On March 5, the Supreme Court will hear oral arguments in Halliburton v. Erica P. John Fund, a class action brought on behalf of investors allegedly defrauded by false disclosures of the Texas oil giant. Halliburton has fought to deny a trial on the merits for over a decade, and is now asking the conservative justices to overturn decades of precedent that allows shareholder lawsuits under the rebuttable presumption that this type of misinformation is a “fraud on the market.”
Conservative Justices Invited This Opportunity To Dismantle Protections For Securities Fraud Victims
The New York Times' DealBook: This Case Could “Put A Stake Through The Heart” Of These Class Actions. In his analysis of why decades of Supreme Court precedent aimed at effectively regulating stock markets could be at risk, legal expert Steven M. Davidoff noted that four of the conservative justices are willing to do away with a 25-year old legal doctrine. From The Times' DealBook on October 15, 2013:
A group of pro-corporate forces has begun a behind-the-scenes fight at the Supreme Court. You may not have heard about it, but it could just end shareholders' ability to sue companies for securities fraud.
Halliburton is asking the Supreme Court to confront one of the fundamental tenets of securities fraud litigation: a doctrine known as “fraud on the market.”
The doctrine has its origins in the 1986 Supreme Court case Basic v. Levinson. To state a claim for securities fraud, a shareholder must show “reliance,” meaning that the shareholder acted in some way based on the fraudulent conduct of the company.
In the Basic case, the Supreme Court held that “eyeball” reliance -- a requirement that a shareholder read the actual documents and relied on those statements before buying or selling shares -- wasn't necessary. Instead, the court adopted a presumption, based on the efficient market hypothesis, that all publicly available information about a company is incorporated into its stock price.
Applying this doctrine, the Supreme Court reasoned that any fraud would affect a company's price. The court held that therefore a shareholder need not prove reliance because the shareholder's purchase or sale was based on an inaccurate share price, a price that changed as a result of false information.
[T]he question probably comes down to whether there are five justices who want to put a stake through the heart of securities fraud cases.
The opponents of the Basic decision are getting closer. In a case involving the biotechnology company Amgen in 2013, four dissenting justices appeared to support overruling the Basic ruling. [The New York Times, 10/15/13]
The Supreme Court Reaffirmed This Fraud-On-The-Market Precedent As Recently As 2013
Supreme Court Justice Ruth Bader Ginsburg: Denying The Opportunity Of Fraud Victims Their Day In Court Is To “Put The Cart Before The Horse.” Writing for the Court in a majority opinion that included Chief Justice John Roberts and confirmed the fraud-on-the-market doctrine of Basic, Ginsburg rejected the last attack on class action certification rules as a backwards attempt to immunize alleged fraudsters from trial. From Amgen v. Connecticut Retirement (2013):
[T]he dissenters from today's decision, would have us put the cart before the horse. To gain certification under Rule 23(b)(3), [the defendant] and the dissenters urge, [the plaintiff] must first establish that it will win the fray. But the office of a Rule 23(b)(3) certification ruling is not to adjudicate the case; rather, it is to select the “metho[d]” best suited to adjudication of the controversy “fairly and efficiently.”
Although we have cautioned that a court's class-certification analysis must be “rigorous” and may “entail some overlap with the merits of the plaintiff 's underlying claim,” Rule 23 grants courts no license to engage in free-ranging merits inquiries at the certification stage. Merits questions may be considered to the extent--but only to the extent--that they are relevant to determining whether the Rule 23 prerequisites for class certification are satisfied.
Absent the fraud-on-the-market theory, the requirement that [securities-fraud] plaintiffs establish reliance would ordinarily preclude certification of a class action seeking money damages because individual reliance issues would overwhelm questions common to the class. The fraud-on-the-market theory, however, facilitates class certification by recognizing a rebuttable presumption of classwide reliance on public, material misrepresentations when shares are traded in an efficient market. [Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 2/27/13]
Overturning The Basic Decision Would Be A Radical Disregard Of The Rules Of Statutory Interpretation And Stare Decisis
Former U.S. Solicitor General Charles Fried: The Need To Respect Precedent Is “Particularly Rigorous” When Congress Relies On The Courts' Interpretation Of Statutes. Writing as counsel of record for well-known legal scholars, the former solicitor general for Ronald Reagan explained that stare decisis, the judicial doctrine of standing by things decided, is particularly strong in this case where Congress and the courts have spent decades relying on each other's intent and interpretation of securities fraud law. From their amicus brief of February 5, 2014:
This Court's decision in Basic Inc. v. Levinson, interprets a statute enacted by Congress and, as a consequence, is subject to revision by the legislative branch if, and in the manner, our elected representatives see fit. Congress has, in fact, paid detailed attention to the issue of Rule 10b-5 class actions in the wake of Basic. The doctrine of stare decisis accordingly applies to Basic with particular force, triggering a strong presumption that it is for Congress, rather than the courts, to change statutory rules.
