Death by One Thousand Cuts

Ask any plaintiff’s lawyer about Halliburton II, and you will hear a predictable response: “Whew! We Dodged the Bullet!”  But that is not entirely accurate.  The bullet hit, but inflicted a non-fatal wound.  Prior to Halliburton II, class certification was automatic in securities class actions, at least if the stock traded on the NYSE or the upper reaches of Nasdaq.  After Halliburton II, defendants will now have a chance to show a lack of “price distortion” (with the burden on them, to be sure).  That may be a fair and balanced result (as I wrote here earlier this year before the decision was argued), but it signals an eclipsed future for the securities class action.

At a minimum, Halliburton II will have two implications for plaintiffs:  First, there is added cost.  As class certification moves in the direction of becoming a mini-trial featuring a battle of experts, plaintiff’s attorneys can expect that they will have to incur additional costs, probably running around $250,000 for the requisite studies and testimony.  That added cost will most impact “boutique” law firms, will thus drive further consolidation within the plaintiff’s bar, will probably reduce the size of many settlements, and could result in some marginal cases not being pursued.  Much depends here on an unresolved issue to which we will shortly turn:  precisely what must the defendant show to meet its burden at class certification?

The second implication of Halliburton II is that the defendant in a securities class action now gets three bites at the apple: (1) a motion to dismiss, (2) a motion for class certification; and (3) a motion for summary judgment.  Although plaintiffs will bear the burden only on the second motion (with the burden on proving price distortion remaining on the defendant), this should incline the defendant to be aggressive and pursue victory at the second stage.  Securities class actions most commonly settle, and they most frequently settle around the summary judgment stage.  Why?  When push comes to shove, defendants are seldom willing to risk a trial before an unpredictable jury. Hence, even if defendants have an overwhelming advantage on the papers filed at summary judgment, they often prefer to settle, fearing that some courts will duck tough issues and let the case proceed to a jury.  But at the certification stage, defendants can roll the dice.

From this perspective, Halliburton I was a significant defeat for defendants because it held that loss causation issues would not be heard at class certification and must be deferred to trial.  That substituted a jury for the judge as decision-maker, and defendants understandably winced.  But now Halliburton II has effectively overruled Halliburton I and ruled that this same evidence, now repackaged as evidence about “price distortion”, can be heard earlier at the class certification stage (and by the judge, not a lay jury).  The ironical message here is that law is often a label game, and “loss causation” and “price distortion” will be decided at different points by different decision-makers under different legal standards, but involve the same evidence.

Here, we come to the most unresolved question after Halliburton II: how much does the burden of proof matter?  Plaintiff has that burden at trial and must demonstrate loss causation (but juries may ignore statistical evidence that floats over their heads).  At summary judgment, the procedural burden is on the moving party, but the court may insist on persuasive evidence from the plaintiff showing a statistically significant adverse market response to the corrective disclosure.  At class certification, the burden on price distortion is on the defendant.  Suppose then that, at the class certification hearing, defendants show that on the corrective disclosure the market declined, but the response was significant only at the 90% level of confidence (and not the conventional 95% level).  Have defendants met their burden when they actually show that there was a 90% chance of price distortion?  Plaintiffs may further respond that the market also declined the prior week when a prominent securities analyst predicted that the company would make a corrective disclosure indicating that it had earlier overstated (but again the market’s response was below the 95% level of confidence).  Plaintiffs will argue that the information leaked out (or was deliberately disseminated) in multiple steps to minimize its impact, but defendants will respond that they have shown that plaintiffs cannot ultimately prove loss causation.  Who wins?  Statisticians and proceduralists may disagree here as to what the court’s response should be.  Stay tuned, but I predict that courts will struggle with these facts.

The critical importance of the market’s response to the corrective disclosure also suggests that behavior may change.  If corporate counsel understands that everything hinges on the market’s response to the corrective disclosure, he or she may engage in “information bundling”—i.e. release the “bad” corrective news only when coupled with “good” (and even overstated) news to preclude any significantly negative movement.  In short, an earnings restatement might be coupled in a press release with a recklessly rosy earnings forecast (because the market’s muted reaction to the press release may preclude liability for either misstatement).  When everything hinges on a short-term event study, fingers predictably will be placed on the scales.

The bottom line is that plaintiffs have won a Pyrrhic victory.  Committed to stare decisis, the Court has shown that it will not overrule precedent in order to end the class action, but each time a case comes before it, the majority will increase the burdens or cut a further salami-like slice off what can be certified.  Dark clouds are also appearing on the horizon.  Next Term, the Court will hear both the Omnicare case (which could greatly change the standard for Section 11 liability) and the IndyMac case (which may modify the old rule that the filing of a class action stays the statute of limitations for class members).  Just over the horizon is the possibility that corporations may be able to insert mandatory arbitration clauses or “loser pays” rules into their bylaws.

Plaintiff’s attorneys may drink a toast to their “victory,” but realists should understand that the longer term future of the securities class action is diminishing.

John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia Law School and Director of its Center on Corporate Governance.