The United States Supreme Court heard oral argument on March 5th in a case that could overturn one of the most Basic rules in securities litigation – the “efficient capital markets hypothesis,” – better known as the “fraud-on-the-market” presumption. This rule of law comes from the high court in an previously decided case, Basic Inc. v. Levinson. The current case, Halliburton Co. v. Erica P. John Fund Inc., has the potential to overturn the “fraud-on-the-market” presumption of reliance in securities cases.
The fraud-on-the-market presumption is based on the concept that the “market price” of a security trading in an efficient market is determined from all material public information concerning the company and its stock. It allows a Plaintiff to proceed without having to demonstrate individual reliance. Under that rule, any allegedly material public misstatement by a company about itself, or its stock, operates as a “fraud on the market” that distorts the market price of the stock at issue. It also presumes that stock sale prices are always affected by these misrepresentations. Although it is a rebuttable presumption, the rule from the Basic case is that any stock purchaser or seller relies on the integrity of the market pricing process and the “truth” of its underlying information.
In Halliburton, the Plaintiff invoked the fraud-on-the-market presumption in her class certification to demonstrate class-wide reliance on Halliburton’s financial statements and projections. According to the Plaintiff, from June 3, 1999, through December 7, 2001, Halliburton made misrepresentations concerning three aspects of its operations:
Boiled down to the most basic terms, Halliburton did not have enough assets or revenues to cover its expected losses due to ongoing asbestos litigation. Halliburton knew this, but publicly misrepresented its financial position. Because of this misrepresentation, Halliburton’s stock prices remained high. Of course, while Halliburton insiders were aware that these statements were false, outside investors had no way of determining the truth or falsity of the statements. Neither could the outsiders assess whether Halliburton’s stock prices were based on accurate information.
The federal district court prevented Halliburton from presenting evidence to rebut the presumption and certified the class. On appeal to the Fifth Circuit Court of Appeals, the court held that evidence to rebut the Basic presumption could not be presented until the trial on the merits and affirmed the district court. On appeal to the U.S. Supreme Court, Halliburton is hoping to replace the presumption with a requirement that Plaintiffs prove that the misrepresentations actually did distort the market price for the stock, or at least be allowed to rebut the presumption at the class certification stage.
There are several options available to the high court for dealing with Basic at this juncture. The Court can either:
In all but the last option, the world of securities litigation would be drastically changed. Class certification would be much more difficult to achieve, making any litigation much more expensive and much less likely to be pursued. If the Supreme Court changes the rules, and most scholars expect at least some alteration, the case will be another big win for corporations.
The market is complex, fluctuates by the minute, and is controlled by hidden mechanisms that set stock prices. Investors are at the mercy of the market in the sense that they have no access to the type of inside information that Halliburton and its corporate insiders have before deciding whether or not to purchase stock. Investors must rely on the accuracy of corporate representations and the resulting stock valuation. Requiring Plaintiffs to demonstrate actual affect in the market:
Overturning or altering Basic would not only harm the market by causing investors to hesitate before purchasing stock, but would leave investors with little to no chance of recovering for their losses once corporate misrepresentations come to light. In short, that result would grant corporations immunity to misrepresent their finances and operations at the expense of individual investors. Hopefully, the court will do the right thing and affirm the appeals court and keep the rule from Basic in effect.
Sources: John A. Sten, Jason C. Moreau, and Bridget K O’Connell, Back to Basic: Elimination the ‘fraud on the market’ presumption could be costly, 2014 Westlaw Journals Commentary, available at: http://blog.thomsonreuters.com/index.php/back-basic-eliminating-fraud-market-presumption-costly/
Amanda Frost, Academic highlight: Rethinking securities class actions, SCOTUSBLOG (Mar. 7, 2014, 4:21 PM), http://www.scotusblog.com/2014/03/academic-highlight-rethinking-securities-class-actions/
Ronald Mann, Argument recap: Justices not quite ready to jettison landmark securities decision, seeking middle ground, SCOTUSBLOG (Mar. 7, 2014, 4:45 PM), http://www.scotusblog.com/2014/03/argument-recap-justices-not-quite-ready-to-jettison-landmark-securitiesdecision-seeking-middle-ground/
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