On June 23, 2014, the U.S. Supreme Court released its decision in Erica P. John Fund, Inc. v. Halliburton (Halliburton). While the Court declined to dramatically change the law with respect to securities disclosure class actions, the Court held that defendants at the certification stage are entitled to tender evidence that alleged misrepresentations in disclosure did not affect the price of securities, which may defeat certification where that evidence is accepted. This decision overturned a ruling of the Fifth Circuit that such evidence should not be considered at the class certification stage.
In the U.S., it is presumed at the class certification stage of a disclosure class action that investors in a company have taken into account and relied on alleged misrepresentations and omissions in disclosure when they buy or trade in that company’s shares. Halliburton deals with the question of when and how a defendant might rebut this presumption (often called the “fraud-on-the-market” presumption, which was first adopted by the U.S. Supreme Court in Basic Inc. v. Levinson, (Basic) 485 U.S. 224 (1988)).
In Halliburton, the plaintiff, Erica P. John Fund, Inc., alleges that Halliburton made a number of misrepresentations in its public disclosure and corrected them through a series of subsequent disclosures.
Initially, the District Court denied certification of the Fund’s claim as a class action because the Fund had not established “loss causation”—that is, a causal connection between the alleged misrepresentation and the alleged loss to investors—and the Fifth Circuit affirmed. However, the U.S. Supreme Court vacated the Fifth Circuit’s judgment, holding that there was no requirement for plaintiffs in disclosure class actions to prove loss causation at the certification stage.
On remand, Halliburton argued, with the use of expert evidence, that the Fund failed to establish that the alleged misrepresentations had affected the price of Halliburton’s securities, and argued that because of this, it had rebutted the Basic presumption. The District Court rejected this argument and certified a class, and the Fifth Circuit affirmed, holding that Halliburton could not use its evidence on the impact of the alleged misrepresentations on the price of Halliburton’s securities at the certification stage of the litigation.
The Court’s Decision
The U.S. Supreme Court considered whether (i) the “fraud-on-the-market” presumption at the class certification stage of a disclosure class action should be overturned; (ii) if not, whether a plaintiff should be required to prove that the wrongdoing it alleges affected the price of a defendant’s securities; and (iii) if not, whether a defendant could rebut the “fraud-on-the-market” presumption at the class certification stage by tendering evidence that its alleged wrongdoing had no effect on the price of its securities.
The Court refused to overturn Basic or eliminate the “fraud-on-the-market” presumption. The Court also declined to require plaintiffs in disclosure class actions to prove impact on price at the certification stage, holding that “if a plaintiff shows that the defendant's misrepresentation was public and material and that the stock traded in a generally efficient market, he is entitled to a presumption that the misrepresentation affected the stock price.”
However, the Court held that a defendant in a disclosure class action is entitled to put forth evidence of a lack of an impact on the price of securities at the class certification stage. The Court noted that “price impact” is “an essential precondition” for a disclosure class action in the U.S. and held that, “While Basic allows plaintiffs to establish that precondition indirectly, it does not require courts to ignore a defendant's direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock's market price and, consequently, that the Basic presumption does not apply.”
In other words, if a defendant succeeds in establishing a lack of “price impact” at the class certification stage of a disclosure class action, it may stop an action at that stage. In Halliburton, the U.S. Supreme Court again remanded consideration of certification.
Potential Implications in the U.S.
In the last decade, the U.S. Supreme Court has steadily increased the burden on securities class action plaintiffs to demonstrate that alleged misrepresentations actually caused harm to investors. The perception has been that a conservative Court has taken a pro-business approach to these cases, heeding the complaints of corporate America that it has no choice but to settle non-meritorious lawsuits any time a class is certified on the basis of unfounded allegations.
By preserving Basic’s “fraud-on-the-market” presumption, the Court did not dramatically alter the landscape of securities disclosure class actions in the U.S. It did, however, provide corporate defendants with another tool to fend off such litigation at an earlier stage. Even in circumstances where a defendant may not be able to rebut the “fraud-on-the-market” presumption at the class certification stage, the increased risk of a pre-certification dismissal is likely to provide defendants with greater leverage to negotiate lower settlements.
Potential Implications in Canada
Provincial securities legislation in Canada provides for statutory causes of action that deem an investor’s reliance on an issuer’s disclosure, with an effect that is similar to the “fraud-on-the-market” presumption. For example, Part XXIII.1 of the Ontario Securities Act creates a cause of action for misrepresentations in continuous disclosure without regard to whether there was actual reliance on the misrepresentations. That is subject to a defence where it is proven that an investor was aware of the misrepresentation. In addition, the statutory framework for the calculation of damages provides that “assessed damages shall not include any amount that the defendant proves is attributable to a change in the market price of securities that is unrelated to the misrepresentation or the failure to make timely disclosure.”
Cases based on Part XXIII.1 and similar provincial legislation require leave to proceed, based on a test of the merits, in addition to requiring certification as a class action. Where a defendant can establish at the leave and certification stage that an alleged misrepresentation did not actually cause “a change in the market price of securities,” it makes no sense for that case to proceed. The Court in Halliburton used the theoretical example of a case where a plaintiff establishes that the securities that are subject to a claim are trading in an efficient market, but “the evidence shows no price impact with respect to the specific misrepresentation challenged in the suit”. To permit certification in this situation would be, according to Halliburton, a bizarre result.
Despite the differences between the U.S. and Canadian disclosure class action regimes, the reasoning in Halliburton may be instructive in Canadian cases where defendants assert that an alleged misrepresentation had no effect on the price of its securities, and may assist in “weeding out” unmeritorious disclosure class actions at a preliminary stage.
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