Is the U.S. Supreme Court Poised to Eviscerate the Fraud-on-the Market Theory?

By Eric A. Boden

On November 15, 2013, the U.S. Supreme Court granted a cert petition in Halliburton Co. v. Erica P. John Fund, Inc., f/k/a Archdiocese of Milwaukee Supporting Fund, Inc. The petitioner, Halliburton, wants the Court to reverse a Fifth Circuit decision that refused to allow Halliburton to introduce price impact evidence at the class certification stage to rebut the presumption of reliance under the fraud-on-the-market theory.

If the Court rules for Halliburton, it would overrule or substantially modify Basic Inc. v. Levinson, which adopted the fraud-on-the-market theory and its associated presumption of classwide reliance in securities fraud class actions.

Halliburton challenges Basic’s fundamental premise: that an economic theory of inherent market efficiency should be dispositive, at the class certification stage, on the issue of reliance. First, Halliburton contends that the efficient market hypothesis has been roundly rejected by empirical evidence. Second, Halliburton cites to the difficulty federal courts have encountered applying the fraud-on-the-market theory and to the fact that no state courts have recognized it. Finally, Halliburton emphasizes that the Court’s more recent class-certification decisions in Wal-Mart Stores, Inc. v. Dukes and Comcast Corp. v. Behrend make clear that the elements of class certification cannot be satisfied by a presumption (like the presumption of reliance under the fraud-on-the-market theory) but instead must be “proven in fact.”

It is possible the Supreme Court will overrule Basic in its entirety, rejecting the fraud-on-the-market theory, which would draw into question the future of securities class actions. However, the Court may follow a more moderate course, and simply allow a defendant in a putative securities class action to rebut the presumption of reliance with evidence that alleged misrepresentations did not distort the market price of its stock.

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