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Supreme Court Declines to Overrule or Modify Basic, But Allows Rebuttal of "Price Impact" in Opposing Class Certification
June 24, 2014 download PDF
In Halliburton Co. v. Erica P. John Fund,
Inc., No. 13-317, the Supreme Court declined either to
eliminate the fraud-on-the-market presumption established by
Basic Inc. v. Levinson, 485 U.S. 224 (1988), or
to modify Basic to require a plaintiff to prove that a
defendant's misrepresentation affected the stock price (a showing
known as "price impact") in order to invoke the
presumption.[1] However, the Supreme Court clarified that
Basic affords a defendant the opportunity to defeat the
presumption at the class certification stage by introducing
evidence of the absence of price impact. Although defendants
will now have an opportunity to present economic defenses before
being faced with the settlement pressures that they would face upon
the certification of a class, it remains to be seen what lower
courts will require to disprove price impact.
The Fraud-on-the-Market Presumption
The fraud-on-the-market theory has been a primary enabler of class
action securities litigation under Section 10(b) of the Securities
Exchange Act of 1934. One of the elements of a private right
of action under Section 10(b) is that the plaintiff relied on the
alleged misrepresentation in deciding whether to purchase or sell a
security. Each putative class member's reliance would
ordinarily require highly individualized proof, rendering class
treatment unavailable. The fraud-on-the-market theory solves
this problem for securities plaintiffs by creating a presumption of
reliance if certain conditions are met.
First recognized by a four-justice majority in Basic Inc.
v. Levinson, 485 U.S. 224 (1988), the fraud-on-the-market
theory posits that if a company's security trades in an efficient
market, a materially misleading statement by the company affects
the security's price, thus affecting any person buying or selling
the security. Therefore, under the theory, a purchaser or
seller presumptively relies on any allegedly materially misleading
statement by the company when it pays or receives the market
price. Class members can thus plead reliance without regard
to their individual awareness of the misleading statement.
Cases against exchange-traded companies that could otherwise be
brought only individually - an economically viable option only for
the largest investors - can thus readily proceed as class
actions.
The holding in Basic has come under heavy attack in
recent years, charged with weak legal and economic
underpinnings. Last year, four justices expressed their
willingness to reconsider that decision in Amgen Inc. v.
Connecticut Retirement Plans & Trust Funds, 133 S. Ct.
1184 (2013). The Court granted certiorari in
Halliburton for just that purpose. The pendency of
the case was a cause célèbre in the securities bar,
eliciting nearly two dozen amicus briefs, leading litigants in
lower court cases to seek discovery or trial delays, altering
settlement negotiations, and dominating legal panel
discussions. Amici supporting Basic urged that
substantially modifying its rule "would essentially close the
courthouse doors to victims of securities fraud . . . ."
The Halliburton Case
This is the second time that the Halliburton case has
come before the Supreme Court. In 2002, Erica P. John Fund
Inc. ("EPJ Fund") moved to certify a class of purchasers of
Halliburton common stock. The District Court for the Northern
District of Texas found that the proposed plaintiff class met the
threshold requirements of Federal Rule of Civil Procedure 23(a),
but denied the motion for class certification because EPJ Fund had
failed to prove loss causation, or that any of Halliburton's
alleged misrepresentations had caused the claimed economic
losses. The requirement that plaintiffs in putative
securities fraud class actions prove loss causation in order to
obtain class certification was a unique prerequisite imposed by
courts in the Fifth Circuit. The Court of Appeals for the
Fifth Circuit affirmed the district court's denial of
certification, and the Supreme Court granted EPJ Fund's petition
for a writ of certiorari.
On June 6, 2011, in a 9-0 decision, the Supreme Court vacated the
Fifth Circuit's ruling and remanded for proceedings consistent with
its narrow holding that securities fraud plaintiffs need not prove
loss causation in order to invoke Basic's presumption of reliance
and prevail on a motion for class certification. Erica P.
John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179
(2011).
On remand, Halliburton opposed class certification on the ground
that the evidence it had previously introduced to disprove loss
causation also proved that the alleged misrepresentations did not
affect its stock price, and thus rebutted the Basic
presumption. But the district court rejected that argument
and certified the class. The Fifth Circuit affirmed on that
ground and clarified that Halliburton could rely on evidence of the
absence of price impact only at the merits stage of the litigation,
and not before, because such evidence does not bear on the question
of common issue predominance under Rule 23(b)(3).
The Supreme Court again granted certiorari, this time to resolve
the split among the Circuits as to whether securities fraud
defendants may rebut the Basic presumption with evidence
of a lack of price impact at the class certification stage.
It also agreed to reconsider the validity of the Basic
presumption of class-wide reliance.
