On Monday June 23, the Supreme Court released its decision in Halliburton v. Erica P. John Fund. While the Court did not toss out the fraud-on-the-market precedent credited to the Basic v. Levinson case of 1988, it has given corporate defendants leverage to fight back when they’re on the receiving end of a shareholder class action lawsuit. To understand the basis of the decision it’s important to look not only at the underlying facts of the case, but also the precedent it challenged.
Aaron Streett, head of the Supreme Court and constitutional law practice at Baker Botts LLP, presented oral arguments for Halliburton during the case, and breaks out the grounds under which plaintiffs initially brought suit against the company.
“The plaintiffs alleged that Halliburton made misleading statements about its asbestos liability, its accounting practices and the benefits from a merger. Plaintiffs alleged that those misrepresentations prevented the stock price from dropping, and when the issues were revealed there was a price drop. Halliburton alleged that there were no misrepresentations, and that in any event the alleged misrepresentations didn’t distort the market price so there is no way to have a class,” Streett says.
However, under Basic, the theory of fraud on the market was upheld, and courts found that, because investors assume an efficient stock market and presume prices are accurate when they make investment decisions, they do not need to show that they relied on material statements from the company to be considered part of a class. Halliburton’s rejection of the class that had been certified in the suit challenges this precedent, and this matter ultimately made its way to the Supreme Court.
Ultimately the Supreme Court decided that the fraud-on-the-market presumption would be upheld, however its decision now gives defendants of shareholder suits more leverage for fighting back.
“It is a middle of the road ruling in that they didn’t overturn Basic. So in that sense it just maintains status quo. The second part however is a big step forward for defendants. Under the 5th circuit’s ruling that Halliburton appealed, that court said Halliburton couldn’t even contest whether the misrepresentation affected the market price before the class was certified. The Supreme Court’s ruling changes that,” Street explains.
Streett also says that stipulation alone is a big win for shareholder class action defendants. “It’s important, because it puts that price impact question at issue before the class is certified…once the class is certified the potential sum of damages makes settlement pressure so immense that any board of directors needs to consider it.”
The news is not only a relief to companies that may have had to weigh their options in the wake of a big class action suit, but also another point in the Supreme Court’s trend towards heavier scrutiny to the assembly of classes targeting corporations.
“In other areas of the law, the court has been increasingly careful to require plaintiffs to prove that a class is warranted,” Streett says. “Until this ruling, there was essentially an exception to that rule in securities class action cases. This ruling brings securities more in line with the Supreme Court’s approach in the Walmart gender discrimination case, and the Comcast case relating to antitrust class certification.”