Class Certification: Back to 'Basic'
Twenty-five years ago, a four-justice majority of the Supreme Court held, in Basic v. Levinson, 485 U.S. 224 (1988), that a putative class of investors need not prove actual common reliance on a misrepresentation to achieve class certification and prevail upon the merits. Instead, they may invoke a classwide presumption of reliance, the "fraud-on-the-market presumption," based upon the theory that the market price of a security in an efficient market will immediately incorporate any material, public representation, and thus a purchaser who buys a security at the market price will be presumed to have relied upon the representation. The Supreme Court is now being asked to overrule Basic because (1) its theoretical economic framework, the "efficient capital markets hypothesis," has been repudiated through scholarly and empirical attack, (2) there has been a high level of inconsistency in the courts regarding market efficiency, which is required to trigger the presumption, and (3) the Basic presumption is inconsistent with recent Supreme Court's holdings.1
The opportunity to reconsider Basic is presented through a petition for a writ of certiorari by Halliburton Company from a Fifth Circuit decision in Erica P. John Fund v. Halliburton, 718 F.3d 423 (5th Cir. 2013), which affirmed a district court order granting class certification over Halliburton's opposition.2 If certiorari is granted, it would be the second time the Supreme Court considered this case. Previously, the district court denied class certification and was affirmed by the U.S. Court of Appeals for the Fifth Circuit, which held that proof of loss causation was required to establish the predominance of common issues under Rule 23(b)(3).3 The Supreme Court granted certiorari and reversed, sub. nom Erica P. John Fund v. Halliburton, 131 S.Ct. 2179 (2011) (EPJ Fund), holding that proof of loss causation was not required at the class certification stage. In doing so, the Supreme Court declined to address Halliburton's assertion that it was entitled to rebut the fraud-on-the-market presumption or "any other question about the presumption, or how and when it may be rebutted." 131 S.Ct. at 2187.
On remand, Halliburton argued that class certification should be denied because the alleged misrepresentations did not impact the price of its stock, thus rebutting the fraud-on-the-market presumption. The district court refused to consider Halliburton's evidence to that effect, finding such evidence did not bear on whether common issues predominated under Rule 23(b)(3). In the Fifth Circuit, Halliburton argued that it should be permitted to show the absence of price impact at the class certification stage to establish that the presumption should not apply and, thus, common issues among class members do not predominate and class certification was inappropriate.
Relying on the Supreme Court's rationale in Amgen v. Conn. Ret. Plans and Trust Funds, 133 S.Ct. 1184 (2013) (holding that proof of materiality was not required to satisfy Rule 23(b)(3)'s requirement of common question predominance), the Fifth Circuit explained that "the focus of the Rule 23(b)(3) class certification inquiry—predominance—is not whether the plaintiffs will fail or succeed, but whether they will fail or succeed together." 718 F.3d at 431. Accordingly, the court had to determine "whether the failure to prove price impact will necessarily cause all plaintiffs' claims to fall together." Id. at 434.
Because "[p]rice impact can be shown either by an increase in price following a fraudulent public statement or a decrease in price following a revelation of the fraud," the Fifth Circuit reasoned that "[t]o successfully prove a lack of price impact, Halliburton would thus be required to demonstrate both that the stock price did not increase when the misrepresentation was announced, and that the price did not decrease when the truth was revealed." Id. (Emphasis added.) However, because a showing of price impact is required to establish loss causation, if Halliburton were successful in rebutting the presumption by proving no price impact, "the claims of all individual plaintiffs would fail because they could not establish an essential element of the fraud action." Id. Citing Amgen, the Fifth Circuit reasoned that "the class members' claims will have failed on their merits, thus bringing the litigation to a close." Id., citing Amgen, 133 S.Ct. at 1204.
The Fifth Circuit found "[t]he Amgen court's analysis leads to the conclusion that price impact fraud-on-the-market rebuttal evidence should not be considered at class certification." Id. at 435. Because proof of price impact is based on common evidence and proof of no price impact will not result in the possibility of individual claims continuing, Halliburton's evidence with respect to price impact "does not bear on the question of common question predominance, and is thus appropriately considered only on the merits after the class has been certified." Id.
In its petition, Halliburton argues that (1) Basic should be overruled,4 and (2) alternatively, the Supreme Court either should require plaintiffs to prove actual market price distortion, or should clarify that defendants may rebut price distortion at the class certification stage.
Arguing that the Basic majority erred "by substituting economic theory for law—and bad economic theory at that"—and by "trust[ing] in the accuracy of then-recent empirical studies," Halliburton asserts that "[a]cademics have largely given up on Basic's economic premises," and practical experience and empirical evidence now show that the fraud-on-the-market theory "just doesn't work." The "core tenet" of Basic, that the market acts rationally and depends heavily on "market professionals" who "generally consider most publicly announced material statements about companies, thereby affecting stock prices," has been undermined by "both the case law and economic literature," which now reflect that market makers and stock analysts do not guarantee efficiency.
A contrary argument is that "the persuasive power of Basic does not depend on acceptance of the efficient market hypothesis" and that "Basic is a pragmatic, not a theoretical, opinion based on the purposes of the federal securities laws, including the protection of investors and the enhancement of investor confidence."5 From the premise that although presumptions "[arise] out of considerations of fairness, public policy, and probability, as well as judicial economy, they are also "useful devices for allocating burdens of proof between parties," Basic concluded that the "presumption of reliance employed in this case is consistent with, and by facilitating Rule 10b-5 litigation, supports, the congressional policy embodied in the [Securities Exchange] Act. 485 U.S. at 245.
Halliburton argues that a central problem with Basic is that efficiency is not a binary, yes or no question. There is a lack of uniformity in efficiency, even for a single stock, which might trade efficiently some of the time for some information types, but trade inefficiently at other times, for other information types. Information that is easy to understand and "trumpeted in the business media" may be incorporated into market prices "almost instantaneously," but information that is difficult to access or requires a specialist's knowledge to understand may take weeks or months to be incorporated into prices, or may never be incorporated at all. Yet, Basic relies on the outdated binary conception of efficiency: "[I]f a market is shown to be efficient, courts may presume investors' reliance on all public material misrepresentations regarding those securities," Amgen, 133 S.Ct. at 1292, without requiring plaintiffs to first prove that the market price actually incorporated the misrepresentation alleged in the case.