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From Securities Regulation Daily, June 23, 2014

Basic decision stands; Halliburton may defeat presumption with price-impact evidence

By Jim Hamilton, J.D., LL.M.

In the most serious challenge to the fraud-on-the-market doctrine in decades, the U.S. Supreme Court ruled that the presumption of reliance announced inBasic, Inc. v. Levinson (U.S. 1988) remains valid, but that a defendant may present evidence of a lack of price impact to rebut the presumption before class certification (Halliburton Co. v. Erica P. John Fund, Inc., June 23, 2014, Roberts, J.).

Reliance presumption. Investors can recover damages in a private securities fraud action only if they prove that they relied on the defendant’s misrepresentation in deciding to buy or sell a company’s stock. In Basic, the Court held that investors could satisfy this reliance requirement by invoking a presumption that the price of stock traded in an efficient market reflects all public, material information, including material misstatements. In such a case, anyone who buys or sells the stock at the market price may be considered to have relied on those misstatements.

Meeting Halliburton halfway. Halliburton, arguing that Basic’s reliance presumption contravenes congressional intent and has been undermined by subsequent developments in economic theory, urged the Court to overrule the decision. The Court rejected this argument, but agreed with Halliburton that defendants should be allowed to defeat the presumption at the class certification stage through evidence that the misrepresentation did not affect the stock price.

The Court declined to overrule the Basic decision based on economic theories advanced since 1988. The Court’s respect for precedent, the principle of stare decisis, had special force here since this is a statutory interpretation and thus Congress remains free to alter what the Court has done and said.

However, the Court held that price impact is an essential precondition for any Rule 10b–5 class action. While Basic allows plaintiffs to establish that precondition indirectly, it does not require courts to ignore a defendant’s direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock’s market price and, consequently, that the Basic presumption does not apply.

9-0 decision. The judgment was unanimous, but only Justices Kennedy and Kagan completely joined the Chief Justice’s opinion. Justices Thomas, Alito, and Scalia wanted to overrule Basic, and only concurred in the Court’s judgment. Justice Ginsburg wrote a concurring opinion, joined by Justices Sotomayor and Breyer, clarifying that the Court’s opinion recognizes that it is incumbent upon the defendant to show the absence of price impact. The Court’s judgment, therefore, should impose no heavy toll on securities-fraud plaintiffs with tenable claims.

In concurring only in the judgment, Justices Thomas, Alito, and Scalia said that “Basic took an implied cause of action and grafted on a policy-driven presumption of reliance based on nascent economic theory and personal intuitions about investment behavior. The result was an unrecognizably broad cause of action ready-made for class certification.” In the Justices’ view, time and experience have shown the error of the Court’s decision, in Basic, to conform securities law to the alleged new realities of financial markets rather than leave that to Congress.

Amici positions. The U.S. Chamber of Commerce and National Association of Manufacturers had urged the Court to reconsider the fraud-on-the-market doctrine, writing, “The rebuttable presumption of reliance in private Rule 10b-5 actions endorsed in Basic is a judicially created procedural device designed to facilitate class-wide proof of an element of a claim that itself arises from a judicially inferred private right of action.” The SEC took the opposite position,writing that the presumption rests on the common-sense premise that material information about a public company affects the price of the company’s stock. The presumption also reflects the view that investors may reasonably assume that the market price has not been tainted by material misinformation.

Analysis. University of Michigan Law Professor Adam Pritchard said that the Court missed an opportunity to make class certification more efficient and more consistent with fraud deterrence. As a result of the Court’s ruling, he said, we now have both market efficiency and price impact. He also noted that the perverse policy implications of Basic remain intact, but that some defendants will now be able to defeat class certifications. Professor Pritchard predicts that the price impact determination will become a war of experts.

The case is No. 13-317.

Attorneys: Aaron M. Streett (Baker Botts LLP) for Halliburton Co., et al. David Boies (Boies Schiller & Flexner LLP) for Erica P. John Fund, Inc.

Companies: Halliburton Co.; Erica P. John Fund, Inc.

MainStory: TopStory FraudManipulation

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