Halliburton II: Where Do We Go From Here?

The recent all out, well-orchestrated effort in Halliburton II to reverse the “fraud on the market” presumption of reliance of Basic v. Levinson, 485 US 224 (1988), has clearly failed, but as we shall see, there is more to worry about for both sides.  The Supreme Court delivered what is termed an unanimous opinion but is, in substance, more like a 6:3 decision with three concurring justices (Thomas, Scalia and Alito) sharply critical of the basis for the opinion of the six justices who signed onto the “Opinion of the Court.”  Chief Justice Roberts, writing for the Court, pointedly rejected Halliburton’s and its supporting amici’s major points.  Some legal skeptics appear not to have taken very seriously the Chief Justice’s repeated caution, at his confirmation hearing and other legal venues, that stare decisis would significantly affect his judicial outlook when it came to overruling long-held Supreme Court precedents.  The majority opinion finds that neither Halliburton nor its amicus supporters have shown the kind of “special justification,” which was necessary for reversing “long settled precedent,” such as the 1988 ruling in Basic, citing Dickerson v. U.S., 530 U.S. 428, 443 (2000).  An argument that the precedent was wrongly decided was not deemed sufficient. Not only does Basic live, but stare decisis seems to have had something of a rebirth, at least in the area of securities regulation.  In any event, how far that dedication to precedent will go in practice remains to be seen as the Halliburton litigation continues on remand.

I

We know that Sec 10(b), as Professor Painter reminds us, does not create an express right of action, but as the Court’s opinion points out, “we have long recognized an implied private cause of action to enforce the provision [Sec. 10(b)] and its implementing regulation [Rule 10b-5].”  (slip. op. p.5)[1].  So, as Prof. Fox points out, given the stare decisis view of the majority, another frontal assault on Basic is “unlikely for the foreseeable future.” The key issue remains: what standard must defendants in Sec. 10(b) class action cases meet to effectively rebut the Basic presumption of reliance?

Prof. Grundfest, a leader of a group of professors and former SEC officials that filed an amicus brief in support of Halliburton, has also argued that Sec. 10(b) was never intended to provide a private implied right of action and, indeed, that rights under 10(b) are narrow and damages under that section “. . . can be no broader than the damages available pursuant to Sec. 18(a) of the Exchange Act, the most analogous express private right of action. . .” in that Act (Grundfest, “Damages and Reliance Under Sec. 10(b) of the Exchange Act,” The Business Lawyer, (Feb. 2014) 307 at pp. 313, 318 and 328 et seq.).  He reasserted this position in his amicus submission.  (Grundfest brief, 16; Pet. Brief 35).  They argue that, accordingly, plaintiff’s claims require direct proof of reliance on an individual basis (by each plaintiff), thereby effectively precluding certification of many class actions under Sec. 10(b).  This textualist-based “eyeball and eardrum” requirement to support only individual rather than class claims of reliance also fails.  The Court’s opinion makes short work of this Sec. 18(a) argument, concluding:

We need not settle this dispute.  In Basic, the dissenting Justices made the same argument based on section 18(a) that Halliburton presses here.  See 485 U.S., at 257-258 (White, J., concurring in part and dissenting in part).  The Basic majority did not find that argument persuasive then, and Halliburton has given us no new reason to endorse it now.[2]

Having disposed of Defendant’s and supporting amici’s attacks on the reach of implied private actions under Sec. 10(b), the Court turned to consideration of the two premises that are the key to Defendant’s argument that Basic’s support of the fraud on the market (FOTM) presumption must be overruled. Both of Defendant’s arguments are rejected by the Court.  One involves the “efficient market hypothesis”; that “the market price of shares traded on well-developed markets reflects all available public information” and therefore includes any material misrepresentations.  (slip op. 8-9). They argue that theory is “no longer tenable” and “overwhelming empirical  evidence now suggests that capital markets are not fundamentally efficient.”  (Id. at 9, citing Pet. br. p. 14-16, including a twenty year-old Stanford Law Review article and the Grundfest amicus brief at 15-19).

