RESPONDENT:Erica P. John Fund, Inc.
LOCATION: Halliburton Headquarters
DOCKET NO.: 13-317
DECIDED BY: Roberts Court (2010-2016)
CITATION: 573 US (2014)
GRANTED: Nov 15, 2013
ARGUED: Mar 05, 2014
DECIDED: Jun 23, 2014
David Boies – for the respondent
Malcolm L. Stewart – Deputy Solicitor General, Department of Justice, for the United States as amicus curiae supporting the respondent
Aaron M. Streett – for the petitioners
Facts of the case
Former shareholders of Halliburton Company (Halliburton) filed a class action lawsuit against the company and argued that Halliburton falsified its financial statements and misrepresented projected earnings between 1999 and 2001. In their petition for class certification, the shareholders invoked the “fraud on the market” presumption to demonstrate their class-wide reliance on Halliburton’s statements. The “fraud on the market” theory assumes that, in an efficient market, the price of a security reflects any material, public representation affecting that security. Therefore, under this theory, the law presumes that investors have relied on a material misstatement when they purchase a security at an artificially high or low price. The federal district court certified the shareholders as a class and prevented Halliburton from introducing evidence that the statements did not impact its stock prices at all. The U.S. Court of Appeals for the Fifth Circuit affirmed and held that Halliburton could not rebut the presumption that the plaintiffs relied on the statements until a trial on the merits of the plaintiffs’ claims.
May Halliburton challenge the class certification of its former shareholders by introducing evidence that the alleged fraud did not impact the price of the stock?
Media for Halliburton Co. v. Erica P. John Fund, Inc.
Audio Transcription for Opinion Announcement – June 23, 2014 in Halliburton Co. v. Erica P. John Fund, Inc.
I have our opinion this morning in Case 13-317 Halliburton versus Erica P. John Fund, Incorporated.
Under federal law, investors can sue anyone who knowingly makes a material misstatement or omission in connection with the purchase or sale of stock or any other security.
To recover damages for such fraud, an investor must prove among other things that he relied on the defendant’s misstatement in deciding to buy or sell stock, that is that he would not have bought or sold, had the misstatement never been made.
Well, that’s very hard to do.
For one thing, many investors who buy or sell stock on exchanges like the New York Stock Exchange will be unaware of misstatements made regarding a particular stock.
And even if they were aware of such misstatements, they would still have to prove something very speculative that they would’ve acted differently, let’s say sold rather than bought or held rather than sold, had the misstatement never been made.
Recognizing these difficulties, we held in our 1988 decision in a case called Basic Incorporated versus Levinson, that the investors could satisfy the reliance requirement by invoking a presumption that the price of stock traded in an efficient market reflects all public material information.
The theory was that if stock prices do reflect public material information, then, they will also reflect public material misstatements and when an investor decides to buy or sell a particular stock, he can be said to have relied indirectly on any misstatements reflected in the stock’s price.
We also held in the Basic case however that the presumption of reliance was rebuttable.
One way a defendant can rebut the presumption is by showing that his alleged misrepresentation did not actually affect the stock’s price.
In other words, that the misrepresentation had no price impact.
The theory was that if there were no price impact then an investor could not be said to have indirectly relied on a defendant’s misstatement simply by buying or selling stock at the market price.
Now, the Basic presumption proves crucial in securities class actions.
For a class action to be certified under federal rules, the plaintiffs must show that and this is a “questions of law or fact common to class members predominate over any questions affecting only individual members.”
Securities fraud plaintiffs would never be able to satisfy this requirement if they had to prove directly that each individually relied on a defendant’s misstatement.
The Basic presumption allows them to satisfy the reliance requirement on a classwide basis.
Because there generally cannot be a securities fraud class action without the Basic presumption and because the certification of a class action puts tremendous pressure on a defendant to settle the case much turns on when defendants may attempt to rebut the presumption.
Basic itself made clear that defendants could at least do so a trial after a class is certified.
But if a defendant may not also attempt to rebut the Basic presumption before class certification then the availability of rebuttal at trial will as a practical matter be of little use, the case will almost never make it that far.
Respondent Erica P. John Fund, Incorporated, EPJ Fund is the lead plaintiff in a putative class action against Halliburton and one of its executives.
The fund alleges that Halliburton attempted to artificially inflate the price of its stock by making a series of misrepresentations regarding its potential liability in asbestos litigation, its expected revenue from certain construction contracts and the anticipated benefits of its merger with another company.
When the truth was finally revealed, EPJ Fund contends Halliburton’s stock price dropped causing investors to lose money.
The fund moved to certify a class comprising all investors who purchased Halliburton’s stock during the period in question.
