July 7, 2014
This Article was written by Mark H. Moore, a Partner in the Firm
The Supreme Court, in its recent decision, Halliburton Co. v. Erica P. John Fund, Inc., ___ U.S. __, 2014 WL 2807181 (June 23, 2014), declined petitioner Halliburton’s invitation to put a quick end to class action lawsuits for investors seeking redress for securities fraud. However, the Court, in a decision authored by Chief Justice John Roberts, raised a new barrier to certifying classes of investors in such cases.
In federal securities fraud cases brought under Section 10(b) of the Securities Exchange Act of 1934, investors must establish that they relied upon a defendant’s misrepresentation in deciding whether to buy or sell a security. Of course, such reliance is difficult to prove when an investor trades in an impersonal market and has no direct knowledge of the misrepresentation. In Basic Inc. v. Levinson, 485 U.S. 224 (1988), the Supreme Court dealt with this issue by holding that investors bringing a class action lawsuit could satisfy the element of reliance by use of a presumption that the price of stock traded in an “efficient market” reflects all public, material information—including material misrepresentations.
Under the “efficient market theory,” when a capital market trades securities efficiently (including access to all publicly available material information about securities), then that market effectively absorbs such information and reflects such information in the prices of traded securities. Thus, a material misrepresentation would be absorbed into the price of the traded security, whether or not the masses of individual investors were aware of the misrepresentation. The presumption established by the Court in Basic permits an investor, who may not have been aware of the misrepresentation at issue at the time of the trade, to presume on the integrity of the marketplace in order to prove the element of reliance. Under Basic, however, a defendant could rebut this presumption by showing that the alleged misrepresentation did not actually affect the stock price—that is, that it had no “price impact.”
There has been a great deal of academic resistance to the “efficient market” theory since the Basic decision. In Haliburton, the defendant cited to studies which purport to show that public information is “often not incorporated immediately (much less rationally) into market price.” On the basis of such studies, Haliburton urged that the Court drop the presumption of reliance by individual investors altogether—a position which would have sounded the death knell of securities class action litigation.
Justice Roberts, writing for the majority, rejected this radical change. He cited Basic for the proposition that requiring direct proof of reliance from every individual plaintiff “would place an unnecessarily unrealistic evidentiary burden” on the plaintiff who has traded on an “impersonal market,” and effectively would prevent plaintiffs from proceeding with a class action in securities fraud suits. Even where academic research may tend to demonstrate that markets are somewhat imperfect, to Justice Roberts, the “efficient market” theory is persuasive enough to justify the continued use of the reliance presumption. The presumption, he said, is based on the “fairly modest premise that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.”
Justice Roberts did make the process of gaining class certification more demanding for plaintiffs. Before the Haliburton decision, defendants could not challenge the “price impact” of the misrepresentation during the class certification stage, by showing with direct evidence that an alleged misrepresentation did not actually affect the stock’s price. Such evidence could only be presented during the merits stage of the litigation. Now, under Haliburton, defendants will be permitted to introduce such evidence to attempt to defeat class certification.
This article is intended only as a general discussion of these issues. It is not considered to be legal advice or relied upon. We would be pleased to consider providing additional details or advice about specific situations. For additional information on this topic, please feel free to contact Mark Moore who regularly counsels and litigates for clients in connection with securities litigation and other business disputes.