The 10b-5 Daily

The Halliburton case in the U.S. Supreme Court is moving quickly, with oral argument scheduled for March 5, 2014. At issue, at least potentially, is the continued viability of the fraud-on-the-market presumption of reliance. The presumption was judicially created by the Court and is routinely invoked in securities class actions to justify the grant of class certification.

The merits brief for the petitioners (Halliburton and its CEO) and the supporting amicus briefs have been filed with the Court. A listing of the briefs can be found here. The author of The 10b-5 Daily – Lyle Roberts of Cooley LLP – assisted the Washington Legal Foundation (WLF) with the filing of an amicus brief that focuses on the second question presented: Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.

The WLF brief argues that price impact is not dispositive as to either materiality or loss causation for all class members and, as a result, allowing a price impact rebuttal at the class certification stage does not run afoul of the Court’s Amgen decision. In addition, the brief points out that allowing a price impact rebuttal would harmonize the Court’s approach to affirmative misstatement and omissions cases and would better protect the rights of individual investors who can demonstrate actual reliance. The WLF brief is available on the Foundation’s website.

The U.S. Supreme Court has granted certiorari in Halliburton v. Erica P. John Fund, setting up what could be the most important securities litigation decision in the last twenty-five years. At issue is the continued validity of the fraud-on-the market-theory, whereby 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 is routinely invoked in securities class actions to justify the grant of class certification.

In its petition, Halliburton presented the following two questions:

1. Whether this Court should overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory.

2. Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.

In granting review, the Court did not limit its consideration to either question. As a result, SCOTUSBlog notes that the Court presumably “at least will consider the broader plea to cast aside the prior ruling.”

The case will be argued early next year. Reuters and Bloomberg have coverage of the cert grant. For more on the underlying case and the cert petition, see this recent blog post.

Quote of note (Bloomberg): “Four justices — Antonin Scalia, Clarence Thomas, Anthony Kennedy and Samuel Alito — suggested in a ruling in February that they might jettison the ‘Basic presumption,’ as it has become known. The outcome of the case may be in the hands of Chief Justice John Roberts, who usually joins that group in ideologically divisive cases.”

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.

On Monday, the U.S. Supreme Court heard oral argument in three related cases – Chadbourne & Parke v. Samuel Troice, No. 12-79; Willis of Colorado v. Troice, No. 12-86; and Proskauer Rose v. Troice, No. 12-88 – raising the issue of the scope of the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). SLUSA precludes certain class actions based upon state law that allege a misrepresentation in connection with the purchase or sale of nationally traded securities (“covered securities”).

Observers who were hoping for a lot of discussion about the meaning and import of SLUSA, however, were sorely dissapointed. Instead, oral argument focused on an issue that the Court has considered before: exactly what fact patterns does “in connection with the purchase or sale” (which is taken from Section 10(b) of the Securities Exchange Act of 1934) cover? The three cases related to the Stanford ponzi scheme, in which high-interest certificates of deposit (not covered securities) were sold to investors who were falsely told that the proceeds would be invested in liquid securities (at least some of which would be covered securities).

The justices appeared to struggle with idea that a false statement concerning whether securities have been purchased can satisfy the “in connection with” requirement. Almost immediately, Chief Justice Roberts asked counsel for the petitioners “if I’m trying to get a home loan and they ask you what assets you have and I list a couple of stocks and, in fact, it’s fraudulent, I don’t own them, that’s a covered transaction, that’s a 10(b)(5) violation?” When counsel responded that the scenario would appear to be missing any representation about a purchase or sale, Justice Kagan argued that the problem is “In all of our cases, there’s been something to say when somebody can ask the question: How has this affected a potential purchaser or seller in the market for the relevant securities? And here there’s nothing to say.” For his part, Justice Scalia appeared willing to go even further, noting that the “purpose of the securities laws was to protect the purchasers and sellers of the covered securities. There is no purchaser [] or seller of a covered security involved here.” Ultimately, counsel for the petitioners argued that the “in connection with” standard is satisfied “when there is a misrepresentation and a false promise to purchase covered securities for the benefit of the plaintiffs.”

The government argued in favor of the petitioners’ position, but also ran into stiff questioning, When the government suggested that Justice Kagan’s “market effect” test was satisfied because the Stanford scheme would make investors less likely to trust the financial markets, Justice Kennedy responded that this argument was the equivalent of saying “if you went to church and heard a sermon that there are lots of people that are evil, maybe then you wouldn’t invest.”

Counsel for the respondents argued that the alleged scheme did not involve purchasing covered securities for the benefit of the plaintiffs. The seller of the C.D.’s “was only buying [covered securities] for itself. It did not pledge to sell the assets. It did not give the plaintiffs any interest in them.” Moreover, what the Court’s precedents “have said over and over and over and what has been the dividing line that has prevented 10(b)(5) from swallowing all fraud is these are misrepresentations that affect the regulated market negatively. This fraud did not do that.”

The New York Times and Reuters have coverage of the oral argument.