The following post comes to us from Jill Fisch, the Perry Golkin Professor of Law at the University of Pennsylvania:
Just a few more thoughts about the event studies and question II in Halliburton. As I noted in my prior post, the level of discussion on the feasibility and mechanics of event studies was disappointing. I have explained the limitations with using event studies to address the question of price impact or price distortion for purposes of Basic. See Jill E. Fisch, The Trouble with Basic: Price Distortion after Halliburton, 90 Wash. U. L. Rev. 895, 919-21 (2013). In particular, a statement or series of statements that falsely confirm existing market expectations will not move stock price at the time it is made. An event study is incapable of measuring the effect that a counterfactual accurate disclosure would have had on the market, had it been made. A substantial number of securities fraud lawsuits present exactly this factual context. Basic itself was such a case. Basic denied the existence of merger negotiations for over a year during which time it was, in fact, involved in such negotiations. Basic’s lies had little or no effect on the stock price (indeed, the price rose after two of the three denials). When the merger was subsequently announced, the stock price rose dramatically. The argument in Basic was that, had the merger negotiations been accurately disclosed at an earlier time, the stock price would have been higher. What the stock price would have been, in October 1977, if Basic had not lied, is a question that event study methodology cannot answer. This, however, is the test that Professors Henderson and Pritchard seek to have the Court impose through a requirement that plaintiffs prove price impact at class certification.
The following post comes to us from Jill Fisch, the Perry Golkin Professor of Law at the University of Pennsylvania:
I was at the Supreme Court this morning to hear the oral argument in the Halliburton case. The debate was lively and the Justices were engaged. Two big surprises. First, the Justices devoted very little attention to the question of whether Basic should be overruled. This was a disappointment to some of the conservative lawyers who were watching the argument with me. Although Aaron Streett led off aggressively in his argument, as in Petitioner’s Brief, with the statement that Basic was wrong when it was decided and more wrong now, the Justices did not seem to have much appetite for discussing this issue. Of course that doesn’t mean they won’t vote to overrule – it is impossible to read the Court from the questions asked at oral argument – but there was very little discussion on economic theory, fraud on the market, congressional intent, etc. Justice Kagan stopped Streett early on when he tried to argue that the Court said 10(b) was just like section 18, and asked wasn’t section 9 a closer analogy, but that was about it.
There was some discussion about congressional acquiescence. Streett argued that Congress hadn’t decided for or against Basic in the PSLRA. Roberts seemed mildly interested in this, but David Boies had a pretty good answer in terms of not just citing the PSLRA but also SLUSA and noting that the legislation would make little sense if class actions were eliminated. The biggest issue here was Justice Alito raising section 203 of the PSLRA in which Congress says nothing in the statute is intended to affect whether there is a private right of action. Justice Scalia critically noted that the parties did not even address section 203 in their briefs.
When Streett tried to talk about the economic arguments, saying that the economic premises for Basic have changed, CJ Roberts asked “How do I review the economic literature?” He then asked, somewhat skeptically whether Streett was suggesting that the Court “jettison” Basic because economists believe the efficient capital markets hypothesis is no longer true. Streett had trouble answering that. Several other Justices noted that the economic debate over the degree of market efficiency was beside the point, stating that prices generally respond to information. Streett did not disagree. Streett also argued that Basic was no longer right because today’s traders don’t rely on the integrity of market price, citing hedge funds, index funds and program traders. David Boies made use of this point when his turn came around, arguing that these new types of traders make market prices respond even more quickly to information and noting that the only information that program traders have is market price.
The second major surprise was the degree of attention that the Justices devoted to question II in the petition for cert. The Justices seemed quite taken by the position advocated by Professors Pritchard and Henderson (which they termed the “law professors’ position) (too bad for the rest of us law professors) that plaintiffs be required to prove price impact, at the class certification stage, through an event study. Several Justices characterized modifying Basic to require that plaintiffs prove price impact as a “middle ground.” They repeatedly asked detailed questions about event studies and why requiring event studies at class certification would be a big deal, especially since they are already used to establish market efficiency in some courts, as well as to prove loss causation. Justice Sotomayor for example, asked why proving price impact would be so difficult
Malcolm Stewart, arguing for the SEC, focused exclusively on retaining Basic, but was happy to sell the plaintiff’s down the river on requiring proof of price impact. Perhaps the most damaging point came when he was asked by Justice Kennedy whether the plaintiffs would be hurt by a requirement that they prove price impact at class certification. Stewart said that the plaintiffs would not be hurt and might even be helped because they would be focusing on the effect of the fraud on a particular stock and not on the market generally.
