Supreme Court’s Halliburton Ruling May Be A Curse in Disguise for Securities Defendants

By Gregory P. Graham, Esq.*

On June 23, 2014, the U.S. Supreme Court issued its anticipated decision in Halliburton Co. v. Erica P. John Fund, Inc., 134 S.Ct. 2398 (2014). Although pre-decision discussion speculated that the case might become the most important securities decision in years, the Court ultimately chose a conservative path that maintains the status quo, but seems to hand securities defendants an important tool in defending class actions. While securities defendants walked away with a minor victory on the day, the long-term impact of the Halliburton decision may turn out to be an unwanted increase in costs for defendants in both class and single investor suits moving forward.

Background

Securities plaintiffs seeking class certification must satisfy the requirements of Rule 23 of the Federal Rules of Civil Procedure. Most significantly, Rule 23 requires that questions of law or fact common to class members must predominate over any questions affecting individuals. For class actions bringing Rule 10b-5 claims, plaintiffs need to demonstrate that reliance upon an alleged misrepresentation or misstatement led to the purchase or sale of the security at issue. Prior to the Supreme Court’s adoption of the “fraud-on-the-market” presumption in Basic Inc. v. Levinson, 485 U.S. 224 (1988), securities plaintiffs were required to prove that each member of the class seeking certification was convinced to purchase or sell the security at issue based upon the same misrepresentation in order to demonstrate that questions of fact were common to the class. Given the manner in which most securities are purchased, this reliance requirement acted as a barrier to securities class action certification.

In Basic, the Supreme Court removed this barrier by ruling that an investor who buys or sells stock at the price set by the market does so in reliance on the integrity of the market price. Because the market price is based upon all publicly available information, buyers’ and sellers’ reliance on any public misrepresentation is presumed. All the potential class members are, therefore, deemed to have relied upon the misrepresentation, removing the need to present facts demonstrating each individual plaintiff’s reliance.

Halliburton Co. v. Erica P. John Fund, Inc.

While the “fraud-on-the-market” presumption has been heavily criticized, it has survived for 26 years as the most common method used for the certification of securities class actions. When the Supreme Court agreed to hear Halliburton v. Erica P. John Fund, Inc., the securities litigation landscape braced itself for substantial upheaval as many speculated that the Halliburton decision might overturn Basic and do away with the reliance presumption.

Halliburton began when the Erica P. John Fund, Inc. purchased stock in Halliburton after Halliburton allegedly made misrepresentations in an attempt to inflate its stock price. Following the disclosure of the accurate information, the Fund brought forth a suit alleging it suffered a monetary injury when Halliburton’s stock price decreased to its correct market value upon the release of the corrective disclosures. The Fund moved to certify a class comprised of all investors who purchased the stock during the same period. Halliburton objected, attempting to argue that, because the misstatements did not impact the market price of the stock, there could be no “fraud-on-the-market” presumption allowing for the putative class certification. The trial court certified the class, refusing to allow Halliburton the opportunity to rebut the presumption.

Halliburton appealed to the Fifth Circuit, which affirmed the certification. Halliburton then appealed to the U.S. Supreme Court. The question before the Court was whether Basic’s “fraud-on-the-market” presumption of reliance should be overruled and, if it was upheld, whether the defendants should be allowed to challenge the “fraud-on-the-market” presumption at the class certification stage by demonstrating that there was no impact on the market price.

Ultimately, the Court took a conservative approach and affirmed Basic and its “fraud-on-the-market” presumption while vacating and remanding the matter so that Halliburton could present evidence in an attempt to rebut the reliance presumption. Chief Justice Roberts authored the majority opinion, which provides that securities class action defendants may rebut the “fraud-on-the-market” presumption by demonstrating that the alleged misrepresentations did not impact a security’s market price. Halliburton gives authority to securities defendants to present direct evidence and arguments at the certification stage in an attempt to demonstrate this lack of impact.

Impact of the Halliburton decision – is this good for securities defendants?

At a quick glance, Halliburton appears to benefit securities defendants who oppose certification. Defendants will likely choose the option of paying limited discovery costs at the certification stage on the narrow issue of price impact in an attempt to defeat certification rather than attempt to prove lack of price impact after incurring the full costs of discovery on the merits of the action.

A closer examination reveals that, while Halliburton may result in a decrease in the number of securities class actions, the long-term implication for securities class action defendants may be negative. As an initial matter, should a securities defendant succeed in presenting evidence that the alleged misrepresentations did not impact the market price of the security, it will only have rebutted the reliance presumption and prevented the putative class from being certified. Those investors in the class with claims worth pursuing will not be deterred from filing suit and will still be able to file individual fraud actions in state and federal courts. If there is a decrease in the number of securities class action certifications because the reliance element of a Rule 10b-5 claim cannot be met, there may well be an increase in the number of state and common law causes of action filed by investors with stronger claims. Should Halliburton result in a significant number of successful challenges to class certification, an unanticipated consequence will be plaintiffs forum-shopping for procedural or substantive advantages. The costs of litigating similar claims in multiple forums, as well as the danger of inconsistent results in different jurisdictions, may be less appealing to class action defendants than the predictability of a class-wide settlement.

For those defendants who produce evidence in an attempt to rebut the reliance presumption and fail, the strength of the plaintiff-class moving forward may be unintentionally increased. Defendants who previously did not have the opportunity to present arguments against market price impact at the certification stage could raise these arguments during settlement negotiations after class certification in an attempt to lower settlement value. Settlement discussions involving plaintiff-classes that survive pre-certification challenges will likely involve a higher initial demand. Additionally, defendants who raise unsuccessful market price impact challenges to class certification early on in the case will have been required to respond to the plaintiffs’ demands for discovery at an earlier stage in the litigation. Should the class be certified despite a defendant’s challenge, plaintiffs’ attorneys will have more information via discovery and benefit from a ruling that there was a market price impact.

The long-term effect of the Halliburton decision on securities class actions is up for debate. But it is clear that defense litigation costs to 10b-5 actions will increase regardless of whether Halliburton ultimately proves to be positive or negative for securities defendants.

Conclusion

While the Halliburton decision provides that the “fraud-on-the-market” reliance theory can be rebutted, defendants must cautiously approach any challenge. Post-Halliburton, defendants must decide whether the costs and potential consequences of raising a pre-certification challenge based on lack of price impact are worth the potential consequences that a slightly altered securities litigation landscape could deliver.

*Greg is an associate in our Pittsburgh, Pennsylvania office. He can be reached at 412.803.1189 or gpgraham@mdwcg.com.

Defense Digest, Vol. 20, No. 3, September 2014

Defense Digest is prepared by Marshall Dennehey Warner Coleman & Goggin to provide information on recent legal developments of interest to our readers. This publication is not intended to provide legal advice for a specific situation or to create an attorney-client relationship. Copyright © 2014 Marshall Dennehey Warner Coleman & Goggin, all rights reserved. This article may not be reprinted without the express written permission of our firm.