Supreme Court To Revisit Fraud-on-the-Market Basis for Class Certification

On 5 March, 2014, the Supreme Court will hear argument in a suit that has the potential to alter significantly the landscape of class action litigation in the United States.  The case, an alleged class action based on securities fraud, calls into question the approach taken by US courts in securities cases for the last 25 years, but could also have ramifications extending beyond securities litigation.  Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317 (U.S. Nov. 15, 2013).

In 1988, the Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224 (1988) adopted a presumption of class-wide reliance under the “fraud-on-the-market” theory, paving the way for numerous securities fraud class actions.  The Basic presumption borrows from the “efficient market” hypothesis: that, in a well-developed market, a company’s stock price will reflect all public information regarding the company and its business.  Under Basic’s “fraud-on-the-market” theory, it may be presumed at the class certification stage that investors purchasing a publicly traded security relied on a defendant’s alleged misrepresentations by relying on the market price, which Basic posits is distorted by public misinformation.  Basic facilitates class certification by removing the need for individualised proof that each class member relied on statements by the defendant.  Absent the “fraud-on-the-market” presumption, investors could obtain class certification only through proof that they relied on false information in common, a difficult standard to meet given that individual investors enter into transactions based on their own individual circumstances and information.

In Halliburton, the Court has been asked to overrule or substantially modify its decision in Basic and to require proof that each member of a prospective class of investors actually relied on a misrepresentation by the defendant.  The case has potential significance beyond the securities context, as class action plaintiffs frequently seek to rely on a version of the “fraud-on-the-market” presumption in non-securities cases where the allegations involve consumer fraud, deceptive marketing, and products liability claims.

Halliburton’s petition to revisit the Basic decision follows criticism of the “fraud-on-the-market” theory voiced by four of the nine justices in a decision issued last term in Amgen, Inc. v. Conn. Ret. Plans and Trust Funds, 133 S.Ct. 1184 (2013).  Justice Alito, who concurred with the majority in Amgen, wrote separately to note that “reconsideration of the Basic presumption may be appropriate” because “more recent evidence suggests that the presumption may rest on a faulty economic premise.”  Justice Thomas, joined by Justices Scalia and Kennedy, stated in dissent that the Basic decision itself is questionable as the portion of the opinion adopting the fraud-on-the-market theory was joined by only four justices.  Justice Thomas further reiterated concern that “[c]onfusion and contradiction in court rulings are inevitable when traditional legal analysis is replaced with economic theorisation by the federal courts” and that the Court is “not well equipped to embrace novel constructions of a statute based on contemporary microeconomic theory”. 

Because the “fraud-on-the-market” theory has been relied upon by class-action plaintiffs in the United States in a variety of contexts, the Court’s decision in Halliburton could have broad effects on US class action litigation.

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