Halliburton II: Recognizing Costs To Companies, Justices Provide Securities Litigation Defendants New Opportunity To Defeat Class Certification

On June 25, 2014, the U.S. Supreme Court decided Halliburton Co. v. Erica P. John Fund, No. 13-317, __ U.S. __ (2014), slip op. (U.S. June 23, 2014) (Halliburton II), holding that defendants in a class action securities lawsuit must be allowed to defeat the fraud-on-the-market presumption of reliance at the class certification stage through evidence that the alleged misrepresentation did not have an impact on the defendant company's stock price. While the decision may not prevent investors from filing class action securities lawsuits, as some had hoped, Halliburton II does provide companies with a meaningful opportunity to defeat class certification.

Background

To bring a securities fraud lawsuit under Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and the U.S. Securities and Exchange Commission (SEC) Rule 10b-5, an investor plaintiff must prove, among other things, that he or she individually relied on the alleged misrepresentation. If courts strictly applied this requirement in the class action context, then common questions would not "predominate" for purposes of satisfying Federal Rule of Civil Procedure Rule 23(b)(3). Instead, each investor would have to testify that he or she was aware of the alleged misrepresentation and made an investment decision based on that representation.

In Basic Inc. v. Levinson, 485 U.S. 224 (1988), the Supreme Court resolved this problem by holding that prospective investor classes could use a proxy for individual reliance by establishing a rebuttable presumption of class-wide reliance via the fraud-on-the-market theory. Under this theory, as long as a company's stock trades in an efficient market, all public information about that stock is viewed as being incorporated in the stock's price - including the alleged misrepresentation. Thus, a court may presume that all members of the putative class indirectly relied on the alleged misrepresentation through reliance on the stock's market price, so long as plaintiffs can prove an efficient market.

Over the years, federal district courts have applied the presumption to certify classes of investor plaintiffs. Proof of efficient markets has been based on such factors as whether the average weekly trading volume of the defendant company's stock was robust, whether there was a high number of analysts and professional investors following and trading in the stock, whether the company had a history of making available detailed SEC filings, and...