Twenty-six years ago, in Basic Inc. v. Levinson, the Supreme Court made it possible for investors to form class actions to sue corporations for securities fraud. Typically, to succeed on a claim of securities fraud, plaintiffs must prove that they relied on a fraudulent misrepresentation when they invested in certain securities. However, the Supreme Court recognized in Basic that this poses a nearly insurmountable task for investors who buy securities on an open exchange, and is particularly unfair when applied to shareholder class actions. Using pragmatic logic, the Court explained that requiring each individual investor to prove actual reliance “would place an unnecessarily unrealistic evidentiary burden on the [securities fraud] plaintiff who has traded on an impersonal market,” and would effectively serve as a “barrier to class certification, since each of the individual investors would have to prove reliance on the alleged misrepresentation.”
To avoid this absurd result, the Court in Basic recognized a rebuttable presumption of reliance based on the “fraud-on-the-market” theory. This doctrine presumes that a stock’s market price “reflects all publicly available information,” including any “public material misrepresentations.” Consequently, when an investor purchases stock at the market price, she presumptively relies on the integrity of that price as influenced by the alleged misrepresentation. Defendant corporations can rebut this presumption by showing either that the stock price never in fact incorporated the misrepresentation, or that the plaintiffs were aware of the misrepresentation when purchasing the stock. Importantly, the fraud-on-the-market presumption can be invoked collectively by putative class members to show reliance when seeking class certification.
The Court’s decision in Basic set the “foundation for modern, private securities litigation,” and the fraud-on-the-market doctrine has been a critical mechanism for allowing shareholders to sue big businesses for fraud through class action lawsuits. Moreover, Congress has since reformed securities litigation on multiple occasions without abandoning or modifying the presumption.
In Halliburton, the fraud-on-the-market theory serves as the basis for an investor class action against that company. The lead plaintiff, the Erica P. John Fund, Inc. (“EJP Fund”), supports the Archdiocese of Milwaukee’s programs for inner city youth and the mentally ill. The EJP Fund filed suit against Halliburton and its president and CEO on behalf of a class of investors, alleging, among other things, that the company knowingly understated its liability for claims from asbestos victims, resulting in investor losses.
However, Halliburton is asking the Court to do away with the time-honored precedent established in Basic and, with it, any realistic possibility that shareholders can hold their executives accountable for harmful fraudulent conduct.
You can learn more about the significance of the Halliburton case by reading Alliance for Justice’s report, Halliburton at the Supreme Court, and checking out AFJ Justice Programs Director Michelle Schwartz’s blog post about the Supreme Court argument in the case, This Isn’t Monopoly Money.