Halliburton and IPO Claims
It happens more than 200 times per year: a publicly traded company discloses an adverse development, its stock price drops, and it — and its directors and officers — are hit with a class action lawsuit by shareholders who allege that they bought the company’s stock based on material misrepresentations and are entitled to financial compensation for the decreased value of their shares once the truth came out. These lawsuits can drag on for years, are expensive to defend even in victory, and can lead to expensive settlements.
In the closely watched Halliburton case, the Supreme Court is reconsidering an earlier holding that made many shareholder class action lawsuits feasible. The Halliburton case involves class action claims brought pursuant to SEC Rule 10b-5, promulgated pursuant to Section 10(b) of the Securities Exchange Act of 1934, as amended. A core element of a 10b-5 claim is that each plaintiff had to rely on the supposed misrepresentation. Plaintiffs’ lawyers have to demonstrate this reliance in the early stages of the lawsuit, as one of the conditions for certification of a plaintiff class. If plaintiffs’ lawyers had to show that each and every plaintiff actually relied on the alleged misrepresentations, broad class actions under Rule 10b-5 would be nearly impossible to pursue.
This problem was solved in the 1988 case of Basic v. Levinson. In Basic, the Supreme Court accepted an economic-based presumption: that in an efficient stock market, the price of a company’s shares reflects all the material, publicly disclosed information about the company (including the supposed truth of the alleged misrepresentation). The adoption of this “fraud on the market” theory allowed courts to presume that each plaintiff in effect relied on the alleged misrepresentation in deciding whether to buy or sell a company’s stock at any particular price.
Class action lawsuits brought under Rule 10b-5 could be significantly affected if in the Halliburton case the Supreme Court rejects or substantially modifies the “fraud on the market” presumption — a Google Search for “Halliburton, class action and death knell” yields almost 170,000 citations. Newly-minted public company directors and officers can be forgiven if they feel that they are at the dawn of an enlightened new age free from spurious and distracting class action lawsuits.
Celebration would be both premature and misplaced. As was discussed in other WGA blog posts and in our recent webinar it seems very likely that even the elimination of the “fraud on the market” theory will lead to significant litigation in the short-term. Lower courts will grapple with their interpretations of the Halliburton decision and plaintiffs’ lawyers will file multiple lawsuits as they test the contours of the decision and seek alternate paths forward.
More importantly for newly public companies and those making subsequent public offerings, the Halliburton decision will not affect the claims typically brought against them after their offerings. Plaintiffs who bring their claims within a year following a public offering do not have to show that they relied on the material misrepresentations or omissions. Neither must they allege that the defendants knew that the prospectus contained a material misrepresentation or omission or recklessly disregarded whether it did — there is virtually strict liability for material misrepresentations in these cases.
Companies approaching a public offering of their securities must therefore maintain their vigilance — and appropriate D&O insurance limits — following the Halliburton decision, and not be lulled into complacency if they see the phrases “securities claims” and “death knell” in the same sentence.
About the Author
John Doernberg is a Vice President working with inside and outside counsel as a Claims Advocate for clients on policy negotiation and the handling and settlement of claims. He also serves as a resource on privacy, information security and risk management issues. Prior to becoming an insurance broker in 1995, he practiced corporate law in New York and Boston for 12 years.