Challenging The Fraud-On-The-Market Theory

Pursuant to the fraud-on-the-market theory, reliance by investors on a misstatement is presumed if the company’s shares were traded on an efficient market that would have incorporated the information into the stock price. The presumption was judicially-created by the U.S. Supreme Court and is routinely invoked in securities class actions to justify the grant of class certification. In the Court’s recent Amgen decision, however, four justices expressed concerns about the fraud-on-the-market theory’s continuing validity. In particular, the Amgen dissent noted that the Court is not well-equipped to apply economic concepts and there is some disagreement about how market efficiency works. Given that invitation, it was only a matter of time before a securities class action defendant asked the Court to reconsider its current position.

Erica P. John Fund v. Halliburton, a securities class action that has been pending in the N.D. of Texas since 2002, has already been the subject of a Supreme Court decision relating to the fraud-on-the-market theory. In 2011, the Court held that loss causation is not a precondition for invoking the fraud-on-the-market presumption and, therefore, is not necessary to establish that reliance is capable of resolution on a common, classwide basis. On remand, the defendants pursued a related issue. Halliburton argued that it should be allowed to rebut the fraud-on-the-market presumption by establishing that the alleged misstatements did not have a stock price impact. The district court found that price impact evidence did not bear on the critical inquiry of whether common issues predominated under FRCP 23(b)(3) and certified the class. The Fifth Circuit subsequently affirmed, finding that although price impact evidence certainly could be used at trial to refute the presumption of reliance, it was not appropriate to consider this evidence at class certification.

Halliburton is once again seeking certiorari in the Supreme Court, but now it is going after an even bigger prize. In addition to arguing that the Fifth Circuit should have allowed the defendants to rebut the presumption by presenting price impact evidence, Halliburton asserts that the Court should overrule or substantially modify the fraud-on-the-market theory. It takes four justices to grant cert – will the Amgen group decide that the Halliburton case is the right vehicle through which to consider this question? A handful of amici have urged them to do so, including the U.S. Chamber of Commerce, and the issue has caught the attention of the legal press. Stay tuned.

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