As foreshadowed in the Supreme Court’s Amgen decision last year, the fraud-on-the-market presumption — allowing plaintiffs in securities class actions the presumption of classwide reliance in cases involving securities traded in efficient markets — was modified today in Halliburton v. Erica P. John Fund, Inc., No. 13-317. The Court held that while plaintiffs could still rely on the presumption of classwide reliance, defendants could now rebut that presumption at the class certification stage.
Recall that in Amgen, the Court would not allow the defendant to rebut the materiality of the alleged misrepresentation at the class certification stage, leading to a disagreement between the right and left wings of the Court as to exactly what its 1988 decision in Basic v. Levinson meant. Justice Alito commented in his concurring opinion in that case that there needed to be more clarity on the Basic presumption of reliance, but that decision itself was not raised in the Amgen matter.
Enter the Halliburton case, where that issue was faced head-on. Chief Justice Roberts wrote the opinion for the Court, in which Justices Kennedy, Ginsburg, Breyer, Sotomayor and Kagan joined. Justice Thomas joined in the judgment in a concurring opion, joined by Justices Scalia and Alito. And Justice Ginsburg write a short concurrence, joined by Justices Breyer and Sotomayor.
This was Halliburton’s second time up before the Supreme Court in recent years. Previously, Halliburton had argued in the same case that plaintiffs had to prove loss causation — i.e., that the alleged misrepresentation caused plaintiffs’ loss — to get a class certified. The Supreme Court held that loss causation need not be shown at the class certification stage. On remand, Halliburton argued that the alleged misrepresentations did not impact the price of the stock, and that accordingly, a fraud-on- the-market presumption of reliance was not appropriate. Without that presumption, each investor would have to prove his or her reliance on the alleged misrepresentation, which would mean that individualized issues of reliance would predominate over any common issues, thereby defeating class certification.
The Supreme Court today stood by its view that the presumption was necessay because class certification would rarely be available in securities cases without the presumption. The Court reasoned that “[a]lthough the presumption is a judicially created doctrine designed to implement a judicially created cause of action, we have described the doctrine as ‘a substantive doctrine of federal securities-fraud law.'” In addition, the Court noted that “the modest premise underlying the presumption of reliance” was still valid: “[e]ven the foremost critics of the effcient-capital-markets hypothesis acknowledge that public information generally affects stock prices.”
Justice Roberts next dealt with the argument that securities class actions were different from all others because the presumption of reliance through the fraud-on-the-market theory meant that class certification could be decided on the pleadings alone: “Halliburton also argues that the Basic presumption cannot be reconciled with our recent decisions governing class certification under Federal Rule of Civil Procedure 23. Those decisions have made clear that plaintiffs wishing to proceed through a class action must actually prove — not simply plead– that their proposed class satisfies each requirement of Rule 23…” To that, the Court held that Basic does not relax the class certification requirements, but simply establishes a presumption that allows the plaintiffs to satisfy their burden: “Basic instead establishes that a plaintiff satisfies that burden by proving the prerequisites for invoking the presumption — namely, publicity, materiality, market efficiency, and market timing. The burden of proving these prerequisites still rests with plaintiffs and (with the exception of materiality) must be satisfied before class certification.”
As for the right to rebut the presumption, the court held that a defendant can still “pick off the occasional class member here or there through individualized rebuttal,” but that would not cause individual questions to predominate over common ones. But, in addition, significantly, the court held that a defendant can seek to rebut the presumption of classwide reliance at the class certification stage by introducing evidence that the alleged misrepresentation did not affect the stock price. This would be to attack the notion of market efficiency underlying the presumption. As the Court held: “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.”
So what about Amgen and the Court’s decision there to confine the question of materiality to the merits phase? Why is market efficiency any different? Justice Roberts reasoned that “[p]rice impact is different,” because it is “‘Basic’s fundamental premise.'” Thus whether Basic applies at all, the court held, can be hashed out at class certification.
As the Court concluded in upholding Basic: “[w]e adhere to that decision and decline to modify the prerequisites for invoking the presumption of reliance. But to maintain the consistency of the presumption . . ., defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the price of the stock.”
In concurring, Justice Ginsburg saw “no heavy toll on securities-fraud plaintiffs with teneable claims.” Meanwhile, Justice Thomas took a harsh view of court-made securities laws: “Basic took an implied cause of action and grafted on a policy-driven presumption of reliance based on nascent economic theory and personal intuitions about investment behavior. The result was an unrecognizably broad cause of action ready made for class certification. Time and experience have pointed up the error of that decision, making it all too clear that the Court’s attempt to revise securities law . . . should have been left to Congress.”
While the plaintiffs’ bar is hailing the decision as a victory because Basic remains in place, the Court did much to undo Basic by allowing defendants to attack the preconditions to the presumption itself at the class certification stage. I would expect to see the battle of whether Basic is applicable played out in expert testimony increasingly in the lower courts. The line that the Court drew between attacking the preconditions to the presumption versus materiality, for instance, is indeed fuzzy, but it is the clearest effort by the Court yet in leveling out the playing field for defendants in securities class actions.