The Halliburton Decision
In an opinion by Chief Justice Roberts, joined by
Justices Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan, the Court
vacated the Fifth Circuit's class certification order on the
narrowest of the three grounds argued by Halliburton.
First, the Court rejected the invitation by Halliburton
and its amici to overrule Basic outright, finding that there was no
"special justification" for doing so. (Op. at 4-16.)
The Court found that Congress's explicit requirement of reliance in
Section 18(a) of the Exchange Act was not a special justification
because that same argument had been presented to the Basic
Court. (Id. at 7-8.) The Court also rejected
the argument that advances in economic scholarship have discredited
Basic's underlying premises. The Court found that Basic did
not rely on a "robust" efficient capital markets hypothesis or on
the assumption that all investors rely on price integrity, but
rather on the more "modest premise" that markets are "generally"
efficient and the presumption that "most" investors rely on price
integrity. (Id. at 8-12.)
The Court also found that the Basic presumption was a
"substantive doctrine of federal securities-fraud law" entitled to
the heightened level of stare decisis applicable to statutory
interpretation cases. (Id. at 12-16.) The
Court rejected Halliburton's argument that Basic was
inconsistent with the line of cases calling for a narrow
construction of the Section 10(b) implied right of action
(id. at 13-14), and with recent decisions under Federal
Rule of Civil Procedure 23 holding that the requirements of class
certification must be proven, not pleaded (id. at
14-15). And the Court found that the arguments about the
"serious and harmful consequences" of securities class actions were
"more appropriately addressed to Congress," which has demonstrated
a willingness to consider such concerns in the Private Securities
Litigation Reform Act of 1995 and the Securities Litigation Uniform
Standards Act of 1998. (Id. at 15-16.)
Second, the Court rejected Halliburton's first
alternative argument that Basic should be modified to
require plaintiffs to prove price impact in order to invoke the
presumption of reliance. (Id. at 16-18.) The
Court found that this alternative, "[f]ar from [being] a modest
refinement of the Basic presumption, . . . would radically alter
the required showing for the reliance element of the Rule 10b-5
cause of action." (Id. at 17.) Such an
alternative would deprive plaintiffs of the first of
Basic's "two constituent presumptions": (i) the
presumption that a public, material misrepresentation in a
generally efficient market affects the stock price; and (ii) the
presumption that a plaintiff who purchases at the market price
during the relevant period purchased in reliance upon the
misrepresentation. (Id. at 17-18.) For the
same reasons that the Court declined to "completely jettison the
Basic presumption," it declined to "effectively jettison half of it
by revising the prerequisites for invoking it." (Id.
at 18.)
Third, the Court accepted Halliburton's second
alternative argument that "defendants should at least be allowed to
defeat the presumption at the class certification stage through
evidence that the misrepresentation did not in fact affect the
stock price." (Id. at 18-23.) It was common
ground that defendants could present such evidence at trial, on a
motion for summary judgment, or in opposition to a motion for class
certification as evidence that the market in question is not
efficient. (Id. at 18-19.) Importantly,
Halliburton holds that defendants also may introduce, at
the class certification stage, evidence of a lack of price impact
as to the specific alleged misrepresentations, rather than
confining price impact evidence to the question of whether the
relevant market is generally efficient.
As the Court explained: "Price impact is . . . an essential
precondition for any Rule 10b-5 class action. While
Basic allows plaintiffs to establish that precondition
indirectly, it does not require courts to ignore a defendant's
direct, more salient evidence showing that the alleged
misrepresentation did not actually affect the stock's market price
and, consequently, that the Basic presumption does not
apply." (Id. at 21.) "[T]o maintain the
consistency of the [Basic fraud-on-the-market] presumption
with the class certification requirements of Federal Rule of Civil
Procedure 23, defendants must be afforded an opportunity before
class certification to defeat the presumption through evidence that
an alleged misrepresentation did not actually affect the market
price of the stock." (Id. at 23.)
In a brief concurrence, Justice Ginsburg, joined by Justices
Breyer and Sotomayor, noted that the majority's opinion, because it
placed the burden of disproving price impact on defendants, "should
impose no heavy toll on securities-fraud plaintiffs with tenable
claims." (Ginsburg Concurrence at 1.)
In a more lengthy opinion concurring in the judgment, Justice
Thomas, joined by Justices Scalia and Alito, argued that
Basic should be overruled because "[l]ogic, economic
realities, and our subsequent jurisprudence have undermined the
foundations of the Basic presumption." (Thomas Concurrence at
2.)
