The Supreme Court approves a new tool to defeat class certification in federal securities fraud cases brought in the Fifth Circuit – price impact evidence
The Supreme Court decision in Halliburton v. Erica P. John Fund, Inc., 134 S.Ct. 2398 (2014) concerns a federal securities fraud class action. The case was appealed from the Fifth Circuit. In Haliburton, the Supreme Court rejected the Fifth Circuit’s holding that defendants could not present direct impact evidence at the class certification stage to rebut the fraud-on-the-market presumption of reliance.
To maintain a class action, Federal Rule of Civil Procedure 23(b)(3) requires a finding that “questions of law or fact common to class members predominate over any questions affecting only individual members . . . .” In other words, if adjudication of the claims of individual members requires a separate inquiry for each class member into significant elements of those claims, a class action is not the proper vehicle to resolve such claims. Before 1988, this requirement for class certification could present a particularly difficult impediment to maintain federal securities fraud class actions asserting claims under Section 10(b) of the Securities Exchange Act of 1934 and the Securities Exchange Commission’s Rule 10b-5.
Section 10(b) and Rule 10b-5 prohibit material misstatements or omissions in connection with the purchase or sale of any security. A plaintiff’s recovery under section 10(b) and Rule 10b-5 requires proof of, among other elements, the plaintiff’s “reliance upon the misrepresentation or omission . . . .” Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730 (1975). Whether a person actually relied on a material misstatement is an inherently individualized inquiry. That necessary individualized inquiry meant that a putative class could not satisfy Rule 23(b)(3), making class certification improper.
The Supreme Court’s 1988 decision in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), however, provided plaintiffs with a mechanism to demonstrate reliance for an entire class without individualized proof of reliance. In Basic, the Supreme Court held that plaintiffs could establish a presumption of reliance based on the fraud-on-the-market theory. That theory assumes that prices of securities traded on developed markets reflect all publicly available information, including the misrepresentations that provide the basis for a securities fraud claim. In other words, the market relied and then traded on a price the market assumed was based on true information, when in fact the price was improperly affected by false information. Establishing the reliance presumption requires (1) a public misrepresentation, (2) that is material, (3) about a security traded in an efficient market and (4) that the plaintiff traded between the time of the misrepresentation and the revelation of the truth. The reliance presumption, however, is rebuttable. To rebut the presumption requires evidence that no “link,” in fact, exists between the alleged misrepresentation and the price at which the plaintiff traded.
Consistent with the Basic decision, the Fifth Circuit had held a defendant could present price impact evidence to defeat plaintiffs’ claims at a trial on the merits. Even so, the Fifth Circuit refused to permit the presentation of price impact evidence to rebut the presumption at the earlier class certification stage. Other circuits, such as the Second Circuit, disagreed and allowed the defendants to present price impact evidence at the class certification stage to rebut the reliance presumption and defeat class certification.
In Haliburton, the Supreme Court rejected the Fifth Circuit’s position on the issue. The Court held that defendants could present price impact evidence to rebut the reliance presumption at the class certification stage. The Court observed that the fraud-on-the-market theory and the prerequisites necessary to establish the reliance presumption are themselves an indirect way for plaintiffs to demonstrate that a misrepresentation impacted a security’s price. The Supreme Court reasoned that to ignore a defendant’s salient direct evidence of no price impact and allow the class action to proceed is both illogical and wasteful.