The Supreme Court ruled on June 23rd in Halliburton, upholding the Fraud on the Market theory, but allowing Defendants to rebut the presumption at the class certification stage

Three years ago, the United States Supreme Court threw out the ability of U.S. investors to sue foreign fraudsters in the U.S. in the Morrison v. National Australia Bank litigation. As a result, investors who have been defrauded by purchases of foreign traded stocks must litigate abroad – a proposition often too expensive, complex and risky to warrant active involvement.

Next defendants tried to get rid of securities fraud class actions altogether.  On March 5, 2014, the Supreme Court heard arguments in Halliburton Co. et al. v. Erica P. John Fund on whether securities laws require each damaged investor to prove that they read or heard the fraudulent statement.

Specifically, the issue argued before the Supreme Court was whether the “fraud on the market” doctrine, adopted by the Supreme Court more than 25 years ago in Basic, Inc. v. Levinson, was based on sound economics ---and hence---whether it should still be used by the Court to presume reliance by each individual investor. Halliburton argued to the Supreme Court that the “efficient market” theory has been discredited and therefore, the “fraud on the market doctrine” should be thrown out.

On June 23rd, the Supreme Court soundly rejected this argument. Chief Justice Roberts, writing for the majority, stated “before overturning a long-settled precedent … we require a special justification” and concluded that Halliburton had not identified the kind of fundamental shift in economic theory that could justify overruling a precedent. Rather, the Justices signaled an interest in adopting an approach – suggested by two law professors – requiring proof that the misrepresentation distorted the price of the stock. The court acknowledged that plaintiffs already commonly submit such proof with event studies at the merits stage….noting that it “did not make sense” to preclude defendants from introducing  that same evidence prior to class certification for the particular purpose of rebutting the presumption altogether.

Justice Ginsburg, with whom Justices Breyer and Sotomayor joined, wrote a one paragraph concurrence, stating that while advancing “price impact consideration from the merits stage to the certification stage may broaden the scope of discovery available at certification”, the defendant bears the burden of proving any absence of price impact. Accordingly, the Justices foresaw no “heavy toll on securities-fraud plaintiffs with tenable claims.”

In dissent, Justices Thomas, joined with Scalia and Alito, made clear that, if they had their way, they would not even get to the question of proving price impact or fraud on the market. Rather, they would throw out the implied right of investors to bring an action under 10b-5, stating that “the implied Rule 10b–5 private cause of action is ‘a relic of the heady days in which this Court assumed common-law powers to create causes of action.’ ”

Regardless of what we consider to be a plaintiff victory, Halliburton case should remind investors to review their investment processes and procedures and be prepared for any outcome.

With the Supreme Court allowing proof of stock price impact at the class certification stage, little changes, but cases may be more costly at the front-end, with the possibility of being thrown out sooner.

In the worst case scenario, if more cases are thrown out at the class certification state, investors need to consider factors for deciding whether or not to pursue an individual case.

Investors are also reminded to review their opt-out decision processes and procedures.

In pursuing either an individual case or an opt-out case investors must ask themselves the following questions:

Is it worth the time? Is it worth the cost? What are the prospects of an individual recovery? Are there others with whom the investor can join to take advantage of economies of scale? Are there broader legal theories or remedies that can be taken advantage of other than the federal securities laws? Should the case be brought in state or federal court?

Even more importantly, in either situation, institutional investors may have to prove individual reliance on the company’s misstatements. That may be difficult, if not impossible, for public funds. Institutional investor clients often employ passive investment management, indexing or technical strategies. None of these strategies involve review of the actual statements made by the company. Even when they do purchase individual stocks based upon an analysis of that stock, institutional investors rarely keep track of everything they have read.

Therefore, if institutional investors want to maintain the ability to hold fraudsters accountable when price impact precludes certification, resources will have to be devoted to capturing the information relied upon in making the stock purchase. State common law and statutory claims, filed either in federal or state court, will also be available to some investors and may become the preferential sources of relief. The Securities Litigation Uniform Standards Act of 1998 (SLUSA) which precludes the use of state laws for most investors, will still offer alternative causes of action to:

• State Pension Funds – defined by statute as, “a pension plan established or maintained for employees of a state or political subdivision, agency or instrumentality,” may still bring individual actions or class actions with other State Pension Funds if provided for under state law;
• Suits brought by fewer than 50 investors seeking the same relief under state law; and
• Private-party claims brought under the law of the state in which the issuer is incorporated or organized.

Irrespective of Halliburton, there will still be class actions for fraud that occur during a stock offering under Section 11 of the Securities Act. Under Section 11, reliance on the registration statement is an element of the claim only if the stock was purchased more than 12 months after the offering and after an earnings statement has been made available to investors.

In the long run, little will change to the securities practice as a result of Halliburton. But it is a reminder to be vigilant that some cases may require proof of individual reliance and institutional investors should preserve such evidence.