Basic Is Anything But: Courts Continue To Wrangle With The Fraud-On-The-Market Presumption

It has been 25 years since the Supreme Court announced the fraud-on-the-market presumption of reliance in Basic Inc. v. Levinson, 485 U.S. 224 (1988). Yet many courts, including the Supreme Court itself, continue to struggle in applying the presumption to securities fraud class actions. The Court will have another opportunity to either further clarify its position, or change course all together and reconsider its decision in Basic, if it chooses to review the Fifth Circuit's recent decision in Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423 (5th Cir. 2013).

BASIC: THE SUPREME COURT ADOPTS THE FRAUD-ON-THE-MARKET PRESUMPTION

Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder make it unlawful to misstate a material fact in connection with the purchase or sale of any security. One of the required elements of a claim under Rule 10b-5 is reliance - a claimant must show that he relied on the material misstatement in making his investment decision. This creates a problem in class actions because reliance typically involves an individualized inquiry, which would preclude certification. At the same time, Rule 10b-5 claims are often brought on behalf of large groups of shareholders that hope to benefit from the simplified resolution of their claims on a class-wide basis.

The Supreme Court balanced these competing interests and came out in favor of class claimants in Basic Inc. v. Levinson, 485 U.S. 224 (1988). The Court held that the fraud-on-the-market presumption of reliance applied to Rule 10b-5 claims, making them amenable to class resolution. The presumption is based on the theory that, in an open, developed and efficient market, market prices reflect all publicly available material information about the company. Thus, when a shareholder makes a decision to trade the company's security, he can assume the market price is a fair representation of the security's value. In other words, he makes that trading decision in reliance on the integrity of the market price. The Supreme Court in Basic held that this creates a presumption of reliance sufficient to satisfy the reliance requirement of Rule 10b-5, and thus relieves claimants of the burden of proving actual reliance on the misstatement. Defendants may then rebut the presumption with any evidence that "severs the link" between the misstatement and the security's price or the claimant's decision to trade at that price.

AMGEN: CLAIMANTS DO NOT NEED TO...