United States: Fraud-On-The-Market Lives On: "Halliburton Co. v. Erica P. John Fund, Inc."

On June 23, 2014, the U.S. Supreme Court issued its second decision in Halliburton Co. v. Erica P. John Fund, Inc., __U.S. __(2014), 2014 WL__ (U.S. June 23, 2014) ("Halliburton II"). In this widely anticipated decision, the Court reaffirmed its earlier embrace of the so-called fraud-on-the-market doctrine in Basic, Inc. v. Levinson, but held that defendants may rebut the presumption of reliance that undergirds certification of Rule 10b-5 securities class actions by showing that alleged misrepresentations did not have a material impact on the price of the stock.

This alert discusses Halliburton II's possible impact on class action suits brought under federal securities laws.

Case Background

Plaintiff-Respondent Erica P. John Fund, Inc. (the "Fund") is a not-for-profit group that supports the outreach work of the Archdiocese of Milwaukee. The Fund purchased stock in Halliburton Company and lost money when Halliburton's stock price dropped following the release of negative news regarding Halliburton's (1) potential liability in asbestos litigation, (2) revenue accounting on fixed-price construction contracts, and (3) merger with Dresser Industries. The Fund filed a lawsuit against Halliburton and its CEO David Lesar (collectively, "Halliburton") alleging that Halliburton had made knowing or severely reckless misrepresentations concerning those topics, in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The Fund sought to certify a class of plaintiffs under Federal Rule of Civil Procedure 23(b)(3), which requires that "the questions of law or fact common to class members predominate over any questions affecting only individual members," known as "predominance."

Since the parties did not dispute that the market for Halliburton common stock was "efficient," the Fund invoked the Supreme Court's decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988) ("Basic") to establish class-wide reliance. The decision in Basic sought to address the difficulties plaintiffs in securities class actions face in establishing predominance under Rule 23(b)(3) concerning alleged misrepresentations in connection with the sale of securities – that if each class member were required to establish actual reliance on defendants' alleged misrepresentations in deciding to purchase a security, the individual issues of reliance would always overwhelm issues common to all class members, defeating predominance and preventing class certification.

The Basic Court recognized a rebuttable presumption of class-wide reliance under the "fraud-on-the-market" theory. That theory was based, in part, on the efficient capital markets hypothesis, which in its simplest form, broadly assumes that in an efficient market all material information concerning a company is known to the market and incorporated immediately in the company's stock price. Thus, when an investor buys or sells stock in an efficient market, the investor presumably does so in reliance upon the integrity of the efficient market's price. Basic instructed federal courts to presume that class members relied on the public, material misrepresentations efficiently incorporated into the company-defendant's stock price, eliminating the need to prove reliance individually, and thereby permitting certification of 10b-5 class actions.

In opposing class certification, the Halliburton Defendants did not challenge the Basic presumption of reliance based on market efficiency. Instead, Halliburton argued that the Fund did not establish loss causation under the Fifth Circuit's requirement that a plaintiff prove a misstatement actually moved the market. The District Court agreed and denied class certification because the Fund did not show any stock price increase resulting from the alleged misrepresentations. On appeal, the Fifth Circuit affirmed the District Court.

In what would be its first pass at this case, the Supreme Court reversed the Fifth Circuit. Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011) ("Halliburton I"). As the Court in Halliburton I explained, the question of loss causation—i.e., whether an alleged misrepresentation actually caused investors to lose money on their securities purchases—is different from the question of reliance under Basic—i.e., whether the investor-class members can be presumed to have relied on the alleged misrepresentation in making the decision to purchase the securities. The Court held that plaintiffs are not required to prove loss causation to obtain class certification, and remanded the case to address other arguments against class certification.

