U.S. Supreme Court Upholds the Fraud-on-the-Market Doctrine

Posted on: June 23rd, 2014 by Keith Dubanevich
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On June 23, 2014, the U.S. Supreme court issued its opinion in Halliburton Co. v. Erica P. John Fund, Inc. and upheld the fraud-on-the-market doctrine.  The doctrine sets forth that the market, including Wall Street analysts and other professional investors, reviews the material public information about the company and sets the price for a security based on that information.

This is the second time that the Supreme Court has reviewed the Halliburton case.  Originally filed in 2002, the plaintiffs alleged that the defendants violated sections 10(b) and 20(a) of the Securities Exchange Act by deliberately falsifying financial results and misleading the public about certain activities by Halliburton.  After surviving a motion to dismiss, and after discovery, the plaintiffs moved to certify a class.  The plaintiffs used the fraud-on-the-market presumption to assert securities fraud on a class-wide basis and not have to prove individual reliance on a particular misrepresentation to recover.  The defendants argued that the plaintiffs had to prove loss causation as required by the Fifth Circuit’s decision in Oscar v. Allegiance Telecom.

The district court agreed with the defendants and denied class certification, and the Court of Appeals for the Fifth Circuit affirmed.  The Supreme Court overruled, holding that a plaintiff need not prove loss causation in order to obtain class certification.  On remand, the Fifth Circuit rejected Halliburton’s attempt to defeat class certification by offering evidence in the absence of price impact.  The Fifth Circuit held that, while the materiality of a misrepresentation must at some point be proven in order to invoke the fraud-on-the-market presumption of reliance, the resolution of the question presents a common issue that affects all class members’ claims equally.  The Fifth Circuit also held that, because Halliburton’s price impact evidence was offered only for the purpose of generally rebutting the presumption of reliance, and affected the ability of all class members to succeed on the merits of their claim, it could not be considered at class certification.

Defendants appealed that decision to the Supreme Court.  The Supreme Court upheld the fraud-on-the-market doctrine, as originally delineated in Basic Inc. v. Levinson, and found that Halliburton failed to show a “special justification” for overruling Basic’s presumption of reliance.  Further, the Court declined to modify the prerequisites for invoking the fraud-on-the-market presumption by requiring plaintiffs to prove “price impact” directly at the class certification stage.  However, the Court agreed with Halliburton that defendants must be given an opportunity to rebut the presumption of reliance before class certification with evidence of a lack of price impact.  The Court reasoned that forbidding defendants to rely on the same evidence prior to class certification for the particular purpose of rebutting the presumption could lead to results that are inconsistent with Basic’s own logic.