I'm Barbara Black, otherwise known as SecuritiesLawProf, and I'm visiting on Conglomerate for the next day or so to comment on Erica P. John Fund v. Halliburton Co., which will be argued tomorrow in the U.S. Supreme Court. Eric Gerding has written an excellent post to start off the Roundtable discussion, and I want to thank him for inviting me to participate, perhaps to provide a historical perspective. In 1984, I was an untenured faculty member, looking for the “next big thing” in securities law to write about. Fortunately for me, I picked the fraud on the market theory, and my article was quoted by both the majority and dissenting opinions in the Supreme Court’s 1988 opinion in Basic Inc. v. Levinson.
A bit of background might be in order for those who do not regularly think about these issues. Until Basic, the reliance element of a Rule 10b-5 claim, and the implication that this involved individual issues of fact, threatened to doom the use of the class action device in securities fraud actions. After Basic, at least in efficient markets, reliance was a common issue, and a class of investor-plaintiffs could be certified under F.R.C.P. 23(b)(3). At the time of Basic, the FOTM was a nascent theory; the Supreme Court, however, did not see its task as “assessing the general validity of the theory,” but to address a narrower question: “whether it was proper for the courts below to apply a rebuttable presumption of reliance, supported in part by the fraud-on-the-market theory” (emphasis added).
After Basic, critics of the Rule 10b-5 class action sought legislatively to reverse the outcome. Congress, however, in the 1995 PSLRA legislation, made clear its purpose was to reform the securities fraud class action, not to kill it, and it rejected efforts to eliminate the FOTM presumption. After PSLRA, the Court has seen its task as implementing Congressional intent in the area of securities fraud class actions (see Stoneridge). Critics of the federal securities class action won a major victory in the Fifth Circuit with the 2007 Oscar decision, in which the Fifth Circuit announced its requirement that plaintiffs prove loss causation at the class certification stage, as a further check on the efficiency of the markets, because of the powerful impact of the Basic presumption. If the Supreme Court adopts the approach of the Fifth Circuit, maintaining a federal securities fraud class action will become extremely difficult.
As Eric states in his post, a fascinating question (beyond the outcome) is how the Court will arrive at its decision. It would be easy for the Court to decide the case narrowly in favor of the plaintiffs. The Fifth Circuit opinion has not been followed in other Circuits; the Seventh Circuit, in an opinion by Judge Easterbrook, labeled the Fifth Circuit’s approach as a “go-it-alone strategy.” Loss causation, measuring as it does the impact of the misstatement on the stock price, is, unlike reliance, typically a common question and therefore not a relevant consideration at the class certification stage. The government supports the petitioners’ position, and the Supreme Court frequently gives deference to the government’s position (again, see Stoneridge). So this could be a short opinion.
But will the Court be persuaded to go farther? If so, the outcome becomes more difficult to predict. Is the Court inclined to re-examine Basic and FOTM, now that there has been over 20 years of further research and scholarship on the issue? In the years subsequent to Basic, there have been real-life events (e.g., tech bubble) and empirical studies that cast doubt on the efficiency of the markets. However, as noted above, Basic was only partly based upon economic theory. The Court also cited “considerations of fairness, public policy, and probability” to support “the congressional policy embedded in the 1934 Act” that “securities markets are affected by information, and enacted legislation to facilitate an investor’s reliance on the integrity of the markets.” Those policy consideration remain equally compelling today.
I look forward to others’ views and reading the transcript of the oral argument.
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