At issue in Halliburton was nothing less than the continuing viability of securities fraud class actions as we know them. If the Supreme Court had overruled the fraud-on-the-market theory of reliance, a step that the defendant and numerous amici had urged the Court to take, public corporations and issuers of securities would effectively be immunized against class actions of investors alleging most forms of securities fraud. Such a decision would have eviscerated an entire substantive area of the law -- not to mention a robust legal industry -- in a single blow.
First, some background: In order to establish a violation of Section 10(b) of the Securities Exchange Act of 1934, a plaintiff must prove “(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.” Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 568 U.S. ___, ___ (2013) (slip op., at 3–4) (internal quotations omitted). Boiled down to plain English, this means that a securities fraud plaintiff must establish that the defendant made a misstatement of fact or failed to disclose a fact; that the misstatement or omission was material, meaning that a typical investor would consider that information meaningful; that the defendant did so intentionally or with knowledge; that the plaintiff relied on the misstatement or omission in purchasing or selling a security; and that the misstatement or omission caused the plaintiff to suffer a loss. (An extended discussion of the many additional nuances of these elements is not necessary for an understanding of the following discussion.)
In 1988, the Supreme Court addressed the element of reliance in Basic Inc. v. Levinson, 485 U.S. 224 (1988). What does it mean for an investor to have relied upon a misstatement in purchasing or selling a security? In recognition that the securities markets were no longer conducted through the face-to-face transactions at issue in earlier fraud cases but, instead, now involved the trading of millions of shares daily through impersonal trading systems, the Court held that an investor could satisfy the requirement of reliance by invoking a presumption that the price of an efficiently-traded stock necessarily incorporated and reflected all public material information, such that an investor's reliance on the stock price was reliance upon the misrepresentation or omission itself (the so-called "fraud-on-the-market" theory). Thus, reliance on the stock price equates to reliance upon the challenged statement. The Basic Court further held that this presumption was rebuttable and could be overcome by "[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price." Thus, if the defendant could show that the investor would have invested anyway, or that the alleged misrepresentation or omission had no effect on the stock price (among other things), it could defeat the reliance presumption.
The impact of Basic on securities law was significant and wide-ranging: Not only could individual investors recover for securities fraud without having relied on -- or, indeed, even having been aware of -- a specific material misstatement or omission, but the necessary element of reliance could now be presumed for an entire group or class, rather than proven individually, leading to a boon to securities class actions. (In the absence of the fraud-on-the-market theory, most securities fraud cases could not proceed as class actions due to individualized issues of reliance by each class member.) Moreover, given that litigation costs would dwarf the potential for recovery in securities fraud cases brought by most individual investors, rejection of the fraud-on-the-market theory would have largely immunized securities issuers from such suits in all but the most egregious of circumstances. Armed with the Basic presumption, however, the plaintiffs' securities bar could aggregate the claims of thousands of investors against the issuer and certify a large class without concern for issues over individual reliance.
Not surprisingly, the business community began challenging the fraud-on-the-market presumption from the very issuance of Basic, arguing that it wrongfully eliminates the requirement for reliance long-established in fraud jurisprudence and that it helps create economic incentives for filing large-scale strike suits, often of questionable merit, in order to extract settlement funds from securities issuers. In the years since Basic, the business community successfully limited certain aspects of the theory but, despite its best efforts, had not succeeded in eliminating application of the theory altogether.
Enter Halliburton, in which the Supreme Court expressly took up the question of whether the fraud-on-the-market presumption of Basic should be overruled or modified. In an opinion that gave something to each side, the Court reaffirmed the holding of Basic and held that fraud-on-the-market continues to be a viable theory for presumptively proving reliance in a securities fraud case. Writing for the six-Justice majority, Chief Justice Roberts reasoned that Halliburton had failed to establish the "special justification" necessary for overturning the long-established precedent of Basic. He noted that the doctrine of stare decisis applies with "special force" in situations where the Court engaged in statutory interpretation (given Congress' ability to alter the result through subsequent legislation) and concluded that Halliburton's challenges to the fraud-on-the-market theory consisted of policy arguments that the Basic Court had already rejected and of irrelevant market theory critiques that in no way "refuted the modest premise underlying the presumption of reliance." The majority found no compelling basis for overturning Basic and thus held that the fraud-on-the-market theory of reliance continues to apply.
The news was not all good for plaintiffs however: In addition to reaffirming that a defendant can rebut the presumption by showing, among other things, the absence of "price impact" (i.e., that the alleged misrepresentation did not affect the stock price), the majority ruled that a defendant has the right to make such a showing at the class certification stage of the case -- which often occurs long before the merits are decided. Thus, efforts to certify a class, which in recent years have already become raging battles, will now lead to all-out war between the parties. Further, Justices Scalia, Thomas and Alito would overrule Basic entirely, giving hope to Corporate America that a differently constituted future Court may reach a contrary conclusion.
