This morning the Supreme Court released its highly-anticipated decision in Hallburton Co. v. Erica P. John Fund, Inc. As we (and, to be fair, others) predicted after the oral argument, the Court did not have the appetite to overturn Basic Inc. v. Levinson (though Justices Thomas, Scalia and Alito were apparently a bit hungrier and explained in a concurring opinion that they would have totally overturned Basic). The Court, as predicted, found a middle ground.
For the uninitiated, Basic’s fraud-on-the-market doctrine has been a critical aspect of securities class actions for the past 25 years. It acts as a substitute for the reliance element of a securities fraud claim and allows plaintiffs to get past the critical class certification stage without showing that any member of the class actually relied on any allegedly false statements. The fraud-on-the-market doctrine was considered an adequate proxy for reliance, in large part, because of the “efficient market hypothesis,” an economic doctrine that was in vogue way back when Basic was decided in 1988—like synth-pop music and Michael Dukakis. The efficient market hypothesis posits that financial markets rapidly take all publicly available information into account, and the price of a security, therefore, has all material information baked into it. So, according to the fraud-on-the-market doctrine, the buyer of a security is presumed to have relied on a particular public misrepresentation because the import of that misrepresentation was already reflected in the stock price at the time of the purchase.
In today’s opinion, written by the Chief Justice, the Court found that there was no “special justification” for overturning Basic. The Court also passed on requiring plaintiffs to demonstrate “price impact” at the class certification stage, i.e., place the burden on the plaintiffs to show that the alleged misrepresentation actually affected the stock price. Instead, the Court chose what was behind curtain number three, allowing defendants to put forth evidence at the class certification stage to rebut the presumption of reliance. This certainly makes sense. As the Court put it:
Suppose a defendant at the certification stage submits an event study looking at the impact on the price of its stock from six discrete events, in an effort to refute the plaintiffs’ claim of general market efficiency. All agree the defendant may do this. Suppose one of the six events is the specific misrepresentation asserted by the plaintiffs. All agree that this too is perfectly acceptable. Now suppose the district court determines that, despite the defendant’s study, the plaintiff has carried its burden to prove market efficiency, but that the evidence shows no price impact with respect to the specific misrepresentation challenged in the suit. The evidence at the certification stage thus shows an efficient market, on which the alleged misrepresentation had no price impact. And yet under EPJ Fund’s view, the plaintiffs’ action should be certified and proceed as a class action (with all that entails), even though the fraud-on-the-market theory does not apply and common reliance thus cannot be presumed.
Such a result is inconsistent with Basic’s own logic. Under Basic’s fraud-on-the-market theory, market efficiency and the other prerequisites for invoking the presumption constitute an indirect way of showing price impact. . . . But an indirect proxy should not preclude direct evidence when such evidence is available. As we explained in Basic, “[a]ny showing that severs the link between the alleged misrepresentation and . . . the price received (or paid) by the plaintiff . . . will be sufficient to rebut the presumption of reliance” because “the basis for finding that the fraud had been transmitted through market price would be gone.”
Make no mistake about it, Halliburton will have an impact on securities class actions and will certainly create more action at the class certification stage. But the case is in no way a death knell to securities class actions. Both plaintiffs and defendants in these cases are used to getting event studies done at early stages of a case, and they will now need to prepare their experts to do battle on price impact at class certification. Presumably some attacks on price impact will be successful, leading to fewer class actions being certified, and then a raft of appeals on nuances of rebuttable presumptions.
We certainly cannot wait, and we thought it was going to be a dull summer!