How the Supreme Court’s Upcoming Halliburton Decision on the Fraud-on-the-Market Presumption May Impact Securities Litigation
In June, the United States Supreme Court will decide whether the fraud-on-the-market presumption should be overruled or modified. For the last quarter century, securities plaintiffs have relied on this presumption to successfully prosecute securities class actions that have resulted in substantial recoveries against publicly traded companies and the D&O insurance industry. In fact, class certification was denied based on the merits in less than 2% of securities actions filed between 2002 and 2010. Cornerstone Research & Stanford Law School Securities Class Action Clearinghouse, Securities Class Action Filings: 2013 Year in Review, 2014, at 9. The consensus of industry experts is that a decision from the Supreme Court overruling or substantially modifying the fraud-on-the-market presumption will stand as a major impediment to the ability of securities plaintiffs’ firms to continue to achieve these results. However, this impediment will not leave plaintiffs’ firms dead in the water. To the contrary, as they have done in the past with previous securities law reforms, the plaintiffs’ bar will likely adjust in a meaningful way.
A Background on the Fraud-on-the-Market Presumption
In order for securities plaintiffs to obtain class certification, they must satisfy Rule 23 of the Federal Rules of Civil Procedure. Among other things, Rule 23 requires that the questions of law or fact common to class members predominate over any questions affecting only individual members. Fed. R. Civ. P. 23(b)(3). This requirement becomes more of an issue in the context of satisfying the reliance element of a Rule 10b-5 claim. The predominance issue generally depends on whether the fraud-on-the-market presumption is available to securities plaintiffs. Without this presumption, plaintiffs’ counsel would be required to demonstrate that each member of the putative class actually considered and believed the misrepresentation. Given that most investors are not aware of statements made by the companies whose stock they purchased and because the existence of thousands or tens of thousands of class members, this process would be unduly burdensome.
The Supreme Court endorsed the fraud-on-the-market presumption in Basic v. Levinson, 485 U.S. 224 (1988). The Court recognized that requiring a Rule 10b-5 plaintiff to show how he would have acted in the absence of the misrepresentation would create an “unnecessarily unrealistic evidentiary burden.” Id. at 245. Accordingly, the Court permitted the use of a rebuttable presumption of reliance based on the fraud-on-the-market theory. The fraud-on-the-market theory is based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business, and misleading statements will therefore defraud stock purchasers even if investors do not directly rely on the misstatements. Id. at 241-42. According to Basic, an investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price, and because all publicly available information is reflected in the market price, an investor’s reliance on any public material misrepresentations may be presumed for purposes of a Rule 10b-5 action. Id. at 247. As this is only a presumption of reliance, the Court explained that any showing severing the link between the alleged misrepresentation and either the stock price or the investor’s decision to trade would be sufficient to rebut the presumption. Id. at 248.
Therefore, Basic has provided a framework for securities plaintiffs to avoid having to prove that each individual investor relied on the alleged misrepresentations, provided that the stock traded in an efficient market where the price reflected all publicly available information. While the fraud-on-market presumption is still subject to challenge after class certification during the summary judgment and trial phases, most securities class actions settle even before class certification is tested on the merits, often during the pleadings stage or soon after the plaintiffs’ claims survive the pleading stage. In fact, with respect to all securities class actions filed and resolved between 2000 and 2013, 73% were either settled or dismissed prior to the filing of a motion for class certification, and a decision on a class certification motion was reached in only 15% of all securities actions filed during this time. Dr. Renzo Comolli & Svetlana Starykh,
Recent Trends in Securities Class Action Litigation: 2013 Full-Year Review, NERA EconomicConsulting, Jan. 21, 2014, at 19. Thus challenging the presumption after class certification has had little to no effect on securities class action litigation.
In recent years, two other U.S. Supreme Court decisions addressed the fraud-on-the-market presumption. First, in Erica P. John Funds, Inc. v. Halliburton Co. (a previous Supreme Court decision in the same Halliburton lawsuit), the Court unanimously held that the plaintiff was not required to prove loss causation at the certification stage. 131 S. Ct. 2179, 2187 (2011). Then, in
Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, while the Court acknowledgedthat materiality is indisputably an essential predicate of the fraud-on-the-market theory, it concluded that proof of materiality is not needed to ensure that the questions of law or fact common to the class will predominate over any questions affecting only individual members for purposes of certifying a class. 133 S. Ct. 1184, 1195 (2013). The Court in Amgen also held that rebuttal evidence on the issue of materiality would not undermine the predominance of questions common to the class, and therefore such rebuttable evidence should be reserved for summary judgment or trial. Id. at 1203-04. Notably, the concurring and dissenting opinions in Amgen expressed reservations regarding the fraud-on-the-market theory and questioned the validity of
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