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1395Supreme Court Refuses To Overturn Fraud-on-the-Market Presumption

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  • Baker, John
    Jun 24, 2014
      The U.S. Supreme Court has refused to overturn its precedent allowing the reliance element of a securities fraud class action to be met using the fraud-on-the-market presumption. Halliburton C. v. Erica P. John Fund, No. 13-317 (U.S. June 23, 2014). The Court also refused to modify the prerequisites for invoking the presumption by requiring plaintiffs to prove "price impact" directly at the class certification stage. However, the Court did allow defendants an opportunity to rebut the presumption of reliance before class certification with evidence of a lack of price impact.

      In a private securities fraud action for misrepresentation under Rule 10b-5, investors can recover damages only if they prove that they relied on the defendant's misrepresentation in deciding to buy or sell a company's securities. The Supreme Court held in Basic Inc. v. Levinson, 485 U.S. 224 (1988), that investors could satisfy this reliance requirement by invoking a presumption that the price of securities traded in an efficient market reflects all public, material information, including material misstatements. In such a case, anyone who buys or sells the securities at the market price may be considered to have relied on those misstatements. In the absence of this presumption, plaintiffs rarely if ever would be able to show that the requirements for class action certification have been met, because individual issues would predominate over common ones. This presumption of reliance has always been controversial, and four Justices hinted last year in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds that it is ripe for reconsideration.

      In the event, however, six Justices ruled that the Basic presumption is protected by stare decisis, the principle that judges generally will respect past precedent. In an opinion by Chief Justice Roberts, the Court stated that before overturning a long-settled precedent it requires special justification, not just an argument that the precedent was wrongly decided. The arguments made here by the defendant were previously made and rejected in the Basic case itself, and the principle of stare decision has special force in respect to statutory interpretation because Congress remains free to alter the Court's rulings and has not chosen to do so. In addition, while the defendant argued that the Basic presumption relies on the efficient capital markets hypothesis, which has been criticized by many economists, the Court stated that even the foremost critics of the efficient capital markets hypothesis acknowledge that public information generally affects stock prices. The defendant argued in the alternative that plaintiffs should be required to prove that a defendant's misrepresentation actually affected the stock price, but the Court refused to make this change for the same stare decisis considerations.

      The Court did, however, accept the defendant's argument that defendants should at least be allowed to defeat the presumption at the class certification stage through evidence that the misrepresentation did not in fact affect the stock price. Defendants already were allowed to do this at the merits stage. Justice Ginsburg, in a one-paragraph concurring opinion joined by Justices Breyer and Sotomayor, stated that the Court's judgment should impose no heavy toll on securities fraud plaintiffs with tenable claims, although it may broaden the scope of discovery available at certification.

      Justice Thomas, in an opinion joined by Justices Scalia and Alito, argued that Basic was wrongly decided and should not be protected by stare decisis. Justice Thomas's opinion, which was in fundamental disagreement with the majority, was nominally a concurring opinion because he agreed that defendants should be able to present evidence at the certification stage. Although Justice Kennedy was among the four Justices who strongly hinted at reconsideration of Basic in the Amgen case, he did not join Justice Thomas's opinion and did not write separately to reconcile his current view with the opinion he joined in Amgen.

      A reversal of Basic would have substantially eliminated Rule 10b-5 class actions for misrepresentations (though not for omissions) and resulted in a wholesale change for private securities litigation. It would have affected not just private investors, but also institutional investors such as mutual funds, which are more likely to be plaintiffs than defendants in Rule 10b-5 cases and would now have had the burden of bringing their own private claims for misrepresentations. The change the Court did make, allowing defendants to present evidence of no price impact at the certification stage, will increase the cost and complexity of litigation at that stage, but should not prevent the certification of strong cases.

      The Court's decision is available at


      For my post when the Court agreed to take the case, see


      John M. Baker, Esquire
      Stradley Ronon Stevens & Young, LLP
      1250 Connecticut Avenue, N.W., Suite 500
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