The Supreme Court has agreed to reassess a 25-year-old decision that is instrumental to investors’ ability to bring securities fraud class actions, opening the door to major changes in the nature and scope of future shareholder lawsuits.
On Friday, the justices granted a petition by Halliburton that they consider whether to “overrule or substantially modify” the high court’s 1988 ruling in Basic v. Levinson. Basic held that, in an efficient market, stock prices reflect all publicly known information and that shareholder plaintiffs therefore are presumed to have relied on such information when making a purchase.
Without Basic’s “fraud-on-the-market presumption,” each individual class member would need to show that they relied on particular knowingly false or misleading statements when they bought a company’s stock. The implications of a Halliburton win are not fully clear. If the presumption is struck down, however, defendants would no doubt argue thereafter that individual questions of reliance predominate over common ones and, thus, the case should not proceed as a class action.
Both sides agree that the Supreme Court’s eventual decision in Halliburton Co. v. Erica P. John Fund, Inc., which is expected in early 2014, involves some very high stakes. In a brief urging the court to accept the case, a group of former SEC commissioners and law professors said that investors filed more than 3,000 securities class actions from 2007 to 2012, generating some $73.1 billion in settlements. In their arguments opposing Halliburton’s petition, lawyers representing plaintiff Erica P. John Fund called Basic “the cornerstone for modern private securities litigation.”
The case itself involves allegations that Halliburton, an oilfields services company, falsified its financial results and misled the public about its exposure to asbestos claims, most of which were made against a brick manufacturer whose liabilities Halliburton had inherited through a 1998 acquisition. The case has been winding its way through the courts since 2002, including a previous trip to the Supreme Court, which in 2011 overturned decisions by the trial and appeals courts denying class certification because plaintiff had not proven loss causation.
Halliburton’s brief argues that Basic‘s presumption of reliance is a flimsy judicial construct based upon a now-discredited economics hypothesis, the efficient market theory. As interpreted by Halliburton’s lawyers, Basic‘s acceptance that “well-developed capital markets efficiently incorporate material information into a stock’s market price and that investors, in turn, purchase stock in reliance on the market price” constitutes a “fiction” “at war with economic reality.”
“Basic‘s substitution of nascent economic theory for bedrock securities and class-action law was questionable from the start … Twenty-five years later, all doubt is gone; Basic‘s theoretical framework has been subjected to withering scholarly and empirical attack,” Halliburton writes in its petition to the court.
Furthermore, Halliburton claims that Basic‘s supposed lenience on reliance flies in the face of established law, promotes splits among appeals courts, and is contrary to the high court’s rulings in other types of class actions. Even if the justices do not overturn Basic, Halliburton argues, they should “substantially modify the threshold for invoking a presumption of reliance” by requiring that plaintiffs “be required to prove that the alleged misrepresentations actually distorted the market price” to obtain class certification.
Plaintiff’s attorneys countered that the fraud-on-the-market presumption of reliance enshrined in Basic has been “repeatedly reaffirmed” by the Supreme Court and left intact by Congress, which “has amended the federal securities laws several times since Basic was issued without legislatively overruling Basic, and has considered but rejected a proposal to overrule Basic.”
“Basic‘s endorsement of the fraud-on-the-market doctrine does not, as Defendants claim, rest on an outdated and discredited economic theory, but rather on Congressional policy as embedded in the Securities Exchange Act of 1934,” plaintiff argues.
Furthermore plaintiff contends that Halliburton incorrectly presents the efficient market theory as an all-or-nothing proposition: that unless all public information is immediately and fully reflected in the share price, then Basic’s presumption is bogus. Quoting a study by financial economists, plaintiff argues that for Basic‘s premise to prevail it is enough that “a false statement will impact price at least to some degree.”
If this year’s Nobel Prize in Economics offers any indication, the debate over market efficiency is very much alive. The Nobel Committee awarded to three U.S. economists “for their empirical analysis of asset prices.” Two of the prize winners, Eugene F. Fama of the University of Chicago and Robert J. Shiller of Yale, personify the competing theories. Fama is widely known as the father of the efficient market hypothesis. Shiller, who had issued warnings about both the Internet and housing bubbles, is a believer in “behavioral finance” that incorporates psychology and sociology into economic theories on pricing.
As the Supreme Court justices prepare to wade into these murky waters, investors hoping that they leave at least some of Basic intact take little comfort from the high court’s recent checkered history in the area. While the Supreme Court has recently issued certain decisions helpful to securities plaintiffs, in 2010 the court took what appeared to be a modest question – whether foreign investors who bought a foreign company’s stock on a foreign stock exchange be allowed to sue under U.S. securities laws – and issued a sweeping ruling that denied protection to anyone who bought shares outside the United States.
That decision, Morrison v. National Australia Bank, set investors back nearly 50 years. Given the question raised in Halliburton, the court could potentially deliver a blow to investors’ rights that makes Morrison seem gentle in retrospect.