The Second Opinion: U.S. Supreme Court To Reconsider Fraud-on-the-Market Theory

On November 15, 2013, the U.S. Supreme Court agreed to hear an appeal in which it will reconsider the "fraud-on-the-market" theory that has been one of the cornerstones of private securities litigation in the United States for the past 25 years. The questions presented to the Court in Halliburton Co. v. Erica P. John Fund, Inc. are as follows:

1. Whether this Court should overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory.

2. Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.

This is the second time the Halliburton case has come before the U.S. Supreme Court. The Court previously decided in Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011) that plaintiffs need not prove loss causation to obtain class certification of secondary market misrepresentation claims under SEC Rule 10b-5. But the potential implications of Halliburton 2 are much broader.

In order to establish liability under Rule 10b-5, the plaintiff must show that it relied upon the defendant's misrepresentation when purchasing or selling their security: Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 133 S. Ct. 1184, 1192 (2013). Although the parallel Canadian securities legislation permits secondary market claims without regard to the plaintiff's reliance, a similar reliance requirement exists in Canada for the common law torts of fraudulent and negligent misrepresentation: Parna v. G. & S. Properties Ltd., [1971] SCR 306 at 316-320; Sharbern Holding Inc. v. Vancouver Airport Centre Ltd., [2011] 2 SCR 175 at paras. 121 and 129. When this requirement is applied in a class action, it can make certification very difficult to obtain, since the individual issues associated with proving reliance will often overwhelm the issues that are common to the class.

The fraud-on-the-market theory was developed to combat this difficulty. As accepted in Basic Inc. v. Levinson, 485 U.S. 224, 241-242 (1988), to which the theory is generally traced, fraud-on-the-market creates a rebuttable presumption of class-wide reliance based on the following logic:

The fraud on the market theory is based on the...