Two points from the oral argument were particularly troubling. First, as Stewart’s answer demonstrated, the argument was permeated with a limited understanding of how event studies work and the complexities involved in using an event study to measure price impact, particularly in the case of misrepresentations that falsely confirm continued good news. Several of the Justices seemed to think that an event study is an easy and reliable way to ascertain price impact; so if it is available, why not require it? CJ Roberts even asked Malcolm Stewart if event studies were around at the time of Basic. David Boies failed to explain the fact that, in many FOTM cases, there is no price effect at the time of the false statement and that an event study is faced with the complex or possibly scientifically impossible task of ascertaining how price would have reacted in the counterfactual situation in which the truth had been disclosed earlier. The big picture discussion of event studies also overlooked logistical issues that could turn out to be quite significant in the lower courts such as burden of proof – what happens if the economists cannot say whether or not the price was distorted to a sufficient degree of statistical significance? Boies did try to explain that the loss causation event study looks at a different event – the corrective disclosure – which is often a cleaner event for purposes of the event study methodology in that it is less likely to be affected by confounding information.
Second, Streett suggested and appeared to persuade the Justices that class certification was the end of the game – that if a class is certified, it is almost a sure win or an inevitable settlement because of the in terrorem effect of class actions. He repeatedly argued that, because the NYSE is an efficient market and therefore market efficiency is easy to prove for all NYSE-listed companies, relying on efficiency alone without also requiring price impact is not enough. Sotomayor appeared quite troubled by the fact that less than 1% of securities fraud cases go to trial and then asked David Boies what percentage of cases involve a court rejecting class certification, seeming to suggest that it is problematic if cases were not weeded out by the class certification stage. No one raised the fact that the PSLRA pleading requirement coupled with the motion to dismiss together effectively weed out a substantial number of cases at an early stage, prior to discovery and its effect on the incentives to settle. Similarly none of the lawyers focused on why price impact must be litigated at class certification or at trial – why not, alternatively, in the context of a motion for summary judgment – although Justice Ginsburg asked what difference it made at what stage price impact is litigated.
A few weeks ago, the faculty here gave a lunchtime discussion of various SCOTUS cases in the 2013OT. As a corporate law professor, there's never a lot to choose from, and this year's skimpy offering was no different. I chose the consolidated cases of Chadbourne & Parke LLP v. Troice; Proskauer Rose LLP v. Troice and Willis of Colorado Inc. v. Troice. (Documents courtesy of Scotusblog.) Though the names do not suggest it, these are the private securities lawsuits stemming from Allen Stanford's Ponzi Scheme. Mr. Stanford is serving 100 years in prison right now and probably doesn't have a lot of extra cash lying around, so investors have chosen to sue these other entities. Because federal securities law is not very amenable to securities fraud lawsuits against aiders and abetters (like these defendants would be), these cases were brought under state law.
Unfortunately, federal securities law, and the Private Securities Litigation Reform Act, is not that easy to bypass. Defendants wanted the case dismissed under the Securities Litigation Uniform Standards Act, which pre-empts class actions in which plaintiffs allege a misrepresentation in connection with the purchase or sale of a "covered security." As you can tell from my quotation marks and boldface, plaintiffs counter that the fraud was not in connection with a "covered security."
What was the fraud? Stanford touted certificates of deposit (CD) accounts that paid 10% (what?) at Stanford International Bank, based in Antigua. Now, CDs at U.S. banks aren't considered securities at all, but the SEC and the DOJ argued that Stanford committed securities fraud in the purchase and sale of a security anyway. However, these charges were dropped in favor of wire fraud, obstruction and money laundering, and he was convicted on those counts.
