Later this year, the the U.S. Supreme Court will begin hearing arguments in Halliburton Co. v. Erica P. John Fund, Inc., a case that has enormous potential implications for securities class actions. Arguably one of the most important securities cases of the last twenty years, Halliburton concerns the fraud-on-the-market presumption of reliance that applies in class actions under section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
Courts have held that Rule 10b-5 provides a private right of action that allows investors to recover damages in cases of securities fraud. To be entitled for damages, investors must demonstrate: (i) a material misrepresentation or omission by the defendant; (ii) scienter; (iii) a connection between the misrepresentation or omission and the purchase or sale of a security; (iv) reliance upon the misrepresentation or omission; (v) economic loss; and (vi) loss causation.
In Basic Inc. v. Levinson (1988), the U.S. Supreme Court stated that the reliance requirement placed "an unnecessarily unrealistic evidentiary burden" on plaintiffs who traded on an impersonal market. To alleviate this concern, the Court endorsed the "fraud-on-the-market" theory, pursuant to which plaintiffs benefit from a rebuttable presumption of reliance on material misrepresentations made to the public. The endorsement of the fraud-on-the-market presumption spurred the development of securities class actions in the U.S.
The fraud-on-the-market presumption rests on the assumption that, in an efficient market, the price of shares reflects all publicly available information. Thus, a material misrepresentation is reflected quickly in the price of a share. Further, investors rely on share price as an expression of the share's value in light of all public information.
In Halliburton, the U.S. Supreme Court will rule on the questions as to whether it "should overrule of substantially modify the holding of Basic Inc. v. Levinson [...] to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory". The upcoming decision is even more anticipated in light of Amgen Inc. v. Connecticut Retirement Plans, decided in early 2013 and in which members of the Supreme Court expressed reservations toward the fraud-on-the-market theory.
The outcome of Halliburton is of significant interest for Canadian companies that are exposed to Rule 10b-5 liability in the U.S. The revision of the fraud-on-the-market theory is also relevant for Canadian law. Canadian securities legislation exempts plaintiffs from the need to prove reliance in cases of secondary market misrepresentations. However, at common law and civil law, it remains unclear as to whether there exists a fraud-on-the-market presumption of reliance. Thus, the decision in Halliburton could influence Canadian case law on the existence of a presumption of reliance.
This is the third in a series of five posts intended to consider securities regulatory developments to watch in 2014. Watch for the remaining posts over the course of the next week.
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