U.S. Supreme Court Upholds “Fraud-On-The-Market” Theory, Permits Defendants to Challenge Reliance Presumption at Class Certification Stage
Earlier this week, in Halliburton Co. v. Erica P. John Fund, Inc., the United States Supreme Court upheld the “fraud-on-the-market” theory in federal securities fraud class actions, but ruled that at the class certification stage defendants can introduce evidence to challenge the rebuttable presumption created by that theory. Established in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), the “fraud-on-the-market” theory allows a securities fraud plaintiff to establish a rebuttable presumption of reliance on publicly made, material misrepresentations regarding a particular stock, so long as the stock is traded in a well-developed, efficient trading market. Halliburton attacked the theory on the ground that the premise of the Basic rule was no longer tenable, in light of recent scholarship and empirical evidence that called into question the fundamental efficiency of markets. The Court declined to reverse Basic, however, explaining that “Halliburton has not identified the kind of fundamental shift in economic theory that could justify overruling a precedent on the ground that it misunderstood, or has since been overtaken by, economic realities.” The “fraud-on-the-market” theory thus survives as a method for establishing reliance in federal securities class actions, provided plaintiffs prove the elements of publicity, materiality, and market efficiency.
Halliburton challenged the validity of the theory in the context of class certification, arguing that it should be permitted to introduce evidence rebutting the reliance presumption at the class certification stage. In particular, Halliburton sought to prove that the alleged misrepresentations did not impact the stock price, thereby calling into question market efficiency. Such a showing, Halliburton argued, would rebut the presumption of reliance and permit defendants to defeat class certification by contradicting the plaintiff’s showing that class-wide issues of fact predominated over individualized fact questions; once the presumption of reliance afforded by the “fraud-on-the-market” theory was disproved by the lack-of-price-impact evidence, the plaintiff would have to show actual reliance by each member of the putative class.
The Supreme Court agreed that lack-of-price-impact evidence was permissible at the class certification stage. Such evidence, the Court reasoned, would be relevant to the issue of whether the market for the subject security was efficient, an element plaintiffs must establish before the “fraud-on-the-market” presumption arises. Thus, while Halliburton’s facial attack on the “fraud-on-the-market” theory failed, the Supreme Court's decision provides defendants in federal securities class actions a new defensive tool at the class certification stage: lack-of-price-impact evidence to rebut the reliance presumption, and a corresponding argument against the predominance requirement of Rule 23(b)(3).