That being said, no one is arguing that the CDs aren't a "security." But, plaintiffs argue that the CDs aren't a "covered security." A covered security is one that is listed on a regulated national exchange and traded nationally. The CDs are definitely not covered securities. But, SIB represented that the accounts were backed by "safe, liquid investments" and that monies were "invested in a well-diversified portfolio of highly marketable securities issued by stable governments, strong multinational companies and major international banks." Defendants argue that this is enough to meet the "in connection with" standard -- the monies were supposed to be used to purchase covered securities at some point. (The money was never used to purchase anything, but no one is taking the "phantom securities aren't securities" angle in this post-Madoff era!) In addition, defendants make the argument, and the SEC was using this argument in the Stanford case, that at least one plaintiff sold covered securities to invest in the CDs. If the defendants are right, then the case is dismissed under SLUSA and cannot continue in any court as a class action.
Here is the transcript of the oral arguments on the first day of the term. Other commentators seem to think it was split and that defendants may win. I wasn't there, but the transcript seems to suggest that the justices were very skeptical of the reach of the defendants arguments. Both the "in connection with" argument and the "selling covered securities to purchase the fraud" arguments seem to bring up spectres of ordinary purchases becoming securities fraud fodder. I.e., if I sell stock to buy a house, the seller better not say anything misleading or its securities fraud for you! I hope the plaintiffs win for this and other reasons.
As Broc Romanek observes, that is indeed rare:
Supreme Court Delivers Two Securities Law Decisions in Single Week!
Last week, the Supreme Court delivered two decisions impacting the securities law. Even one in a term is rare. Some say that securities defendants won one and lost one. Others say differently (for eg. see this blogby Lane Powell's Doug Greene). We have been posting dozens of memos on both Gabelli v. SEC andAmgen v. Connecticut Retirement Plans and Trust Funds in our "Securities Litigation" Practice Area.
The Gabelli court found that five-year statute of limitations period for federal enforcement actions seeking civil penalties begins to run "when the fraud is complete," not when it is discovered by the government (unlike the standard for private plaintiffs). And the Amgen court found that plaintiffs don't need to establish that allegedly false statements were material to the market before they can gain class certification.
Either the SEC is living in its own little bubble world or else the Commission is operating under some masochistic urge to embarrass itself. The Supreme Court simultaneously burst the SEC’s bubble and embarrassed the agency in its yesterday’s decision in Gabelli v. Securities and Exchange Commission. The Court rejected the SEC’s proffered interpretation of 28 U.S.C. § 2462, a general statute of limitations that governs many penalty provisions throughout the federal code.
Amgen is interesting because three justices are annoyed that the materiality requirement in the securities laws has bascially been dispensed with. That's three justices who don't have much use for precedent in this area:
In an unsurprising decision, the Court declined to raise the bar for the certification of securities class actions by requiring plaintiffs to establish the materiality of alleged misstatements to invoke the fraud-on-the-market theory in support of class certification. Instead, it remains sufficient for plaintiffs to simply plead materiality, and establish the traditional requirements of Rule 23 at the certification stage.
I never met Robert Bork, but I was an intern at the DC Court of Appeals in 1985, when he and Antonin Scalia were still on that court. The word among the staff and clerks at the Court was that one of those two would become the next nominee to the United States Supreme Court, if President Reagan were given the opportunity to nominate someone.
The next year, when William Rehnquist was elevated to Chief Justice on the retirement of Warren Burger, President Reagan had an opportunity to nominate a new Associate Justice. Should he nominate Scalia or Bork?
I don't know if this story is true, but I was told later by someone who claimed to be an insider that President Reagan nominated Scalia in part because he was younger than Bork and in better health. (Bork was a smoker.) If you want a justice to leave a legacy, it probably helps if the justice stays on the Court awhile. That was over 26 years ago.
Of course, Robert Bork would also get his nomination the year after Scalia was confirmed. The battle over Bork's nomination happened during my first year of law school, and it consumed much of the time and attention of the students and faculty at the University of Chicago. That seat eventually went to Anthony Kennedy.
After the Senate rejected Bork's nomination, I took Antitrust from Frank Easterbrook, who introduced me to The Antitrust Paradox. I know a lot of antitrust scholars criticize that book, but as a law student, I was enthralled by Bork's command of history and policy. He was a great writer. Reading that book made me think that being a law professor could be both fun and important, and I am grateful to Bork for that.
Robert Bork died today. He was 85 years old.
Tomorrow is the first Monday in October, and the Supremes will be back in session. So far, the Court’s docket includes two securities cases.
