On March 5, 2014, the U.S. Supreme Court heard oral argument in Halliburton Co. v. Erica P. John Fund, Inc., where Halliburton asked the Court to overrule the controversial fraud on the market theory that was established in the Court’s 1988 Basic v. Levinson decision. The fraud on the market theory allows plaintiffs to presume reliance on a defendant’s material misrepresentation when the security is traded in an efficient market. Halliburton initially argued to the Court that Basic was improperly decided because it created a presumption of reliance where actual reliance is usually required. Prompted by Justice Kagan, who seemed reluctant to overturn precedent Congress had sub silentio endorsed in the Private Securities Litigation Reform Act (“PSLRA”) and the Securities Litigation Uniform Standards Act, Halliburton also argued that changed circumstances required its reversal. Halliburton asserted that since Basic the Court has continuously taken a narrow approach to interpreting the private right in section 10(b), that the Court has disfavored presumptions of class-wide issues, and that the economics have changed with many investors utilizing high-frequency trading strategies that do not rely on the integrity of the market.
Discussion, however, quickly turned to Halliburton’s fallback position and a position articulated in an amicus brief submitted by a group of law professors. The so-called “midway position” would call for event studies at the class certification stage to determine whether the alleged misrepresentation affected the market price. Halliburton argued that the burden should be on plaintiffs to establish the connection because it would be consistent with Rule 23 of the Federal Rules of Civil Procedure to require plaintiffs to show that common issues of reliance predominate over the class. Justices Kennedy, Scalia, and Roberts all expressed at least some interest in the midway position. Justices Kagan and Breyer struggled with how the midway position would fit in with the Court’s decision last year in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, which held that materiality did not need to be proven at the class certification stage.
The Erica P. John Fund argued that the fraud on the market theory, and its underlying premise—that fraudulent misrepresentations made in public necessarily affect the market price in an efficient market—is the whole foundation of the securities laws, that nothing has changed since Basic, and that, if anything, the markets are more efficient today than when Basic was decided. The Fund also expressed doubts about allowing Basic’s presumption to be contested at the class certification stage because it would involve merits discovery prior to class certification. The Government, in contrast, conceded that the midway position would affect plaintiffs less dramatically than disposing of the fraud on the market theory altogether. The justices also expressed competing policy concerns, including that an in terrorem effect causes many class action lawsuits to settle after the class is certified, regardless of the case’s merits, and that the PSLRA and summary judgment practice already place significant barriers to plaintiffs’ recovery in securities actions.
A decision on the case is expected near the end of the Court’s term, which ends June 30, 2014.