[W]hen a statutory precedent has come under fire, the question for the Court is not simply whether ordinary stare decisis considerations would warrant revisiting the precedent, for Congress is perfectly capable of making the same calculus - e.g., whether the rule has proven unworkable, whether overturning it would unfairly impose hardships upon those who have relied on it, or whether the rule has been overtaken by changes in the world or our understanding of it. The Court must also ask whether there is a sufficient reason to depart from the ordinary understanding that revising statutory precedents is the job of the politically accountable branches, not the courts. [Brief of Legal Scholars As Amici Curiae With Respect To Stare Decisis In Support of Respondent, 2/5/14]
Congress Considered Abandoning The Fraud-On-The-Market Doctrine But Instead Twice Validated It
Current And Former Congressional Members: Congress “Twice Legislated On The Specific Issue” Of Overturning Basic And Rejected The Idea. Legislators involved in the drafting of recent securities fraud law confirmed the 2013 conclusion of the Supreme Court that Congress specifically intended for the fraud-on-the-market doctrine to continue to be a part of class actions. From their amicus brief of February 5, 2014:
Congress has twice legislated on the specific issue Halliburton raises here: private securities class-action litigation. In both the [Private Securities Litigation Reform Act of 1995 (PSLRA)] and the Securities Litigation Uniform Standards Act (SLUSA), Congress imposed limits on such class actions to strike a balance between the need to protect investors, on the one hand, and issuers' ability to raise capital without fear of strike suits, on the other. In enacting the PSLRA, Congress was expressly invited to revisit Basic. It refused to do so. Thus, Congress did not intend to simply refrain from commenting altogether--but instead sought to preserve the law as it stood. That is clear both from Congress's decision not to reconsider Basic and from numerous provisions of the PSLRA that make sense only if class-based fraud-on-the-market suits are permitted. Later, when Congress decided to supplement the PSLRA by enacting SLUSA, Congress again left Basic intact. Viewed in light of Congress's policy objectives and the alternatives it considered, the enactment of the PSLRA and SLUSA constitutes legislative validation of Basic.
[T]his Court correctly observed in Amgen that Congress has endorsed Basic and its embrace of the fraud-on-the-market theory. [Brief for Current and Former Members of Congress and Staff as Amici Curiae Supporting Respondent, 2/5/14]
Securities Regulators Depend On Basic And Private Securities Litigation
The United States Government: There Is “No Good Reason” To Dismantle Protections Against Market Fraud That Go Back To The Securities Exchange Act Of 1934. Speaking for both the Department of Justice and the Securities Exchange Commission (SEC), the current solicitor general explained that Basic and the fraud-on-the-market presumption for class actions are an essential part of over a half-century of public and private securities law enforcement. From their amicus brief of February 5, 2014:
[M]eritorious private securities-fraud actions, including class actions, are an essential supplement to criminal prosecutions and civil enforcement actions brought by the Department of Justice and the SEC[.]
[The fraud-on-the-market] presumption rests on the common-sense premise that public, material information about a publicly-traded company affects the price of the company's stock. The presumption also reflects the view that investors, in deciding whether to buy publicly-traded securities, may reasonably assume that the market price has not been tainted by material misinformation...[Halliburton] ideintif[ies] no good reason to overrule Basic's fraud-on-the-market holding. The fraud-on-the-market presumption has proved workable, and its essential premises remain sound. Academic debate about the efficient-market hypothesis has not undermined the presumption. Congress has declined to disturb the presumption but instead has taken it as given while enacting measures designed to curb potential abuses in private securities-fraud suits. The Court therefore should reject [Halliburton's] request to upset this settled and sensible presumption. [Brief for the United States as Amicus Curiae Supporting Respondent, 2/5/14]
There Is No Academic Debate Over Market Efficiency That Undermines Basic's Fraud-On-The-Market Doctrine
Securities Law Scholars: Halliburton And The U.S. Chamber Of Commerce “Are Wrong” In Citing Securities Law Scholars' Discussion Of Market Efficiency As A Rejection Of Basic. Corporate interests seeking to end securities class actions have cited legal experts' work in this field in support of overruling Basic, but this is a distortion of their scholarship that has been flatly disavowed. From their amicus brief of February 4, 2014:
[Halliburton] assert[s] that Basic rested on a concept of market efficiency, and that “academic consensus” and “new evidence” justify overruling it. Both assertions are wrong.
