The Supreme Court has raised the class certification stakes yet again, holding in Halliburton v. Erica P. John Fund that defendants in securities class actions may rebut the fraud-on-the-market presumption of reliance at the class certification stage. Over the objections of Justices Thomas, Scalia, and Alito, the Court declined to toss out the presumption altogether.
The fraud-on-the-market presumption of reliance, first recognized in Basic v. Levinson, permits a plaintiff to show indirectly that the defendant’s misrepresentation impacted the price of its stock. In Halliburton, the Court observed that price impact is “an essential precondition” for a securities class action because if the presumption does not apply, each individual plaintiff must prove its own reliance, causing individual issues to predominate over common issues. Therefore, the Halliburton Court reasoned that it would be illogical to permit indirect proof of price impact through the fraud-on-the-market presumption at the class certification stage — as a plaintiff may do to prove market efficiency — yet not permit direct evidence of no price impact, i.e., “showing that the alleged misrepresentation did not actually affect the stock’s market price and, consequently, that the Basic presumption does not apply.”
The Supreme Court found this dichotomy particular troubling because defendants may already introduce evidence of a lack of price impact at either the merits stage or to show at the class certification stage that the market is not efficient. Likewise, the Court observed that plaintiffs can introduce price impact evidence to show that the defendant’s stock price generally responds to publicly reported events. Accordingly, said the Court, the defendants’ evidence may show that the market is efficient, but the alleged misrepresentation had no price impact. In this situation, if the defendant is not permitted to rebut the presumption at the class certification stage, the action will proceed as a class action despite the fact that the fraud-on-the-market theory cannot possibly apply and common reliance cannot be presumed.
The Court distinguished its holding in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds that a plaintiff need not prove — and defendants may not disprove — materiality at the class certification stage. It reasoned that materiality differs from price impact in that it “is an objective issue susceptible to common, classwide proof.” In other words, a plaintiff’s failure to prove materiality would not cause individual issues to predominate over common ones, but evidence that an alleged misrepresentation had no impact on a stock’s price would do so.
While handing another weapon to defense counsel in securities class actions, the Supreme Court nevertheless preserved a valuable tool for plaintiffs who may have difficulty establishing reliance on an individual basis by declining to entirely dispose of the presumption. The Court recognized that Basic’s rationale — that requiring proof of individualized reliance from every securities fraud plaintiff would preclude use of the class action device — remains valid. It stated that a plaintiff is not relieved of the burden of establishing reliance at the class certification stage but that it is permitted to satisfy its burden by “proving the prerequisites for invoking the presumption — namely, publicity, materiality, market efficiency, and market timing.”
Halliburton will benefit companies defending against securities fraud class actions by enabling them to defeat weak claims prior to the class certification stage and thereby avoid the pressure to settle claims of dubious merit at greater cost after certification. While the costs of expert discovery at the class certification stage will likely rise, it may be a small price to pay for earlier resolution of securities claims.