On remand, the District Court certified the class and held, without analysis, that "[t]he fraud-on-the-market theory applies to this case, so proof of each individual class member's reliance is not required." Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 2012 WL 565997, at *2 (N.D. Tex. Jan. 27, 2012). The Fifth Circuit affirmed class certification and, significantly, rejected Halliburton's contention that the absence of "price impact"—an effect of a misrepresentation on stock price—could rebut the fraud-on-the-market presumption. The court relied on the Supreme Court's decision in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184 (2013), which held that since the element of materiality was established by evidence common to all plaintiffs and failure to prove materiality would cause all individual claims to succeed or fail on evidence common to the class, materiality was unnecessary to consider at the class certification stage. The Fifth Circuit similarly found that price impact was an objective inquiry that applied to everyone in the class. If Halliburton could prove the absence of price impact, all individual claims would fail because plaintiffs would be unable to establish loss causation. "[T]he focus of the 23(b)(3) class certification inquiry—predominance—is not whether the plaintiffs will fail or succeed, but whether they will fail or succeed together." Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423, 431 (5th Cir. 2013). Since price impact evidence did not bear on the question of whether common questions predominated, the Fifth Circuit affirmed class certification.

On appeal to the Supreme Court for the second time, Halliburton asked the Court two questions: (1) should the Court overrule Basic to the extent that Basic recognized a presumption of class-wide reliance derived from the fraud-on-the-market theory?; and (2) where a plaintiff invokes the Basic presumption, should a defendant be allowed to rebut the presumption and prevent class certification by introducing evidence that any alleged misrepresentations did not actually distort the stock price? The Court answered no to the first question and yes to the second.

The Decision

On the first question, the Court declined to overrule its prior holding in Basic. As to Halliburton's argument that the Basic presumption was inconsistent with Congress's intent in passing the 1934 Exchange Act, the Court noted that Justice White made "the same argument" in his dissent in Basic; the majority found it unpersuasive then, "and Halliburton has given us no new reason to endorse it now."

Turning to the substance of Halliburton's argument to overturn Basic, the Court first rejected Halliburton's argument that the efficient capital markets hypothesis supporting the Basic presumption was erroneous at adoption and had fallen out of favor with the economic and finance experts cited throughout its brief. Noting that the academic "debate is not new," the Court held that Halliburton's argument did not fundamentally address Basic "on its own terms." The Court explained that Halliburton's contentions about the invalidity of the efficient capital markets hypothesis were beside the point, because the Court in Basic did not "adopt any particular theory of how quickly and completely publicly available information is reflected in market price." Instead, the Court said, Basic stood for the more "modest" proposition that "professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices." The majority concluded that "[t]he academic debates discussed by Halliburton have not refuted the modest premise underlying the presumption of reliance."

Halliburton also argued that it was a fallacy that all investors relied on the integrity of the market, pointing out many examples of investors who purchased or sold securities for other goals or purposes. For example, a "value investor" purchases stocks on the belief that the price of the securities does not accurately reflect all public information available at the time of the purchase. But the majority retorted that Basic never denied the existence of such investors, who in any event, rely at least on the fact that market prices will incorporate public information within a reasonable period, and that market prices, however inaccurate, are not distorted by fraud. Thus, the Court appears to have adopted a "weak" version of the presumption of reliance, in which investors are not presumed to have relied on the efficiency of the market in instantaneously setting an accurate price, but on some effect from market efficiency that is less precise, determinable and measurable.

The Court also cast aside Halliburton's last argument—that stare decisis was of less import here because Basic could no longer be reconciled with the Court's more recent jurisprudence concerning securities class actions. For example, Halliburton argued that Basic expanded the Rule 10b-5 cause of action, while the Court's holding in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994) called for the rule to be more narrowly applied. The Court distinguished Halliburton from Central Bank and Stoneridge as cases that rejected attempts to broaden Rule 10b-5 liability to defendants who were not alleged to have made misstatements. "While the presumption makes it easier for plaintiffs to prove reliance, it does not alter the elements of the Rule 10b-5 cause of action and thus maintains the action's original legal scope."

The Court similarly declined to accept Halliburton's argument that the Court's holdings in Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2551 (2011), and Comcast Corp. v. Behrend, 133 S. Ct. 1426, 1432 (2013), which required plaintiffs to "actually prove—not simply plead—that their proposed class satisfies each requirement of Rule 23," could not be squared with Basic, which, as Halliburton argued, "relieves Rule 10b-5 plaintiffs of that burden." "That is not the effect of the Basic presumption," the Court retorted, observing that the Basic presumption puts the burden on plaintiffs to establish the prerequisites for invoking the presumption — "namely, publicity, materiality, market efficiency, and market timing."