[W]rong is the claim that academic consensus has rejected Basic's view of market efficiency. Legal and finance scholars widely accept that the public capital markets demonstrate the required level of efficiency - that prices respond to and incorporate material information. Nobel Prize winner Robert Shiller, in noting his disagreement with co-winner Eugene Fama explained “Of course prices reflect available information.” It is that almost common-sense conception of market efficiency that Basic requires, nothing more. Notable conservative Judge and Law and Economics Scholar Frank Easterbrook recently observed that the semi-strong version of the efficient capital markets hypothesis, on which fraud-on-the-market theory rests, is “widely accepted.”
To be clear, this is not perfect efficiency in the sense that all information is incorporated into prices instantaneously. As [Georgetown University Professor of Law] Donald Langevoort explains, “perfect efficiency is just an ideal; all markets fall short, some more than others.” Moreover, informational efficiency is a spectrum, not a binary concept, meaning that the speed with which information is impounded into stock prices varies according to the issuer's information environment and the type of information involved. As Professor Langevoort has observed, Basic “was not insisting on anything approaching perfect efficiency.” [Brief of Securities Law Scholars as Amici Curiae In Support of Respondent, 2/4/14]
U.S. Chamber Of Commerce Involvement In This Case Reflects Its Current Campaign Against Class Actions
NYT Supreme Court Correspondent Adam Liptak: “Thanks To The Roberts Court” It Is Much Harder For Victims Of Corporate Wrongdoing To Bring Class Action Suits. Reporting on new studies showing the current Court's historic pro-business tilt and favorability to the U.S. Chamber of Commerce, The New York Times' Liptak observed that the conservative justices' increasing restrictions on class action certification has “delighted business groups.” From the May 4, 2013, edition of The New York Times:
By reaffirming Wal-Mart v. Dukes, a 2011 blockbuster case in which the court threw out a large employment sex discrimination class, [the 2013 case of Comcast v. Behrend] limited class actions more broadly.
The question of whether plaintiffs have enough in common to sue as a class is different from whether they deserve to win. The first question is generally resolved early in the case. The second one may await trial.
But the Wal-Mart and Comcast decisions said the two questions often overlap and may call for an early answer. The decisions essentially required early scrutiny -- by a judge, not a jury -- of the ultimate legal question in high-stakes cases, sometimes before all the relevant evidence has been gathered. This delighted business groups, which have pushed to limit class actions.
“The court is telling lower courts across the country they really do have to fulfill their gate-keeping function and keep these meritless classes out of the courts,” said Kate Comerford Todd, a lawyer with the litigation unit of the United States Chamber of Commerce.
Jason M. Halper, a lawyer at Cadwalader, Wickersham & Taft in New York, said the collective message of those and related cases was clear: “When you take all of them together, the effect is certainly to make the use of class actions much more difficult.”
It is easy to understand why companies hate class actions. Once a class is certified, the damages sought are often so enormous that the only rational calculation is to settle even if the chances of losing at trial are small. The costs of litigation -- for lawyers, experts and the exchange of information -- are also far larger in class actions. And it is not always clear that the plaintiffs, as opposed to their lawyers, receive very much in the settlements.
Plaintiffs' lawyers, on the other hand, say class actions are the only way to vindicate small harms caused to many people. The victim of, say, a fraudulent charge for a few dollars on a billing statement will never sue. But a lawyer representing a million such people has an incentive to press the claim.
“Realistically,” [New York University Law Professor Arthur R. Miller has written], “the choice for class members is between collective access to the judicial system or no access at all.”
The Comcast decision is just over a month old. But lower courts have already relied on it to reject class actions contending harm from defective trucks, poisoned drinking water, discrimination against disabled workers, misrepresentations in insurance policies and improperly docked wages.
Some of the plaintiffs in those cases will now pursue their claims in individual suits. But many will not, and the businesses accused of wrongdoing will, thanks to the Roberts court, breathe a little easier. [The New York Times, 5/4/13]