That economic argument is not new, the Court finds, and the Basic Court in 1988 declined to enter the economic debate and found no need to resolve it.  The Basic Court, as the Roberts opinion notes, based its presumption of reliance on the fairly modest premise that “market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.” 485 U.S. at 246, n.24. The Basic Court was careful to make the presumption rebuttable, recognizing that “efficiency” is a matter of degree, thereby making it “a matter of proof.” What is clear, the Roberts majority opinion finds, is that “public information generally affects stock prices.” So much for the economic attack on market efficiency.  “[F]alse statements affect [the price of stock] and cause loss,” which is all Basic requires.  (Slip op. p. 10-11, citing Chief Judge Easterbrook in a 2010, 7th Circuit decision, Schleicher v. Wendt, 618 F.3d 679, 685).  The Court concludes: “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.” (Slip. op. 11).

The Court also deals with the “integrity of [the market] price” basis for the presumption.  Halliburton identifies a number of types of investors for whom “price integrity” is not a significant factor.  The Roberts opinion responds that Basic only concluded that “it is reasonable to presume that most investors knowing they have little hope of outperforming the market in the long run based solely on the basis of their analysis of publicly available information—will rely on the securities’ market price as an unbiased assessment of the securities value in the light of all public information.” (Slip. op. 12, citing  Amgen, Inc. v. Connecticut Retirement Plans, 568 U.S. ____.) (Slip op. at 5).

The Court does not accept the argument as sufficient to overturn Basic and even questions the accuracy of its premise. “The principle of stare decisis has ‘special force’ ‘in respect to statutory interpretation’ because ‘Congress remains free to alter what we have done,’” citing John R. Sand & Gravel Co. v. U.S., 522 U.S. 130, 130 (2008) (Slip. op. 12).

The Court then explains why its opinion upholding the Basic FOTM presumption is not an extension of Sec. 10(b)’s reach, as it was found to be in Stoneridge[3] and Central Bank,[4] but is consonant with the element of reliance.  The Court pointedly cites the existing opportunity under Basic for defendants to rebut the presumption (Slip op. 13-14).  It is this important confirmation of defendant’s right under Basic to rebut the presumption of reliance that offers defendants in a Sec. 10(b) class action hope of success in overcoming the presumption at the class certification stage, rather than going through extensive discovery and the costs of a full merits trial, likely before a jury.

II

Accordingly, what we are now likely to see is an effort by defendants to achieve as full a trial of the reliance issue as the courts will allow at certification by seeking to repackage their economic theory, which the Chief Justice found was not “. . . the kind of fundamental shift in economic theory that could justify overruling a precedent,” and to continue their doctrinal attack on the regulatory regime, established by the Congress in the Exchange Act in 1934.  That regulatory regime, the Court notes, was supported and adjusted to market developments and technological advances through regulatory and Congressional updates, which were explicitly designed to support the fairness and integrity of our capital markets by requiring timely, public periodic and specific disclosures of material facts by issuers, so that the market price of their securities would more closely and expeditiously reflect a fair value for the securities being traded.[5]  So, here we have the former true believers in the “efficiency of the market” (e.g., the U.S. Chamber of Commerce, Professor Grundfest and others), trying to defeat Basic’s rebuttable presumption of reliance in Sec. 10(b) class action cases, doubting the efficiency of the markets to reflect fairly the accuracy of prices in well-traded securities.

