And the bells rang out: “Wicked securities class action suits are dead!” At least this is what some hopeful prognosticators are saying now that the U.S. Supreme Court has decided to hear Halliburton v. Erica P. John Fund, a challenge to the way classes are certified in Section 10(b) securities cases. It’s a nice thought, but don’t drop the company’s D&O insurance just yet. While the Court has an opportunity in Halliburton to severely curtail securities class action suits, it probably won’t.
First, a quick reminder: securities class action suits are filed by a company’s shareholders against the company as well as its directors and officers. When they sue under section 10(b) of the Securities and Exchange Act, shareholders are suing for damages that resulted from material misrepresentations or omissions made by the company. Such a securities suit could be brought by an individual shareholder. The mega-dollar settlements reported in the press, however, are usually the result of a large group of shareholders suing as a class.
Should shareholders be allowed to sue as a class? Class certification is supposed to be granted in the name of judicial efficiency, and only when the class of individuals are similarly situated. Even in the ruling in Basic v. Levinson in 1988, the “similarly situated” part has been a layup for plaintiffs. In Basic, the Supreme Court accepted the fraud-on-the-market theory and held that in securities suits involving broadly traded stock, plaintiffs are presumed to have relied on the company’s misstatements. As a result, plaintiffs can obtain class certification without bearing the burden of proving that each plaintiff actually relied on the misrepresentation of the company he or she is suing when transacting in that company’s stock.
Even before Basic, the fraud-on-the-market theory has been widely criticized. The theory essentially holds that, in an efficient market, the price at which a security trades reflects all material public information. In challenging Basic, the Halliburton defense is asserting that this theory and the related presumption that all plaintiffs relied on the company’s alleged material misstatements should not stand. Instead, individual plaintiffs should be forced to show reliance on misstatements before the class status is granted.
It would indeed be a significant shift in the securities litigation landscape if the Supreme Court agrees with the Halliburton defense and overturns Basic. A reversal of Basic is, however, unlikely: Congress has amended the federal securities laws many times since 1988, but never took the opportunity to eliminate the presumption of reliance that Basic gives plaintiffs. It would be surprising for the current, conservative court to ignore this lack of action and change the law on its own.
Moreover, even if Basic were overturned, such a ruling would do nothing to eliminate the other major source of securities class action suits, Section 11 of the Securities Act. Companies are strictly liable under Section 11 for their misstatements when issuing securities; overturning Basic would not change this.
While it is worth being informed about the Halliburton case, for now there is no action item for inside counsel: the law has not changed, and a prospective change is too unlikely to justify taking the bold step of reducing the amount of D&O insurance a company buys to protect itself against securities class action suits. This is especially true for companies that regularly issue securities and as such have Section 11 in addition to Section 10(b) exposure.