SCOTUS to Reconsider “Fraud-on-the-Market” Theory in Halliburton

By Allison Norris

On March 5, 2014, the Supreme Court heard oral arguments in the case of Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317. This case will challenge the “fraud-on-the-market” presumption in securities fraud cases.  Without this presumption, putative class action plaintiffs will not be able to maintain a securities fraud class action unless they can prove that each individual shareholder relied on the alleged misrepresentations in cases involving securities that trade on “efficient markets.”  The presumption is based on the economic theory that states that an efficient market will reflect all publicly available information about a company.  Accordingly, a buyer of the security may be presumed to have relied on that information in purchasing the security.

The Supreme Court first recognized the “fraud-on-the-market-theory” in Basic Inc. v. Levinson, 485 U.S. 224 (1988).  By taking away the need to prove individual reliance, this theory allows classes to be certified under Section 10(b) of the Securities Exchange Act, whereas they would otherwise have to be certified under Federal Rule of Civil Procedure 23(b)(3).  In the latter case, individual reliance questions would likely predominate over common questions affecting the class as a whole.

After the Court simplified the reliance requirement, both the number of securities fraud cases filed and amount of settlements paid increased significantly.  The Court, skeptical of a judge-made rule increasing securities litigation to such an extent, has created a number of limits to § 10(b) actions over the last few years.  Even in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184, 1208 (2013), a case that expanded the reach of Basic, four Justices (Scalia, Kennedy, Thomas, and Alito) went out of their way to note that Amgen had not challenged the validity of the “fraud-on-the-market” doctrine, and those Justices expressed doubts about the legal and economic foundations of the doctrine.

After the concurring and dissenting Justices in Amgen opened the door to a challenge of the continuing validity of Basic’s “fraud-on-the-market” presumption, the Court’s acceptance of Halliburton’s petition for certiorari hints that the Court might be primed to overrule or significantly limit Basic.  If the Court were to abrogate or significantly limit the “fraud-on-the-market” theory, it would dramatically change the landscape of class-action securities litigation.  The need to individually determine investor reliance would make securities fraud class certification difficult or practically impossible in most cases, as common class-wide issues would no longer outweigh individual concerns.