The US Supreme Court heard oral arguments last week. Among the most compelling, and significant, were the arguments on the potentially landmark securities fraud case Halliburton v. Erica P. John Fund. This high stakes, class action suit challenges the prevailing theory of the last quarter century, established in Basic v. Levison. The Basic ruling resulted in a boom in securities fraud class actions—in fact, producing almost $80 billion in settlements since 1996, according to reports by NERA Economic Consulting, a unit of insurance broker Marsh & McClennan Cos. Institutional investors seek the preservation of the status quo and continued big winnings. Companies subject to the so-called “abusive” class actions and “extortionist” settlements seek the Court’s reversal.
Since the Court’s ruling in Basic v. Levison the plaintiff stockholder in a securities fraud action need not prove that he relied on a company’s misleading statements in establishing a prima facie case. Rather, it is enough for the plaintiff to allege “fraud on the market.” This means that the Court may presume that the fraud can be inferred through price inflation present at the time of purchase, rather than proven through a showing of the stockholder’s reliance on the company’s misleading statement. Without the presumption, each shareholder would have to show individual reliance on an alleged misstatement. That requirement, in turn, would preclude class actions, because it would require judges to conduct a case-by-base inquiry into the circumstances of each shareholder.
The post-Basic landscape proved bountiful for securities fraud plaintiffs bringing class actions, plaintiff’s attorneys, and litigation funders. The “fraud-on-the-market presumption,” reduced the burden of proof on investors and enabled them to easily sue as a class, by establishing that their claims were similar enough to be pooled. Once the case was allowed to move forward, claims would settle as a class action, sometimes despite it’s merits, because company defendants found it most economical to do so. According to a Cornerstone Research analysis of securities fraud cases filed between 1996 and 2011, 67% were dismissed or settled before the case was ever heard on its merits.
The Halliburton case presents the Court with an opportunity to make a paradigm shift in securities fraud class actions. A total reversal of the Basic ruling would have a serious impact as plaintiff’s would once again have to prove reliance on an alleged misstatement by the company and in most cases preclude multiple plaintiffs to one action. The ramifications of an abandonment of the “fraud on the market” theory, established in Basic, would extend beyond the litigants to the legal financing industry, as well. The probability of settlement in securities fraud suits would be greatly reduced and arguably less predictable. Many future allegedly defrauded investors would not have the opportunity to partake in the billions paid in settlements available to those of the Basic era. Or, perhaps the Court will decide to leave Basic undisturbed preserving huge class action awards for the future. Ascertaining a middle ground may be in order.
The Court listened attentively throughout the hour-long oral arguments on Wednesday. Their comments and questions came across as divided. Quietly, the trajectory of American jurisprudence will be preserved, altered, or reversed. The future prospects of billions of dollars of awards to victims, and income to legal professionals, will be determined. The Halliburton ruling is expected this summer.