Halliburton II: The Securities Fraud-On-The-Market Presumption Is Here To Stay

As anticipated, a majority of the U.S. Supreme Court declined to overrule the fraud-on-the-market presumption of Basic v. Levinson.[1] The Court rejected Halliburton's opening argument that the presumption is misplaced because today many investors do not assume market efficiency or base their investment decisions on the premise that a security’s price reflects all material, public information. Instead, the Court adopted the middle ground approach urged by a number of amici and by Halliburton as its fallback position, and held that defendants may rebut the fraud-on-the-market presumption of reliance at class certification by showing a lack of price impact. An overturning of Basic’s reliance presumption, the Court admonished, may only be done by Congress which, as the Court noted, has twice before responded to the proliferation of securities fraud class actions by enacting laws intended to curtail such actions with heightened pleading requirements and preempting certain state law securities fraud class actions.[2] Ultimately, 10b-5 cases will continue to survive, but substantive expert proceedings regarding price impact will be critical.

The Majority’s Decision

The plaintiff in Halliburton II alleged that Halliburton inflated its share price by misrepresenting its potential liability in asbestos litigation and its projected revenue from construction contracts, as well as certain benefits it anticipated from a merger. When disappointing news about these events came to pass and was publicly reported, the plaintiff alleged that Halliburton’s stock price dropped.

In its first trip to the Supreme Court in 2011, Halliburton argued, unsuccessfully, that it was entitled to defeat class certification with economic evidence showing that the misrepresentations alleged by plaintiff did not cause its losses and that its stock price declined due to other factors.[3] Halliburton argued that since loss causation is an essential element of a Section 10(b) claim, this sufficed to defeat class certification as the predominance requirement of Rule 23(b)(3) was not satisfied. The Supreme Court disagreed and held that loss causation goes to the merits of a Section 10(b) claim and that a plaintiff need not prove the merits of its claim at the class certification phase of the case.[4]

Following remand of Halliburton I to the district court, Halliburton argued that it was entitled to rebut the reliance presumption at class certification with evidence that the alleged misrepresentations had no impact on its stock price. Halliburton used the same economic evidence it had developed on loss causation, an event study and expert testimony, to argue that there was no artificial price inflation and therefore the reliance presumption was rebutted. Under the fraud-on-the-market theory, if the market for a security is efficient, then all material public information regarding the value of that security is promptly reflected in its market price. By extension, if there is no artificial price inflation, investors are not entitled to the reliance presumption.

The district court declined to consider Halliburton’s argument. The Fifth Circuit, citing recent Supreme Court precedent that class certification proceedings should not be turned into merits trials, agreed and held that any rebuttal of the reliance presumption had to await the merits phase of the case.[5]

While a majority of the Supreme Court rejected Halliburton’s request to overrule Basic’s fraud-on-the-market theory, it adopted the alternative middle ground approach, allowing defendants to rebut reliance at class certification with proof that defendants’ statements did not inflate the stock price.

The Court reasoned that since plaintiffs and defendants already are allowed to submit price impact evidence prior to class certification for the purpose of proving or disproving market efficiency, such evidence should be allowed to rebut the presumption of reliance, as well. “Under Basic’s fraud-on-the-market theory, market efficiency and the other prerequisites for invoking the presumption constitute an indirect way of showing price impact.” Id. at 20. The Court saw no reason to limit defendants’ ability to rebut the presumption since “[p]rice impact is thus an essential precondition for any Rule 10b-5 class action.” Id. at 21.

The Court rejected plaintiff’s argument that evidentiary challenges to price impact allegations necessitate an impermissible merits determination of whether their alleged misrepresentations were material.

The tension between the Supreme Court’s recent holding in Amgen,[6] that a merits based resolution of claims (there, materiality) must await the merits phase of the case, and two other recent rulings in class actions,[7] that class certification may at times require courts to address the merits of plaintiffs’ claims, was at play again in Halliburton II. The Court side-stepped this seeming inconsistency explaining that price impact “differs from materiality in a crucial respect. . . . The fact that a misrepresentation ‘was reflected in the market price at the time of [the] transaction’ – that it had price impact – is ‘Basic’s fundamental premise.’ It thus has everything to do with the issue of predominance at the class certification stage.” Id. at 21-22 (citation omitted).

Three Justices, Scalia, Thomas and Alito, concurring in name only, called “Basic's reimagined reliance requirement . . . a mistake, and the passage of time has compounded its failings.” Concurrence Op. at 5. Plaintiff’s argument that Congress ratified the reliance presumption via legislative inaction at the time of the PSLRA and SLUSA was criticized as “speculative at best.” Id. at 17.

What Effect Will Halliburton II Have On Securities Class Action Litigation?

Now that the Court has given the green light to defendants to challenge price inflation claims at class certification, we can expect more protracted Daubert style evidentiary hearings at class certification with battling financial economists and events studies.

Since the Court did not impose on plaintiff the burden of proving price impact at class certification, plaintiffs will still have leeway to present expert reports that do little more than opine generally about the efficiency of the market for the securities at issue. In this situation, defendants may not have the benefit of plaintiff’s work product on price inflation when they depose plaintiff’s expert or when they prepare their own expert rebuttal report. Defense counsel may have to cross-examine the plaintiff’s expert at the class certification hearing without the benefit of having deposed the plaintiff’s expert about their price impact analysis which presumably will not be undertaken until plaintiff responds to defendants’ expert reports and/or testimony, if at all. Disaggregating other confounding news that impacted stock prices is properly addressed at class certification.

Given the importance that event studies at class certification will continue to hold, consistent judicial guidance on the parameters of what constitutes a reliable methodology for event studies, such as the helpful guidance provided in the recent First Circuit decision in Credit Suisse,[8] will be important. Even in cases where some but not all of the challenged statements impacted the price of a security, it may still be worthwhile for defendants to challenge the price impact of these statements since eliminating some but not all claims may help to reduce both damages and the size of the class. On the other hand, price impact is entwined with the question of materiality. Thus, a grant of class certification with a finding that the alleged misrepresentations inflated stock prices may effectively foreclose a summary judgment motion on this point and delay ultimate resolution of materiality until the time of trial when the issue is presented to the jury.

Plaintiffs may be well advised to whittle down disclosure claims in their complaint: rather than pleading 200 false statements, few of which caused any stock price movement, they may wish to focus on those statements that did precipitate a significant price movement now that those disclosure dates will be subject to expert testimony and cross-examination early in the case, at class certification.

In sum, Halliburton II gave a little something to all constituents, but mainly to financial economists who are in the business of providing expert advisory services. Recognizing this boon to consulting firms, one insurer, AIG, just announced that it is now offering a class certification event study endorsement to its D&O insurance policy holders which provides coverage for the cost of class certification event studies with no deductible.