United States: Supreme Court Preserves "Fraud-On-The-Market" And Validates Use Of "Price Impact" Defense Against Class Certification In Securities Class Actions

Last Updated: July 7 2014
Article by Shearman & Sterling LLP

In its long-awaited decision in Halliburton Co. v. Erica P. John Fund, Inc. ("Halliburton II"), the US Supreme Court upheld the validity of the fraud-on-the-market presumption set forth in Basic Inc. v. Levinson, 485 US 224 (1988), while clarifying that a defendant in a securities fraud class action must be permitted to rebut Basic's presumption of reliance at the class certification stage with evidence that alleged misrepresentations had no price impact at the time of investment. This ruling confirms the existence of an important defense against class certification in federal securities fraud class actions and raises significant new questions for consideration by the lower courts.

A. Background

Plaintiff Erica P. John Fund, Inc. (the "EPJ Fund") brought a putative class action against Halliburton Company and its CEO David Lesar (together, "Halliburton") alleging that Halliburton violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 by making misrepresentations in Halliburton's SEC filings between June 1999 and December 2001. The EPJ Fund's attempts to bring a viable suit and certify a class based on the fraud-on-the-market presumption have resulted in more than a decade of litigation and two significant Supreme Court decisions, including Halliburton II, which was issued on June 23, 2014.

The fraud-on-the market presumption was adopted by the Supreme Court in its landmark opinion in Basic. It established that plaintiffs may satisfy the reliance element of a claim under Rule 10b-5 without showing that they were actually aware of alleged misrepresentations if they can establish "(1) that the alleged misrepresentations were publicly known, (2) that they were material, (3) that the stock traded in an efficient market, and (4) that the plaintiff traded the stock between the time the misrepresentations were made and when the truth was revealed."1 The presumption, which is based on the efficient capital markets hypothesis (which, in simple terms, theorizes that the price of actively traded public securities will reflect all material public information), assumes that (a) material public information in an efficient market is reflected in a security's price, and (b) investors therefore necessarily rely on all such information when they purchase or sell securities in an efficient market.2 The presumption is a key element in modern securities class action practice. Without it, plaintiffs would not be able to meet the predominance requirement of Federal Rule of Civil Procedure 23(b)(3), because individual questions—concerning which members of a purported class actually relied on which misrepresentations (and whether they did so reasonably)—would predominate over common questions and thereby preclude class certification.

In 2011, the Supreme Court reversed a prior decision of the US Court of Appeals for the Fifth Circuit in the Halliburton case by holding that plaintiffs need not establish loss causation (i.e., that the revelation of the "truth" actually caused an economic loss) to satisfy the fraud-on-the market presumption at the class certification stage because, the Court held, the presence or absence of loss causation is a merits issue that does not, in and of itself, implicate Rule 23 predominance issues.3 The Court remanded the case for further proceedings and, in 2012, the US District Court for the Northern District of Texas granted the EPJ Fund's motion for class certification, notwithstanding Halliburton's argument that it had rebutted the presumption of reliance with direct evidence that the alleged misrepresentations had not actually affected Halliburton's stock price. In the District Court's view, Halliburton could not use "price impact" evidence at the class certification stage to rebut the presumption of reliance because such evidence, like evidence of loss causation, has no bearing on whether common issues predominated under Rule 23(b)(3).4 In 2013, the Fifth Circuit affirmed that decision, relying heavily on Halliburton I and the US Supreme Court's intervening 2013 decision in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds—which held that plaintiffs need not prove the materiality of the alleged misstatements to invoke Basic's presumption of reliance at class certification.5 Failure to prove materiality, according to the Amgen decision, did not mean individualized issues regarding materiality would predominate; rather, it meant the class as a whole could not recover at all.6

In light of the Fifth Circuit's ruling, Halliburton petitioned the Supreme Court to address two legal questions: (1) "Whether th[e] [Supreme] Court should overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 US 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory" and (2) "Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock."7 On November 15, 2013, the Supreme Court granted Halliburton's certiorari petition.8

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1 Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317, 573 US ___, 2014 WL 2807181, at *7 (June 23, 2014) ("Halliburton II") (citing Basic Inc. v. Levinson, 485 US 224, 248, n.27 (1998)).

2 Halliburton II, 2014 WL 2807181, at *14.

3 Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179, 2183, 2186 (2011) ("Halliburton I").

4 See Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., No. 3:02–CV–1152–M, 2012 WL 565997, at *2 (N.D. Tex. Jan. 27, 2012).

5 Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423, 435 (5th Cir. 2013) ("The Amgen Court's analysis leads to the conclusion that price impact fraud-on-the-market rebuttal evidence should not be considered at class certification.").

6 Amgen Inc. v. Conn. Ret. Plans and Trust Funds, 133 S. Ct. 1184, 1191 (2013).

7 Petition for a Writ of Certiorari, Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317, 2013 WL 4855972, at *i (Sept. 9, 2013).

8 Halliburton Co. v. Erica P. John Fund, No. 13-317, 2013 WL 4858670, at *1 (US Nov. 15, 2013).

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