Halliburton Co. v. Erica P. John Fund, Inc., ___ U.S. ___ (2014). In general, in a securities fraud case under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §78j(b), plaintiffs must show reliance on a defendant’s misrepresentation or omission in order to recover. In Basic, Inc. v. Levinson, 485 U.S. 224 (1988), the Supreme Court held that plaintiffs could obtain a rebuttable presumption that they satisfied this reliance requirement by showing that the stock of the company involved traded in an “efficient market,” that is, a market in which stock prices reflect all material public information, whether true or false. That result reflects an economic doctrine known as the “fraud on the market” theory. Since that time, securities fraud defendants and certain jurists have sought the overruling of Basic, a result that would have a devastating effect on securities fraud class actions, since it would be difficult or impossible for plaintiff classes to show reliance on an individual basis. When the Supreme Court granted Halliburton’s petition for review of this case, in which one of the questions presented by the petition for certiorari was whether the Court “should overrule or substantially modify the holding of Basic, Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory,” many believed that the Court might wipe out the Basic rule.
Today, however, by a 6-3 vote, the Court refused to overrule Basic. The Court did, though, allow defendants to challenge the efficiency of the market at the class certification stage, rather than having to wait to do that until the subsequent, merits portion of the case, a partial win for defendants but in no sense the “home run” that they hoped for. Chief Justice Roberts wrote the majority opinion, in which Justices Kennedy, Ginsburg, Breyer, Sotomayor, and Kagan joined. Justice Thomas wrote a dissent, which Justices Scalia and Alito joined. Those Justices would have overruled Basic.
Chief Justice Roberts began by noting that, to overturn a “long-settled precedent,” the Court requires ‘special justification,’ not just an argument that the precedent was wrongly decided” (quoting Dickerson v. United States, 530 U.S. 428, 443 (2000)). That is because the principle of stare decisis “has special force in respect to statutory interpretation,” in that Congress can alter what the Court does. Halliburton did not show “special justification.”
Halliburton first contended that Basic was inconsistent with the intent of Congress in enacting the 1934 Act. But the Chief Justice observed that the dissenters in Basic had made that same argument, without success. Halliburton did not offer any reason for the Court to adopt that failed contention now.
Halliburton also asserted that economists now no longer believe in the efficient market hypothesis, so that Basic is no longer tenable. But Chief Justice Roberts noted that even the most formidable critics of that hypothesis “acknowledge that public information generally affects stock prices.” By making its presumption regarding reliance rebuttable, Basic “recognized that market efficiency is a matter of degree and accordingly made it a matter of proof.” Thus, academic debates about the degree to which the efficient market doctrine operates are “largely beside the point.” And those debates did not represent “the kind of fundamental shift in economic theory that could justify overruling a precedent on the ground that it misunderstood, or has since been overtaken by, economic realities.”
Halliburton also claimed that Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541 (2011), and Comcast Corp. v. Behrend, 133 S. Ct. 1426 (2013), two recent anti-class action rulings, mean that Basic is now out of step with current Supreme Court jurisprudence. Defendants routinely invoke Wal-Mart and Comcast in all sorts of contexts that are entirely foreign to the limited situations that those cases addressed. Chief Justice Roberts rightly rejected Halliburton’s attempt to do that here. Though Halliburton claimed that Basic relieved plaintiffs of the obligation to prove their claims, contrary to what Halliburton saw as the mandate of Wal-Mart and Comcast, Basic in fact did no such thing. Instead, Basic merely set forth what plaintiffs must prove while allowing defendants to rebut the fraud on the market presumption. The Court’s refusal to overapply Wal-Mart and Comcast is very beneficial to plaintiffs, who will now be able to use that ruling to show lower courts that those decisions do not have the seemingly unlimited effect that defendants have contended that they have.
Finally, Halliburton presented the tired argument that Basic encourages extortionate settlements of meritless claims and unfairly burdens corporations. Chief Justice Roberts correctly suggested that such arguments are for Congress, not the Court. As he went on to recount, Congress has adopted at least two significant statutes regarding securities fraud class actions since Basic, the Private Securities Litigation Reform Act of 1995, and the Securities Litigation Uniform Standards Act of 1998, without altering Basic.
Unable to overrule Basic, Halliburton offered two “modifications.” The majority accepted one of those: while Basic allowed defendants to challenge market efficiency and reliance after class certification, when a case reaches the merits stage, today’s decision permits defendants to challenge that aspect of the case at the class certification stage. That represents a wonderful decision for experts who perform “event studies,” which are analyses that help show whether a market is in fact efficient. Until now, such studies normally were not needed until a case reached the merits stage, a point that many cases, whether settled or dismissed, do not reach. Now that defendants can attack this issue at class certification, parties, especially plaintiffs, who have the burden of proof, likely will have to retain these experts at that point, which has the effect of front-loading these significant expert costs. In a one-paragraph concurrence, three Justices opined that this change would not substantially burden plaintiffs. Plaintiffs themselves may not be so sanguine about that.
Nonetheless, considering the result as compared with what might have occurred, today’s decision is a favorable one for plaintiffs. The attack on Basic was repulsed, and securities fraud class actions were thereby preserved. (Even lawyers who represent defendants in these cases are secretly breathing sighs of relief about that). The Court’s unwillingness to accept Halliburton’s misguided argument about Wal-Mart and Comcast may enable plaintiffs to limit those cases to their own contexts in other cases. All in all, plaintiffs likely feel that they dodged a bullet, despite the likely large increase in upfront costs that plaintiffs will now have to bear.