fact, the Second and Third Circuit already allowed defendants to do just this. See, e.g., In re Salomon Analyst Metromedia Litig., 544 F.3d 474, 484 (2d Cir. 2008); In re DVI, Inc. Sec. Litig., 639 F.3d 623, 638 (3d Cir. 2011). The fact that the Supreme Court essentially just adopted the precedent of these Circuits should prevent defendants from attempting to make new arguments based on Halliburton II in those courts, and also defeat misleading arguments about the opinion’s meaning, like the fallacious notion that plaintiffs must now show a price increase to demonstrate price impact.
Affirming the continued vitality of Basic and the efficient market theory that underpins Basic is a significant victory for investors. The procedural guidelines imposed by the Court keep the burden on defendants to attempt to rebut the presumption of reliance with evidence that the alleged misrepresentation did not impact the price of a defendant’s stock. The ruling should not unduly restrict the rights of investors, and the conduct of securities class actions should not substantially change in the wake of the decision. Indeed, in her own concurrence, joined by Justices Breyer and Sotomayor, Justice Ginsburg made it clear that because the burden for demonstrating lack of price impact continues to rest solely on defendants, the Court’s ruling “should impose no heavy toll on securities-fraud plaintiffs with tenable claims.”
S. Douglas Bunch is a member of the Securities Fraud/Investor Protection practice group at Cohen Milstein. He is currently litigating multiple securities class actions.