Halliburton case decision: Companies get another (expensive) bite at the dismissal apple
This time the smart money was right. As most readers know, in the Halliburton case the Supreme Court was presented with a challenge to its 1988 case (Basic v. Levinson) that made many shareholder class-action securities cases possible. Plaintiffs’ lawyers hoped that the Court would uphold Basic, while business groups advocated reversal. Most who heard oral arguments before the Court felt that the justices were struggling to find an acceptable compromise — limiting the scope of Basic but not requiring each and every plaintiff to show individual reliance on an misrepresentation. The Court found that middle ground. It gave defendant companies an opportunity early in a purported securities class action case to convince judges to deny class certification to plaintiffs — and thereby prevent the claims from moving forward.
The Background and the Decision
As discussed in an earlier post the Halliburton case involved securities class action claims brought pursuant to SEC Rule 10b-5. In Basic, the Supreme Court accepted the 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 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. Plaintiffs could win class certification without each plaintiff having to show that it had actually relied on the misrepresentation in deciding to buy or sell a company’s stock.
While the Court in Basic called the fraud-on-the-market” theory a “rebuttable” presumption, defendant companies were not able to defeat class certification by showing (through the kind of econometric “event study” that will be of increased importance in the post-Halliburton world) that the particular misrepresentation in question had no impact on the company’s stock price. According to the Court in Halliburton, the components required for plaintiffs successfully to invoke the fraud-on-the-market theory — that the alleged misrepresentations were public, that they were material, that the market in the company’s stock was efficient, and that the plaintiff traded the stock between the time of the misrepresentation and the time the truth was revealed — were in effect an indirect way of demonstrating the price impact of the alleged misrepresentation. Once the trial court determined that there is an efficient market for the company’s stock generally, that prong of the fraud-on-the-market theory was deemed satisfied even if the defendant had shown that the specific misrepresentation at issue had no impact on the stock price. In other words, the defendants could not use the demonstrated absence of price impact with respect to the specific misrepresentation to defeat the presumption of market efficiency with respect to the company’s stock generally. The absence of price impact could prove to be a winning issue for the defendants, but only at later (and more costly) stages of the case. In Halliburton, the Court called this outcome “inconsistent with Basic’s own logic.”
The Court in Halliburton therefore held that defendants in securities class action cases pursuant to Rule 10b-5 should be allowed to defeat Basic’s fraud-on-the-market presumption at the class certification stage by introducing evidence that the alleged misrepresentation had no impact on the defendant’s company’s stock price. In the words of the majority opinion:
“More than 25 years ago, we held that plaintiffs could satisfy the reliance element of the Rule 10b–5 cause of action by invoking a presumption that a public, material misrepresentation will distort the price of stock traded in an efficient market, and that anyone who purchases the stock at the market price may be considered to have done so in reliance on the misrepresentation. We adhere to that decision and decline to modify the prerequisites for invoking the presumption of reliance. But … defendants must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.”
The Halliburton decision therefore neither left Basic untouched as plaintiffs’ lawyers had waned nor reversed it as defendant lawyers had hoped. It simply gave defendants an additional shot, of uncertain quality, at defeating class action claims early in the litigation. In the words of John Donovan of Ropes & Gray, a prominent litigator for companies defending securities class-action cases, “the defense bar took a home run swing and hit a single.”
Some Possible Effects
It is almost universally expected that the Halliburton decision will lead to a period (of years) of uncertainty as lower courts grapple with its meaning and attempt to apply standards that reflect and implement its intent. Some of the possible effects:
- Plaintiffs’ lawyers be more selective in deciding which cases to pursue, in part because they too will be hiring their own consultants to do event studies. They may even hire staff economists to try and “pre-qualify” potential targets by doing as much analytical legwork as possible before cases are filed — at least with respect to industries and sectors that have historically had volatile stock prices.
- Plaintiffs’ lawyers will almost certainly search for sympathetic trial courts that impose a high bar for rebutting the fraud-on-the-market theory. It is unclear what the standard will be for determining if a defendant’s evidence of “no price impact” is sufficient to defeat the presumption of the fraud-on-the-market theory: preponderance of the evidence, clear and convincing evidence, or some other standard. Resolving this issue and other issues will surely considerable litigation, and possibly further Supreme Court guidance.
- The class certification stage of a case comes after the defendant’s motion to dismiss is denied, so the Halliburton decision offers defendants another opportunity to try and avoid the protracted litigation, discovery costs, and settlement risks that they now face when they lose their motions to dismiss. The Halliburton decision will likely lead to “dueling economists” in securities class action cases under Rule 10b-5, with both plaintiffs and defendants presenting their respective event studies demonstrating the presence or absence of an alleged misrepresentation’s price impact. Defendant companies will often “pay now” by hiring consultants to do event studies at the class certification stage in order to try and avoid “paying later” through higher defense costs and the increased risk of adverse settlements.
- As the costs of litigation and settlement rise significantly when a motion to dismiss is denied, it also seems likely that D&O insurers will support defendants’ efforts to defeat class certification by providing coverage for the engagement of consultants to do event studies. At least one prominent insurer had anticipated the Halliburton decision by providing a policy endorsement that covered the cost of event studies without any retention (deductible). Different insurers may employ varying standards for the engagement of such consultants, with respect to such matters as the identity of the consultants, their rates and budgets, the application of a retention, sublimit or other cost-sharing mechanism, etc.
- There may be adjustments in insurance retentions and/or premiums to reflect the increased early-stage costs of defending securities class-action claims. It will be very interesting to see if the increased upfront costs of defending 10b-5 class-action cases are offset by fewer filings, more dismissals, and reduced settlements and judgments — and therefore have a salutary dampening effect on D&O insurance premiums generally. The Halliburton decision may lead to more denials of class certification in certain volatile industries such as life sciences if event studies demonstrate that price fluctuations are more reflective of industry volatility generally than of alleged misrepresentations about a particular company. This result would make it easier for savvy brokers to overcome insurers’ aggressive efforts to raise prices in these sectors.
- The Halliburton decision may have the same kind of “binary” effect as other reforms to 10b-5 class action cases: fewer filings and/or more dismissals, but also larger settlements as plaintiffs push harder on the cases that survive litigation’s early stages to make up for their increased costs and greater risks. If Halliburton does in fact lead to a “binary” result of fewer, more selective filings but higher litigation costs and settlements, insurance buyers may well react by purchasing higher coverage limits to protect them from the increased severity of surviving claims – thus offsetting the potential industrywide premium savings that might be realized as the result of the decision.
- And of course, the Halliburton decision does not affect Section 11 claims. Many observers predict that the large number of JOBS Act IPOs will inevitably lead to an increased number of Section 11 claims against some of those young newly-minted public companies.
As has been noted often throughout the years, the battle between plaintiffs’ lawyers and the companies they sue is one of action and response, move and counter-move. The battle is likely to continue raging with new stratagems, slow advances and reluctant retreats. The Halliburton decision seems highly unlikely to cause any breakthrough for either side.
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.