At this point, it is important to stop and remind ourselves of the key policies which Congress considered in enacting the Exchange Act in 1934 and the more recent legislative actions and resulting regulations that are the basis for our current securities regulatory regime, in which the antifraud provisions and particularly Sec. 10(b) and rule 10 b-5 play such an important role.[6]

A basic premise of the securities laws, as noted above and recognized by the Court, is that market prices will generally reflect important (material) publicly available information.  A key role of the SEC is to require and supervise the dissemination of accurate annual and periodic financial and other relevant reporting by issuers to the public.  It is not just a cliché to say that the integrity of the capital markets depends on honest prices that in turn depend on fair and honest public reporting by issuers of financial and other information that would be important to investors in making market decisions regarding the issuer’s securities.  Maintaining investors’ confidence in the integrity of the market should not be undermined by elimination or piecemeal reduction of investor protections which are crucial to that integrity.  Pointing to different schemes in other countries and “globalization of the markets” as requiring the reduction of important regulatory requirements, like the reach of our antifraud rules (like Sec. 10(b)), and pointing to the limitations in Morrison v. National Australia Bank, 130 U.S. ____ (2010), was apparently not the best argument for cutting back investor protection.  It is relevant that the ruling was quickly corrected by the Congress in the Dodd-Frank Act, restoring SEC/DOJ jurisdiction, overruling the Supreme Court’s rejection of the longstanding “conduct and effects” test[7] for the government and ordering a study to determine whether Congress should restore that jurisdiction for private parties.  Does the Halliburton II decision indicate that the Supreme Court may now be somewhat less prone to follow the purist deregulatory road advocated by defendants and certain amici supporters?  One thing is certain; the textualists will keep trying.  In Halliburton, it seems they overreached and that strategy failed.  We shall see whether the rebuttal opportunity afforded by Basic and the Halliburton II majority will be reasonably employed by defendants or pushed too far.  We need to wait for development of a standard for what will be necessary to rebut the presumption.  It starts with the remand.

III

So, where are we now?

1. The main attack on Basic and the fraud on the market presumption failed.  The FOTM presumption has been clearly reaffirmed, as has the defendant’s right to rebut the presumption at the certification stage.

2. The defendants and their amici supporters turned to a strategy of limiting the scope of Sec. 10(b) by raising the narrower express private action in Sec. 18(a) as a limit on the reach of the more broadly worded Sec. 10(b), which they argued should not be afforded to mere implied rights of action for investors under Sec. 10(b).  This argument was rejected by the Court in no uncertain terms.

3. Halliburton and friends undertook to undermine the “efficiency of the market” standard by claiming that, after all, the markets are really not very efficient.  That argument didn’t work either.  Indeed, the Court affirmed a showing of market efficiency as a condition of recognizing the presumption.

4. Since market efficiency involves an examination of the volume and pricing of the security, much of the current district courts’ determinations of the appropriate class may already be covered at a typical class certification hearing, where “price impact” is a subject of interest.

What now seems to be the defendant’s last hope, in this litigation, is to turn the certification process into as close to a full trial on the merits as possible.  The Court clearly reaffirms the Basic opportunity for defendants to rebut the presumption of reliance at certification.  By what standard?  One suggestion is for defendants to be required to demonstrate clearly and convincingly that they have shown enough evidence to defeat the certification of the class and to permit such an attempt at rebuttal at the certification stage.  That burden is on the defendants.  Plaintiffs’ burden on reliance has been initially met by the presumption of the FOTM doctrine, which then shifts to the defendants to establish their rebuttal case.  The plaintiffs must, of course, still meet the other requirements (e.g., efficient market, well traded security, specific pleadings of fraud, etc.)  The Court’s opinion does not delineate the exact nature of the review a district court should afford defendants on certification; so there is, as most commentators have noted, an unchartered area to navigate.  It would seem that, having gone so far to reaffirm Basic, that respect for stare decisis was a key basis for the Courts’ decision, and the clear intent of the Exchange Act and the SEC’s disclosure requirements, along with Congressional refinements of pleadings and requirements in securities fraud cases (SLUSA), the Chief Justice and his majority colleagues would not accept a pro forma recital by various experts as sufficient rebuttal to overcome the Basic presumption of reliance.  Presumably, a battle of experts would not move this Court to choose one economic theory over another, as it refused to do in this case.  Defendant’s evidence, it would seem, would need to be cogent and at least as compelling as any opposing inference, which is the standard adopted to determine the adequacy of the pleading of scienter under the Reform Act (PSLRA), adopted by the Court in Tellabs, Inc. v. Makor, 551 U.S. 308 (2007).  If there is a dispute on the facts, there is always summary judgment before a judge, not a jury, and as Prof. Coffee pointed out, that is often an advantage for defendants.  These are, as he notes, still issues that will touch on reliance as a part of the defendant’s rebuttal, (e.g., “price distortion” or “impact.”).

Whether or not plaintiffs won a Pyrrhic victory or defendants really secured much ground at turning the certification hearing into a long, torturesome trek into economic uncertainties, which may end up in a settlement anyway, we won’t know until the key question is answered what standard must the defendant meet to defeat the Basic presumption at certification?  That answer may be long in coming as Halliburton’s remand wends its way back through the district court and back to the Fifth Circuit (or it may settle and we will wait for another case to answer this question).

The Wall Street Journal headline in this case says it well:  “Securities Ruling Mixed Bag; Ground Gained by Companies.  Looks Tenuous in High Court’s Class Action Decision.”  WSJ. June 30, 2014.  But see, contra, WSJ editorial June 24, 2014: “Trial Lawyers Party at the Court,” Subhead: Chief Justice Roberts misses a chance to fix a class action mistake.

As the great legal philosopher Yogi Berra noted:  “It ain’t over, till it’s over.”  And we all agree that it is definitely not over. . . . And we can definitely look forward to Omnicare (Sec. 11 of the 1993 Act) next term. . . . But that is a subject for another day.

[1]  Citing Blue Chip Stamps v. Manor Drug Store, 520 U.S. 723, 730 (19975).  See also Sup’t of Insurance v. Bankers Life & Casualty, 403 US 6, note 9 (1971); “It is now established that a private right of action is implied under Sec. 10(b)” Herman McLean v. Huddleston, 459 U.S. 375 (1983).  Prof. Coffee, in his Securities Regulation casebook (with Prof. Sale), notes that the 1995 PSLRA (“Reform Act”) had provisions relating to an implied regulation under Sec. 10(b). (12th ed., at 921).

[2]  Slip op. at p. 8.  See discussion of the Sec. 18(a) argument, in the amicus brief in Halliburton II, on behalf of “Former SEC chairmen, William H. Donaldson and Arthur Levitt, Jr., as Amici Curiae Supporting Respondent,” at pp. 22-24.  (The writer was one of the counsel on the brief).

[3]  522 U.S. at 167.

[4] Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994).

[5] See brief of former SEC Chairmen William H. Donaldson and Arthur Levitt, Jr., Amicus Curiae, (Summary of Argument at pp. 3-6 and fully discussed in the Argument at pp. 7-22), supra n.2.

[6] Ibid. at p. 9: The committee reports on the Exchange Act reflect the need to ensure that market prices reflect honest, not fraudulent, information.  As the House Report explained, “[t]he idea of a free and open public market is built upon the theory that competing judgments of buyers and sellers . . . brings about a situation where the market price reflects as nearly as possible a just price.” H.R. Rep. No. 1383, 73rd Cong. 2d Sess. 11 (1934). Although “[t]he disclosure of information materially important to investors may not instantaneously be reflected in market value, . . . truth does find relatively quick acceptance on the market.” Ibid. See S. Rep. No. 1455, 73rd Cong. 2d Sess. 68 (1934) (“Insofar as the judgment of either [buyer or seller] is warped by false, inaccurate, or incomplete information regarding the corporation, the market price fails to reflect the normal operation of the law of supply and demand.”).

[7] Schoenbaum v. Firstbrook, 405 F.2d 200 (2d Cir. 1968) Sec. Discussion, Coffee and Sale, Securities Regulation, supra, pp. 1547-53.

Meyer Eisenberg is a Senior Research Scholar and Lecturer in Law at Columbia Law School. He served as Deputy General Counsel of the Securities and Exchange Commission from 1998-2006.