Halliburton II and Market Efficiency

I agree with much that was said in earlier postings on the implications of Halliburton II going forward. We simply don’t know how lower courts will structure the price distortion inquiry, and if the mess the courts have made of loss causation is any indication (and I realize that the burden there is on the plaintiffs, not the defendants), we shouldn’t expect coherence. I hope courts will bring a great deal of common sense to the process, and not be fooled into thinking—as so many of the members of the Court seemed to at oral argument—that event studies will offer a neat and reliable answer to whether there was distortion, so that the only task is to find a credible economist.

To me, the most helpful conceptual contribution made by Halliburton II is on market efficiency. Certiorari was granted largely in response to the question Justice Alito posed in Amgen: do developments in our contemporary understanding of stock market efficiency—particularly skepticism about how efficient they really are—call into question Basic’s fundamental assumptions? The Chief Justice says no, at least not enough to overcome the stare decisis presumption. He does so by stressing that the efficiency question is not meant to be particularly rigorous—“generalized” efficiency is sufficient, not some idealized vision of hyper-efficiency. On this, Halliburton II is clearly right.

Stock price integrity is a worthy policy goal even in the face of (inevitably) imperfect efficiency. The key question in assessing the presumption of reliance is whether the market segment in which the securities are traded is such that it has sufficient efficiency properties to make us reasonably confident that misinformation is likely to distort the stock price. Most all well-organized markets meet this condition. Efficiency, in other words, should just be a proxy for those markets in which passive investing is reasonable.

In recent years, however, defendants have had a fair amount of success in persuading courts that the efficiency inquiry should be much more demanding than this. Perhaps the best known case along these lines is In re PolyMedica Securities Litigation,[1] a First Circuit decision that seems to insist on proof of immediate price reaction to all material information in order to justify a finding of sufficient efficiency. Building on this, particularly after Amgen, the defense-side was continuing the class certification battle as to price distortion by using the apparent absence of evidence of distortion as proof that for the issuer in question, its market must thus not be efficient—raising something that clearly is a certification issue. (The Chief Justice recognizes this strategy in Halliburton II when he says that price distortion is usually before the court in class certification anyway).

Hopefully, Halliburton II will take much of the steam out of this effort by its emphasis on “general” market efficiency rather than hyper-efficiency. PolyMedica justified its more demanding standard by saying that Basic was ambiguous on the subject, explicitly rejecting the importance of a footnote in Basic that seemed to indicate that the inquiry should not be overly demanding. Halliburton II, on the other hand, quotes and emphasizes that very same footnote. There is a consensus in Halliburton II that rejects any binary vision of market efficiency (i.e., that markets are either efficient or not, as opposed to a continuum of relative efficiency). That is all well and good. But this also strongly cautions against putting too much emphasis on the efficiency determination for class certification, because the judge must inevitably answer the question of sufficient efficiency as yes or no. The factors that courts have used previously (the so-called Cammer factors) create an illusion that there is a scientific way of answering that question, when there really is not. The risk here, once again, is that the courts will defer too much to the econometricians. As Lucian Bebchuk and Allen Ferrell argued in their recent article—as had many other legal academics over the past twenty five years—it might have been better to jettison the efficiency requirement entirely for fraud on public markets. The Court didn’t, but hopefully came close.

[1] 432 F.3d 1 (1st Cir. 2005).

Donald C. Langevoort is the Thomas Aquinas Reynolds Professor of Law at the Georgetown University Law Center.