Implications
With only three justices voting to overrule Basic, and with the
six-justice majority also declining to modify Basic to
require the plaintiff to carry the burden of proving price impact
at the class certification stage, it is clear that - barring
congressional legislation or a change in the composition of the
Court - securities class actions are here to stay. In
securities cases, the Court is likely to continue to move
incrementally, rather than adopting sweeping changes in a single
case, as suggested by the narrow issues that it will consider next
term in Omnicare, Inc. v. Laborers District Council
Construction Industry Pension Fund, No. 13-435 (whether a
statement of opinion must be subjectively false rather than merely
objectively wrong to establish a violation of the Securities Act of
1933), and Public Employees' Retirement System v.
IndyMac MBS, Inc. No. 13-640 (whether the filing of a
putative class action tolls the three-year statute of repose in
Section 13 of the Securities Act of 1933 with respect to the claims
of class members).
First, it is not yet clear how often defendants will be
successful in defeating class certification by carrying the burden
of disproving price impact, as Halliburton now permits
them to do. Although some circuits - including the Second
Circuit - already had suggested that defendants might disprove
price impact at that stage, see In re Salomon Analyst
Metromedia Litig., 544 F.3d 474, 484-85 (2d Cir. 2008); In
re DVI, Inc. Sec. Litig., 639 F.3d 623, 638 (3d Cir. 2011),
the Supreme Court's explicit recognition of this defense may
encourage what has, until now, been a strategy of limited
application. Halliburton's price impact rebuttal -
conceptually distinct from disproof of materiality - thus remains
largely unexplored. Rebutting price impact will inevitably
become a battle of the experts, and developing the requisite expert
support early in a case may well prove outcome determinative.
Even if defendants fail to defeat class certification, the expert's
analysis may assist the defendants in seeking summary judgment, on
a more developed record, as to materiality or loss causation.
As a practical matter, defendants' ability to defeat class
certification will depend on what lower courts will require to
disprove price impact. Plaintiffs will likely argue that lack
of price impact cannot be proven when there is evidence of a price
decline at the time of corrective disclosure.
Defendants, by contrast, may argue that an absence of price
movement at the time of the alleged misstatements disproves price
impact in many cases, notwithstanding a price decline at the time
of corrective disclosure. In the event a defendant
successfully proves lack of price impact with respect to certain
alleged misstatements but not others, it may be able to challenge
the length of the class period. There will be a period in
which the courts need to set the parameters as to how defendants
can rebut price impact, and the parties adjust their strategies
accordingly.
Second, it remains an open question whether defendants'
potential rebuttals of the Basic presumption at the class
certification stage will be limited to a lack of price impact or
extended to "[a]ny showing that severs the link" between the
misrepresentation and the transaction price. (Op. at 20
(quoting Basic, 485 U.S. at 248).) For example,
defendants may wish to rebut Basic's second "constituent premise" -
i.e., that "most investors" in a given security relied on price
integrity. (See Op. at 11-12, 17-18.) As with
price impact, it could be argued that "an indirect proxy should not
preclude direct evidence when such evidence is available."
(Id. at 20.) Halliburton opens the door to
such defenses by rejecting, albeit sub silentio, the dicta in the
final footnote of the Basic majority that "[p]roof of that
sort is a matter for trial." Basic, 485 U.S. at 249
n.29.
Third, the Court noted in particular that a defendant
could defeat the fraud on the market theory by showing "that a
plaintiff would have bought or sold the stock even had he been
aware that the stock's price was tainted by fraud . . . ."
(Op. at 7.) This may provide defendants an argument for
challenging the adequacy of proposed class representatives whose
trading practices do not rely on public disclosures, such as index
funds.
Fourth, if the price impact rebuttal authorized by
Halliburton gains meaningful traction, plaintiffs may seek
refuge in other presumptions of reliance, for example by re-casting
misstatements as omissions. See Affiliated Ute
Citizens v. United States, 406 U.S. 128, 153-54
(1972). Whether the Affiliated Ute doctrine can
accommodate such cases, and whether a Halliburton-like
rebuttal is available under Affiliated Ute, remain open
questions.
* * *
This memorandum is not intended to provide legal advice, and no
legal or business decision should be based on its content.
Questions concerning issues addressed in this memorandum should be
directed to:
Susanna M. Buergel
(212) 373-3553
sbuergel@paulweiss.com
Charles E. Davidow
(202) 223-7380
cdavidow@paulweiss.com
Brad S. Karp
(212) 373-3316
bkarp@paulweiss.com
Daniel J. Kramer
(212) 373-3020
dkramer@paulweiss.com
Jane B. O'Brien
(202) 223-7327
jobrien@paulweiss.com
Richard A. Rosen
(212) 373-3305
rrosen@paulweiss.com
Audra J. Soloway
(212) 373-3289
asoloway@paulweiss.com
*Associates Shane D. Avidan and Brette Tannenbaum contributed to this memo.