First, on November 5, the Court will hear oral argument in Amgen v. Connecticut Retirement Plans. This is the latest in what is becoming a series of Supreme Court cases involving which elements of a 10b-5 claim plaintiffs need to prove in order to have a class action certified. Two years ago, in Erica P. John Fund v. Halliburton, the Court reversed a 5th Circuit ruling that required plaintiffs to prove loss causation to certify a class. (Here at the Conglomerate, we hosted a mini-forum on that case as well as a post-mortem). In this current round, the fraud-on-the market theory returns to the justices. The Court will now rule on whether plaintiffs need to prove materiality before a 10b-5 class can be certified. It might also rule on whether the defendant can offer a rebuttal on materiality at the class certification stage.
Second, the Court just granted cert in an odd SEC enforcement case, Gabelli v. SEC, to resolve when the five year statute of limitations (in 28 U.S.C. § 2462) starts to run for the SEC to bring a case. This particular SEC enforcement action involves a mutual fund market timing case, with Judge Jed Rakoff (who has become the most influential federal judge on securities law matters) issuing the trial court opinion.
And looming in the background, the constitutional challenges to Dodd-Frank are congealing. Several states recently joined that portion of this blunderbuss lawsuit against Dodd-Frank that challenges the FDIC Orderly Liquidation Authority. With plaintiffs casting this broad of a net and a D.C. Circuit that has not been gunshy about striking down financial regulation, it would be surprising if some part of Dodd-Frank does not end up before the Supreme Court within the next two years. There will be that much more of a demand for conversation between public law and financial regulation scholars and practitioners.
Yesterday’s Wall Street Journal ran a story (password required) on federal prosecutors using the “responsible corporate officer” doctrine to impose personal liability on the officers and directors of drug companies for violations of food & drug laws.
This revives an obscure doctrine that I wrote about a few years ago (see here, pages 313-318) for a book that compared director liability for corporate actions across countries. The responsible corporate officer is understandably extremely worrying for corporate boards and executives because it means civil and even criminal liability when a corporation violates a law absent a director or officer knowing about the violation.
It is important to note that the scope of the doctrine is limited. It sprang forth in the 1943 Supreme Court case U.S. v. Dotterweich which interpreted the Federal Food, Drug and Cosmetic Act. The Court upheld the application of the doctrine to the same statute in 1975 in U.S. v. Park. In the 2003 case Meyer v. Holley, the Court revisited the doctrine and stated that Congress must be fairly explicit in a statute that it intends the doctrine to apply. And the current Supreme Court is unlikely to reverse course on this. The responsible corporate officer doctrine is unlikely to apply to new statutes absent explicit Congressional language.
Even so, the doctrine does apply to more than one federal food & drug statute. I list a number of federal cases in that book chapter I mention above. Moreover, state legislatures and courts have also applied the statute to state laws (and Meyer v. Holley does not necessarily constrain the ability of state courts to apply the doctrine to state statutes more liberally). So this dormant doctrinal strain should only give pause to boards and executives in certain heavily regulated industries that are subject to certain statutes. The doctrine is more limited, but potentially vastly more powerful – because lack of knowledge is not a defense -- than other sources of liability for directors that have been much more analyzed in recent years (for example, securities laws and Disney/Caremark/Stone v. Ritter).
So, Monday the Supreme Court issued its decision in Wal-Mart Stores, Inc. v. Dukes, an employment class action case. The majority decision was certainly a big win for Wal-Mart, and may be a big win for large-scale employers, but is it a win for securities issuers?
In Wal-Mart, Justice Scalia wrote for the majority, which held that the 1.5 million current and former female employees could not sue as a class because they failed to satisfy the "commonality" prong of Rule 23. (I'm not civ pro expert, but here's Sergio Campos and Lyle Denniston giving more detailed explanations.) The plaintiffs would have to have at least one common question of law or fact, and Scalia reasoned that they did not. The plaintiffs were alleging gender discrimination, which had a disparate impact and resulted in nationwide lower pay and promotion offers for women. As in other large employment discrimination cases, the plaintiffs had an expert armed with regressions to show that these disparities cannot be explained by other variables. However, Wal-Mart has no nationwide policy for hiring, pay or promotion decisions for local, nonmanagment jobs. Discretion, within limits, is given to local managers. The plaintiffs argued that the "nonpolicy" was a policy, so the common question was whether the nonpolicy policy resulted in discrimination. Scalia did not frame the inquiry in that way and so said that the questions would relate to local policies, so no one common question would be had by all claimants. So, no class action. (All the justices agreed that teh case suffered under another, correctable procedural error.) The four-justice dissent disagreed and argued that the reasoning unpermissibly went to the merits (whether there was any evidence that the nationwide nonpolicy affected the local policies).