The Court also declined to accept Halliburton's invitation to modify the prerequisites for invoking the presumption by requiring class-action plaintiffs to prove "price impact" directly at the class certification stage. The Basic presumption itself includes two "constituent presumptions": (1) if the plaintiff can show a public, material misrepresentation concerning a defendant company whose stock trades in an efficient market, the court presumes that the misrepresentation affected the stock price; and (2) if the plaintiff purchased the stock during the relevant period, the court presumes that the plaintiff made that purchase in reliance on the misrepresentation. Accepting Halliburton's position that plaintiffs should be required to show price impact affirmatively would "take away the first constituent presumption."

On the other hand, the Court did agree with Halliburton that defendants must be given the opportunity prior to certification of a class to show evidence of a lack of price impact. What the Fund argued, and the Fifth Circuit held, was that defendants could not rely on this price-impact evidence "prior to class certification for the particular purpose of rebutting the presumption altogether." This restriction, the Court held, "makes no sense, and can readily lead to bizarre results." As the Court explained, Basic allows plaintiffs to establish price impact "indirectly" by showing that a defendant's public, material misrepresentations were made in an efficient market. "But an indirect proxy should not preclude consideration of a defendant's direct, more salient evidence showing that an alleged misrepresentation did not actually affect the stock's price and, consequently, that the Basic presumption does not apply," and "there is no reason to artificially limit the inquiry at that stage by excluding direct evidence of price impact."

Justice Clarence Thomas wrote an opinion concurring in the judgment, in which he was joined by Justices Scalia and Alito. These justices called for Basic to be overruled because "economic realities . . . [had] undermined the foundations of the Basic presumption, and stare decisis cannot prop up the façade that remains." Façade or not, after today's decision, the fraud-on-the-market theory remains alive and well, the growing chorus of voices to overrule it have been squelched, and securities fraud class actions will continue largely as they have for more than twenty-five years. Defense attorneys have acquired another procedural tool in their arsenal to defeat such cases by showing a lack of price impact at the certification stage. Like other developments in securities law over the last twenty years, today's decision in Halliburton can be expected to reduce the percentage of securities fraud cases that survive motion practice. Halliburton should also dampen the enthusiasm that plaintiff's lawyers might have for filing otherwise weak claims where there is no significant price effect at the time that alleged false statements are made.

As with the numerous other limitations on securities class actions that have accrued since Justice Thomas's seminal decision in Central Bank of Denver in 1994, in the near term, corporations may expect to see a marginal decrease in the number of filings, a marginal decrease in the number of classes certified, and although probably not capable of measurement, a marginal decrease in the settlement value of 10b-5 class actions generally. These effects might become more pronounced over time if defendants achieve significant success in disproving price impacts from alleged misrepresentations and developing case law is friendly to such proof. Finally, Halliburton II would seem to be most influential in cases where plaintiffs allege that defendants' misrepresentations effectively reassured investors that business was continuing on trend while concealing significant changes from market expectations; because the expected effect of such misrepresentations would be to prevent the market price from declining in response to new public material information, such cases would seem more susceptible to rebuttal by showing a lack of price impact.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Events from this Firm
26 Sep 2018, Seminar, Tokyo, Japan

Orrick’s Global Japan Practice is hosting a series of “Orrick Library” seminars to explore legal issues in various fields in Japan as well as the United States, Asia and Europe

26 Sep 2018, Conference, New York, United States

Employment Partner, Mandy Perry and Chair of Orrick's Global Employment Law Practice, Mike Delikat will be participating in the Global Business Protections 2018: International Restrictive Covenants and Confidential Information Conference.

10 Oct 2018, Conference, Florida, United States
Julie Totten is Program Chair of this year’s conference, Lynne Hermle is speaking on women in the courtroom, boardroom, and c-suite, and Erin Connell is speaking on pay equity and pay transparency.

Similar Articles
Relevancy Powered by MondaqAI
Schnader Harrison Segal & Lewis LLP
Akin Gump Strauss Hauer & Feld LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Schnader Harrison Segal & Lewis LLP
Akin Gump Strauss Hauer & Feld LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions