Co-authors: Mark Kornfeld and Deborah Renner
Editors’ Note: This post has also been published as a BakerHostetler Client Alert.
It has been 25 years since the Supreme Court announced the fraud-on-the-market presumption of reliance in Basic Inc. v. Levinson, 485 U.S. 224 (1988). Yet many courts, including the Supreme Court itself, continue to struggle in applying the presumption to securities fraud class actions. The Court will have another opportunity to either further clarify its position, or change course all together and reconsider its decision in Basic, if it chooses to review the Fifth Circuit’s recent decision in Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423 (5th Cir. 2013).
Basic: The Supreme Court Adopts the Fraud-on-the-Market Presumption
Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder make it unlawful to misstate a material fact in connection with the purchase or sale of any security. One of the required elements of a claim under Rule 10b-5 is reliance—a claimant must show that he relied on the material misstatement in making his investment decision. This creates a problem in class actions because reliance typically involves an individualized inquiry, which would preclude certification. At the same time, Rule 10b-5 claims are often brought on behalf of large groups of shareholders that hope to benefit from the simplified resolution of their claims on a class-wide basis.
The Supreme Court balanced these competing interests and came out in favor of class claimants in Basic Inc. v. Levinson, 485 U.S. 224 (1988). The Court held that the fraud-on-the-market presumption of reliance applied to Rule 10b-5 claims, making them amenable to class resolution. The presumption is based on the theory that, in an open, developed and efficient market, market prices reflect all publicly available material information about the company. Thus, when a shareholder makes a decision to trade the company’s security, he can assume the market price is a fair representation of the security’s value. In other words, he makes that trading decision in reliance on the integrity of the market price. The Supreme Court in Basic held that this creates a presumption of reliance sufficient to satisfy the reliance requirement of Rule 10b-5, and thus relieves claimants of the burden of proving actual reliance on the misstatement. Defendants may then rebut the presumption with any evidence that “severs the link” between the misstatement and the security’s price or the claimant’s decision to trade at that price.
Amgen: Claimants Do Not Need to Prove Materiality to Invoke the Presumption at the Class Certification Stage
The Supreme Court revisited the fraud-on-the-market presumption earlier this year in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184 (2013). The issue before the Court in Amgen was whether Rule 10b-5 claimants had to prove materiality at the class certification stage in order to invoke the presumption and obtain certification. The Court answered this question in the negative, holding that it was sufficient at class certification for claimants to show that materiality could be determined on a class-wide basis. Because materiality is an objective standard that invokes the “reasonable investor,” the materiality determination would be the same across the entire class. Thus, the Court held, common issues would predominate as to the fraud-on-the-market presumption of reliance and class certification was appropriate.
Justice Ginsburg delivered the opinion of the Court and was joined by Chief Justice Roberts and Justices Breyer, Alito, Sotomayor and Kagan. Justices Scalia and Thomas wrote dissenting opinions, with Justice Kennedy joining Justice Thomas, and Justice Alito wrote a concurring opinion. Justice Scalia reasoned that, not only did Basic govern the issues raised in Amgen because Basic itself involved the question of class certification, but Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541 (2011), and the cases upon which it relies require a “rigorous analysis” of the class certification criteria, which may sometimes require looking at the merits. Justices Thomas and Alito also called into question the underlying assumption that Basic and the fraud-on-the-market presumption remained viable. Justice Thomas quoted Justice White’s dissent in Basic, noting that “traditional legal analysis” should not be replaced with reliance on economic theory. Both justices also reasoned that, since Basic, there had been evidence that the economic theory justifying the presumption was faulty—that market efficiency could not be so easily assumed. However, the Court had not been asked in Amgen to revisit its decision in Basic.
Halliburton: Is Proof of Loss Causation Required?
The question of what needs to be pleaded and proven by claimants hoping to invoke the fraud-on-the-market presumption at class certification has arisen once again, this time in the Fifth Circuit Court of Appeals. The circuit court has ruled that a Rule 10b-5 class action defendant may not submit price impact evidence to rebut the presumption at class certification. Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423 (5th Cir. 2013). The defendant, Halliburton, has filed a petition for a writ of certiorari with the Supreme Court seeking review of the Court of Appeal’s decision. This is not the first trip to the Supreme Court for this case.
In 2002, a group of Halliburton shareholders filed suit against the company pursuant to Rule 10b-5 based on alleged misstatements made by the company, its CEO and its Board of Directors. The district court denied class certification, finding that plaintiffs had failed to demonstrate the element of loss causation, and the Fifth Circuit affirmed. The Supreme Court reversed and remanded, holding that plaintiffs did not need to prove loss causation at the class certification stage. Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011).
On remand, the district court certified a class under Rule 23(b)(3). The court rejected Halliburton’s argument that the misstatements at issue did not impact the market price, a fact which rebutted the fraud-on-the-market presumption. On appeal, the Fifth Circuit affirmed. Applying the Court’s decision in Amgen, the Fifth Circuit found that the materiality element of the presumption did not have to be proven at class certification. Because the price impact evidence Halliburton was offering related to materiality, it could not be considered in deciding whether to certify a class. The court then took the analysis one step further and found that the price impact evidence would not result in individual issues predominating later in the case because that evidence was probative of the loss causation element of a Rule 10b-5 claim (as opposed to the loss causation element of the fraud-on-the-market presumption). If Halliburton’s price impact evidence was persuasive, the claims of every class member would fail.
On September 9, 2013, Halliburton filed a petition for a writ of certiorari with the Supreme Court. Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423 (5th Cir. 2013), petition for cert. filed, No. 13-317 (U.S. Sept. 9, 2013). In its petition, Halliburton asks the Court not only to review the Fifth Circuit’s holding regarding the relevance of price impact evidence, but also to reconsider the presumption altogether and overrule Basic. Halliburton seized on the dissents and concurrence in Amgen, arguing that Basic’s economic premise has been repudiated and that Rule 23 requires a greater degree of proof than fraud-on-the-market presumption involves. The Court has not yet ruled on the petition.
If the Supreme Court accepts the invitation to review the Fifth Circuit’s decision, there are a number of possible outcomes. The Court could take a narrow approach to the lower court decision and base its ruling solely on the issue of whether price impact rebuttal evidence may be considered at class certification. But if the Court is looking for an opportunity to reconsider Basic, this is it. If the Court chooses to disavow Basic, the repercussions to securities fraud litigation would be significant, as plaintiffs in securities fraud class actions would then have the burden of showing class-wide reliance at the class certification stage without the crutch of the presumption. Thus, should the Court grant certiorari, Halliburton will be a case to watch—again.