Supreme Court Limits Securities Class Actions, But Not Fatally

In its much-anticipated decision in Halliburton Co. v. Erica P. John Fund, Inc., the U.S. Supreme Court declined to overturn the landmark Basic v. Levinson decision, but ruled that defendants in securities law class actions may rebut the fraud-on-the-market presumption of reliance before the class certification stage by showing a lack of price impact. This seemingly small turn in the law may have significant practical effects on companies facing securities fraud class actions.

As we discussed here and here, Basic created the fraud-on-the-market theory, which underlies most securities class action cases. The theory provides for a presumption that investors relied on all public information released by a defendant as embodied in the price of its publicly-traded stock. Before Halliburton, defendants could not introduce evidence to directly rebut this presumption before class certification (e.g., that the alleged misrepresentation had no price impact or that the market did not efficiently absorb the information into the stock price).

In Halliburton, the Justices vacated and remanded the 5th Circuit’s decision, holding that defendants should be able to rebut the fraud-on-the-market theory presumption before class certification by showing evidence that an alleged misrepresentation did not, in fact, affect the stock’s price. The Supreme Court did not, however, issue the blockbuster ruling some observers were anticipating—eliminating the fraud-on-the-market theory altogether as a basis for securities class actions. Such a ruling would have had the likely impact of ending securities class actions as we currently know them. Note that enforcement actions brought by the SEC and DOJ are not reliant on the fraud-on-the-market doctrine and the decision therefore has no impact on them.