[NOTE: I asked my colleague, Professor Charles Korsmo [bio/SSRN], to comment briefly on yesterday’s decision in Halliburton v Erica P. John Fund, an important securities fraud class action case. Below are his comments.]
The Supreme Court handed down its opinion in Halliburton v. Erica P. John Fund on Monday. The case was much-anticipated as the term’s most important securities law case. Some hoped, and others feared, the Court would grasp an opportunity to revisit its 1988 decision in Basic v. Levinson adopting the so-called “fraud on the market” doctrine. This controversial doctrine makes the modern securities fraud class action possible by granting plaintiffs a presumption of reliance when plaintiffs can show that the relevant stock traded in an efficient market—the theory being that in an efficient market, any misrepresentations will be reflected in the market price and will thus affect any shareholder who trades in reliance on the market price. In the absence of this presumption, individual issues of whether plaintiffs had actually heard and relied on allegedly fraudulent statements would predominate. While aspects of the doctrine have come before the Court on numerous occasions, the Halliburton case was unusual in that Halliburton, picking up on cues from last year’s Amgen opinion, directly asked the Court to reconsider and overrule Basic.
The Court, somewhat predictably, declined to do so. Instead, Chief Justice Roberts, in an opinion joined by five other Justices, took a more minimalist approach. He held that Halliburton had showed no “special justification” for overturning the quarter-century-old holding of Basic, and that adhering to stare decisis was especially appropriate in a case involving interpretation of the securities laws, which Congress could presumably amend if they were so inclined. Instead of wiping out the fraud on the market doctrine altogether, Roberts sought to chart a middle course, allowing defendants the opportunity to rebut the presumption of reliance at the class certification stage by showing that the alleged misrepresentations had no impact on the market price. In taking this course, the Court largely adopted the position advocated by the law professors Adam Pritchard and Todd Henderson in an amicus brief that was heavily discussed at oral argument.
While the opinion was rather predictable, that does not mean it was good, or even particularly coherent. In fact, it renders an already confused area of the law even more convoluted, and will—I suspect—do little to reduce the incidence of meritless litigation brought simply to extract a settlement. Indeed, Justice Ginsburg—joined by Justices Breyer and Sotomayor—wrote a one-paragraph concurrence noting that she joined the opinion on the understanding that it would impose little or no additional burden on securities fraud plaintiffs. In this, she is almost certainly right. In the vast majority of securities fraud cases, there is a “price impact.” Indeed, the classic “strike suit” scenario is when a company’s stock takes a sharp dive when negative information comes out, and plaintiffs’ attorneys stumble over each other to file claims alleging securities fraud. The dispute is almost never over whether there actually was a stock drop; it is over whether the company fraudulently concealed the negative information. As such, the opportunity to rebut the fraud on the market presumption by showing lack of price impact is likely to be of little avail in most cases.
Not only is the ability to rebut by showing lack of price impact of little practical use, it is also conceptually incoherent. Just last year, the Court in Amgen held that defendants could not rebut the fraud on the market presumption at the class certification stage by showing that the alleged misrepresentations were not material. The Court reasoned that a showing of lack of materiality would simply doom the case for all plaintiffs. Thus the inquiry could wait until the merits stage, with no danger that individual issues would predominate. The same reasoning would certainly seem to apply to price impact. In the absence of an impact on the market price, there can be no damages. One would think, then, that the very fresh Amgen precedent would prevent consideration of price impact at the class certification. Bizarrely, Roberts dubs this argument “[f]air enough,” before dismissing it with a confusing assertion that price impact is “Basic’s fundamental premise.” Of course, if a misrepresentation is immaterial, it would be unlikely to have a price impact, which would seem to make materiality rather fundamental itself.
Unfortunately, the concurrence (which reads far more like a dissent) by Justice Thomas—joined by Justices Scalia and Alito—is not much better. After briefly suggesting that an implied right of action for securities fraud is not in keeping with more recent precedent, and largely ignoring the powerful textual arguments recently put forward by Joseph Grundfest for overturning Basic, Thomas devotes most of his effort to the argument that recent economic research calling into question the efficient capital markets hypothesis has undermined the fraud on the market doctrine. For reasons I explain in a forthcoming paper, this argument is seriously misguided. The fraud on the market doctrine depends simply on the notion that misrepresentations can affect the market price of publicly traded securities, and that people who trade at the market price can thus be injured by misrepresentations even if they have not personally heard or read them. Strong ideas of market efficiency need not come into play.
The majority opinion and concurrences in Halliburton are emblematic of the confusion that has now generated at least 29 Supreme Court opinions interpreting and defining the scope of private securities fraud actions. While more opinions are sure to follow, it is now abundantly clear that opponents of private securities fraud class actions will have to look to Congress for meaningful relief, not the Court.