On November 15, 2013 the Supreme Court agreed to hear Halliburton Co. v. Erica P. John Fund, Inc., a case that has the potential to overturn one of the foundations of securities class actions. In Halliburton, the Court will decide whether to continue applying the fraud-on-the-market doctrine to securities class actions.
Halliburton challenges the rule laid down in Basic Inc. v. Levinson. In Basic, the Court ruled that investors take into account any public announcement when buying shares. This principle was based on a respect for market efficiency – that all information is reflected in the share price in a market where the product is routinely traded. Therefore, any misstatement by a company would impact the company’s share price whose value would have otherwise been accurately captured. The rule laid out in Basic came to be known as the fraud-on-the-market presumption. As a result, shareholders do not have to evidence loss and its direct connection to the misleading announcement- that they actually relied upon the misleading information to buy shares. Overruling Basic could result in a significant reduction in securities class actions primarily because a heavy burden of proof would be transferred to investors.
Halliburton’s arguments are mainly based on research into the impact of Basic on the market. Halliburton argues that research has shown that markets are less efficient than the Court thought them to be in Basic. Halliburton’s sources many supporting examples for its arguments from the 2008 crisis. Halliburton also argues that it should have the chance to overturn the presumption laid down in Basic by providing evidence that there was no adverse impact on the company’s share price.
The U.S. Chamber of Commerce, the National Association of Manufacturers, and former members of the U.S. Securities Exchange Commission together with law professors filed amicus (friend-of-the-Court) briefs in support of Halliburton among other briefs. A textual argument is presented in the briefs expressly mentioned above: Basic conflicts with the Court’s interpretation of Section 10(b) of the Securities Exchange Act. The amici argue that when the Court defines the contours of the right of action under Section 10(b) it should look to analogous provisions. The closest analogue is Section 18 of the Exchange Act, which requires plaintiffs to provide evidence that they actually relied on the misleading information, according to the brief.
Investors who bought Halliburton shares between 1999 and 2001 filed the class action alleging that the company’s misleading information about its asbestos liabilities, revenues from construction contracts, and benefits of its 1998 merger with Dresser Industries constituted securities fraud. Erica P. John Fund took the lead of the shareholders and argues that the fraud-on-the-market theory is crucial to private securities actions, and that Congress has already had the chance to overrule the principle, but has not done so. Respondents also argue that the market efficiency theory that is foundational to Basic has not been undermined, and that Congress expressly relied on this theory in the Security Exchange Act.
It is true that overruling Basic may represent a loss to investor rights and weaken a powerful engine of civil liability established in the securities market. However, a closer look into securities class actions litigation demonstrates that investors are possibly employing fraud-on-the-market as insurance in response to losses for which they do not have a specific explanation. Furthermore, the burden of defending securities litigation falls on current shareholders because amounts that companies pay in these cases eventually represent an adverse impact for current shareholders. Reuters reports that there have been 3,050 securities class actions between 1997 and 2012 resulting in settlements of more than $73.1 billion.
Oral arguments and a ruling are expected by the end of June 2014. Four justices have already demonstrated willingness to revisit Basic. This can be inferred from dissenting opinions in Amgen, Inc., v. Connecticut Retirement Plans & Trust Funds and the decision to hear Halliburton. It is not possible to predict the Supreme Court’s ruling, but undoubtedly this case has a strong potential of reforming one of the most important principles for securities fraud.