But for all the media hoopla over the importance of the decision, here's the rub as far as I'm concerned: Neither group of Justices asserted a logically coherent and justifiable basis for its position. As Professor Korsmo of Case Western Reserve University School of Law recently blogged, the Halliburton decision is not "particularly coherent" and "renders an already confused area of the law even more convoluted."
How? Well, let's start with the majority. I have no issue -- and, in fact, agree -- with the majority's reaffirmation of Basic. Eliminating the fraud-on-the-market theory of reliance in today's electronic trading world would effectively immunize issuers from the vast majority of individual securities fraud actions and nearly all class actions. Because federal and state regulators lack sufficient resources to monitor all securities offerings and public disclosures, the private securities bar provides an important check against unscrupulous or fraudulent behavior. I understand why issuers believe that the fraud-on-the-market theory operates as an end-run around the requirement of causation but in light of the decades-old precent of Basic, as well as the absence of an alternative effective enforcement scheme, I believe the status quo should remain.
However, the majority's decision to allow defendants to challenge "price impact" at the class certification stage seems hopelessly inconsistent with the Court's Amgen decision issued just last year. In Amgen, the Court ruled that a securities defendant is precluded from rebutting the fraud-on-the-market presumption by challenging the materiality of the alleged misrepresentation or omission at the class certification stage. The Amgen majority reasoned that any issue over materiality, while important for merits, was wholly irrelevant for class certification purposes: The challenged statements were either material or immaterial for the class at large; thus, there was no reason to allow defendants to contest materiality at the class certification stage when they adequately could do so later on the merits. Shouldn't the same be true for challenges to "price impact"? As with questions of materiality, the issue of whether a challenged misrepresentation or omission caused the stock price to change (i.e., caused a "price impact") would be the same for the class at large and thus, under the logic of Amgen, is best left to a subsequent resolution on the merits. Why is "price impact" any different? Amazingly, the majority never cogently explains it. After acknowledging the obvious similarity of issues, see slip op., at 21 ("EPJ Fund argues that much of the foregoing could be said of price impact as well. Fair enough."), Chief Justice Roberts labors to distinguish Amgen on the purported ground that the existence of "price impact" was "Basic's fundamental premise," which somehow is already at issue in all class certification proceedings in a way that the materiality element is not. Huh? Aren't related elements of materiality and "price impact" inexorably tied together? A material misrepresentation will generally have a "price impact" and an immaterial one will not; they are two sides of the same coin. You can read the passage and draw your own conclusions (slip op, at 21-23) but I view it as results-driven labyrinthine "logic" that fails to convince. Let's call it for what it is: the effective overruling of Amgen. Having exalted the doctrine of stare decisis to uphold Basic, the majority was intellectually precluded from turning around and promptly overruling Amgen. But it accomplished the same result.
The concurrence in judgment (and dissent in all else) authored by Justice Thomas and joined by Justices Scalia and Alito fares little better. In contending that Basic should be overruled, the concurrence spends the majority of its time making irrelevant arguments about the strength of the efficient capital markets hypothesis and the existence of investors who ignore stock prices -- neither of which, even if accepted, would be a basis for rejecting the fraud-on-the-market theory. Issues over the level of efficiency in a particular market make little difference to the Basic presumption. Whether the correlation is high or weak, if the stock price is affected by the challenged statement in any respect, reliance by the investor on the stock price can be a proxy for reliance upon the statement itself. And for those situations where there is a complete lack of correlation, defendants have the ability to rebut the presumption. Because the fraud-on-the-market theory does not require a purely efficient market to function, academic issues over the level of efficiency of a particular market provide no basis for scrapping the theory altogether. Similarly, the concurrence's argument that not all investors rely upon stock price is equally immaterial. Basic never stated, and is not reliant upon the view, that all investors rely upon stock price. If there are investors who did not rely upon the stock price in making their purchase or sale decision, defendants have the ability to disprove reliance. Again, the fact that there may be a limited number of investors who completely disregard stock price is no reason for rejecting the common-sense notion that most investors at some level rely "on the security’s market price as an unbiased assessment of the security’s value in light of all public information."
So what does all of this mean? More litigation. Halliburton ensures that securities fraud class actions will be alive and well for the foreseeable future. In fact, the decision will provide fodder for an ever-increasing amount of legal work as plaintiffs and defendants alike struggle to interpret and apply the troubled logic that each side invoked. It also makes certain that, from now on, defendants will attempt to attack both "price impact" and "materiality" (under the guise of "price impact" evidence) at class certification, notwithstanding Amgen.
For the securities bar, Christmas came in June this year.