Halliburton argued that class certification was inappropriate because none of its alleged misrepresentations had actually affected its stock price.
By showing the absence of any price impact, Halliburton contented, it had rebutted the Basic presumption with the result that the plaintiffs would have to prove reliance on an individual basis and therefore could not proceed through a class action.
The courts below rejected this argument holding that Halliburton could use price impact evidence to rebut the Basic presumption but only at trial, not before class certification.
Halliburton now asked us to overrule Basic’s presumption of reliance and to instead require every securities fraud plaintiff to prove that he actually was aware of and relied on the defendant’s misrepresentation when he decided to buy or sell a company stock.
Now, Halliburton’s main argument for doing so is that Basic rested on two premises that no longer hold water.
The first premise is that a company’s stock price generally reflects public material information about the company.
Halliburton cites economic studies purporting the show that stock prices do not incorporate such information as quickly or completely as ones thought.
But Basic never suggested the capital markets are perfectly efficient.
It instead suppose only that public information generally affects stock prices.
That is why Basic allowed defendants to rebut the presumption of reliance by showing that despite the general efficiency of the market for a particular stock, a specific misstatement did not actually affect the stock’s price.
The economic debates cited by Halliburton have not refuted Basic’s fairly modest conception of market efficiency and certainly do not represent the kind of fundamental shift in economic theory that could justify overruling a precedent.
The second premise underlying the Basic presumption is that investors in deciding whether to buy or sell stock rely on the integrity of the stock’s price.
They trust in other words that the price is not tainted by fraud.
Halliburton disputes this premise as well on the ground that there are many investors who believe that stock prices do not accurately reflect material information and to try to beat the market by buying undervalued stock and selling overvalued ones.
Even these investors however rely on the integrity of market prices in the sense relevant for the Basic presumption.
They implicitly believe that a stock’s market price will eventually reflect material information otherwise, they wouldn’t make any money.
And their estimates of how undervalued or overvalued a particular stock is can be skewed by a market price tainted by fraud.
Halliburton also argues that by facilitating securities class actions, the Basic presumption produces a number of serious and harmful consequences.
Such concerns however are more appropriately addressed to Congress which has in fact responded to some extent to many of them by enacting legislation, the place’s limits on securities class actions.
We will not overrule our decision in Basic.
Halliburton proposes two alternatives to overruling Basic.
The first would alter the prerequisites for invoking the Basic presumption.
Currently, plaintiffs must show that the defendant’s misrepresentation was public and material and that the stock traded on an efficient market.
When these conditions are present, it is likely that the defendant’s misrepresentation affected the stock price.
Halliburton’s first proposal would instead require plaintiffs to prove that a defendant’s misrepresentation actually affected the stock price that it had what we call price impact.
Only then could the plaintiff be said to have relied on the misrepresentation when he bought or sold the stock.
But Halliburton’s arguments for imposing this requirement are the same as its arguments for overruling the Basic presumption altogether and we do not accept them.
Halliburton’s second fallback argument would allow defendants to do what the District Court and the Fifth Circuit prohibited Halliburton from doing here.
Try to rebut the Basic presumption before class certification with evidence of lack of price impact.
We agree that defendants must be allowed to do this.
It is undisputed that defendants may introduce price impact, evidence at trial to rebut the Basic presumption.
Basic itself said as much.
But both plaintiffs and defendants also introduced general price impact evidence at the critical class certification stage before trial.
They do this to show that the market is either efficient or inefficient as a general matter as a predicate for invoking or rejecting the Basic presumption.
A plaintiff might show for example that when a company issued a good earnings report that stock went up, and when it issued a bad one that stock went down.
This helps to prove that an alleged misrepresentation would also be reflected at the market price so reliance could be presumed when an investor bought at the market price.
But if you can look at a number of events to show that the stock price responds to such events as a general matter, why not allow parties to look at the actual event at issue, the alleged misrepresentation and see if it had any effect on the market price which you allowed to be prove or disprove indirectly, you should allowed to be prove or disprove directly.
An indirect proxy should not preclude a court from considering a defendant’s direct, more salient evidence showing that it’s alleged misrepresentation did not actually affect the stock’s market price and consequently that the Basic presumption does not apply.
We thus — thus hold that defendants must be afforded an opportunity before class certification to defeat the Basic presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock because the courts below denied Halliburton, that opportunity, we vacate the Fifth Circuit’s judgment and remand the case for further proceedings consistent with this opinion.
Justice Ginsburg has filed a concurring opinion in which Justice Breyer and Justice Sotomayor joined.
Justice Thomas has filed an opinion concurring on the judgment in which Justice Scalia and Justice Alito joined.