On Wednesday, the U.S. Supreme Court heard oral argument in the Halliburton v. Erica P. John Fund case, which brings into question the continued viability of the fraud-on-the-market presumption of reliance. The fraud-on-the-market presumption is crucial to pursuing a securities fraud case as a class action – without it, the proposed class of investors would have to provide actual proof of its common reliance on the alleged misrepresentation, a daunting task for classes that can include thousands of investors.
Much of the pre-argument commentary had focused on Chief Justice Roberts as the possible “swing vote” that could create a majority in favor of eliminating the fraud-on-the-market presumption (which was judicially created by a 1988 Supreme Court decision). Based on the questioning at the hearing, however, The 10b-5 Daily’s prediction that Halliburton would be unable to find five justices who are willing to go that far seems more accurate. Indeed, to the extent that the Court is willing to change the current regime, it now appears that they are more likely to embrace the intermediate step of requiring evidence of price impact before a class can be certified (because price impact is a prerequisite of the fraud-on-the-market presumption).
Why read the tea leaves this way? A few highlights:
(1) Petitioner (Halliburton) started off arguing that the fraud-on-the-market presumption should be overruled because at least three things have changed since it was implemented: (a) the Court has consistently construed the private right of action for securities fraud narrowly, (b) the Court has issued decisions making it clear that class-wide issues should be addressed at the class certification stage, and (c) the economic premise that “investors rely in common on the integrity of the market price” is no longer accurate (assuming it ever was). In response, Justice Kagan noted that Petitioner apparently agreed “that market prices generally do respond to new material information,” so in any particular case there will have to be a fact-specific inquiry into “whether there’s an exception to this general rule.” Petitioner responded that “if the Court were inclined to keep the presumption in some sense, it should at least place the burden on the plaintiff to establish that the misrepresentation actually distorted the market price, or to give defendants the full right of rebuttal at the class certification stage to establish the price was not impacted.”
(2) Once the discussion turned to the use of price impact evidence, much of the rest of the hearing focused on that issue. Most notably, Justice Kennedy asked Petitioner to address whether a possible solution to the economic issues it had raised was to require plaintiffs to demonstrate – via an event study at class certification – that the alleged misrepresentation had impacted the market price. Petitioner readily agreed that it made “sense to focus like a laser on the only relevant question, whether the misrepresentation distorted the market price.” In response to questions from Chief Justice Roberts and Justice Alito, Petitioner also argued that the cost of these event studies would not be significant because “plaintiffs are commonly using event studies right now as part of their [overall] market efficiency showing” at class certification and that event studies are “very effective” at determining a misrepresentation’s price effect.
(3) Respondent (investors) and the government also were asked to address the use of price impact evidence at the class certification stage. In response to questioning from Justice Sotomayor and Justice Kennedy, Respondent argued that in a case alleging multiple misrepresentations, conducting event studies would be “very complicated” and “very expensive,” and, moreover, “the idea that there are not significant merits filters that prevent cases from going to trial is simply wrong, both at the pleading stage and at the summary judgment stage.” In contrast, however, the government readily conceded that if the Court were to require proof of price impact at the class certification stage, it “would be a net gain to plaintiffs, because plaintiffs already have to prove price impact at the end of the day.”
Disclosure: The author of The 10b-5 Daily submitted an amicus brief on behalf of the Washington Legal Foundation in support of petitioner.