So, I keep reading news items with throwaway sentences like "this decision will have impact in other class action areas, such as products liability and securities fraud." I'm intrigued by this. The opinion on its face seems to be about commonality. Securities fraud cases seem to be pretty strong in the commonality area. What am I missing? In the WSJ Law Blog, Skadden attorney Charles Smith is quoted as saying Scalia's opinion used "muscular language about the obligation of district courts as gatekeepers to apply rigorously the requirements for class certification, which can be a helpful tool for defendants to limit the scope and costs of these expensive cases." Smith is also cited for the proposition that the case will have an impact in securities fraud cases. Yes, the case seems to be part of a legislative and judicial trend of restricting the use of class actions. However, I have yet to see any examples of how the four requirements of Rule 23 (numerosity, typicality, commonality and adequacy) have been loosely applied in the securities law area, making it an easy target post-Wal-Mart.
Now, if you believe, like Justice Ginsburg, that the majority was looking into the merits at the class certification stage and that this new analysis will be the legacy of Wal-Mart, then you might reasonably look to other areas of class action litigation and say now plaintiffs will have to argue merits at class certification. However, we've already had this fight in securities law, and the plaintiffs won in a unanimous ruling: Erica P. John Fund v. Halliburton.
The best student comment I have ever read was published by the BYU Law Review last year. The Dictionary Is Not a Fortress: Definitional Fallacies and a Corpus-Based Approach to Plain Meaning was written by Stephen Mouritsen, who is now clerking with Justice Tom Lee on the Utah Supreme Court and will start at Cravath this fall. Stephen's comment was cited by the NYT today, though that citation did not do the piece justice. By the way, Stephen and I are writing an article this summer using corpus linguistics. Very cool stuff.
Thanks to our guest Barbara Black for joining Christine and me in previewing and reviewing the oral argument in Erica P. John Fund v. Halliburton. We hope to revisit the case when the opinion comes down.
For now, you can see all the posts in our roundtable below:
- Intro: the Supreme Court to dine on a casserole of class certification and securities fraud
- Thinking about Halliburton
- Halliburton oral argument
- The friendless Fifth, "rebuttable" cooked over-easy, and the Rules are rules
- The arguments I wish I heard
- Class certification versus motion to dismiss
- What will the Supreme Court do?
You can continue to follow Professor Black over at the Securities Law Prof Blog.
I like Barbara’s outline for a Halliburton opinion both as prediction and, to some extent, as prescription as well. There is much to be said for narrow holdings that don’t reach out to rewrite areas of law on issues that have not been fully briefed. In that spirit of making small bites, let me throw out a few thoughts.
First, Dura provides an interesting miniature case study in the unexpected implications of cases. Although when the case came out, it did not seem like a victory for plaintiffs, it helped cement a distinction between loss causation and other elements of a 10b-5 claim. This distinction makes it difficult in Halliburton to defend attempts to smush requirements that loss causation be proved into requirements for proving reliance. Supreme Court opinions, even ones that do not seem earth shattering, can have unexpected consequences. Perhaps one can see some glints of the rule of law even in judicial grains of sand.
By the same token, Judge Easterbrook’s very persuasive opinion in Schleicher v. Wendt, in which he criticized the 5th Circuit approach that resulted in Halliburton, is worthy of note. Easterbrook, well respected in law & economics and securities law circles, offers a blue print for analysis for the Supreme Court. As Don Langevoort notes in his Basic at Twenty article, Easterbrook has been involved in shaping the use of market efficiency theory and evidence in securities litigation for two decades. Part of Easterbrook’s motivation, Langevoort asserts, is that market efficiency can discipline securities litigation. We can see this in Easterbrook’s Schleicher opinion when he touts the truth-on-the-market defense. So market efficiency like legal principles is not necessarily skewed towards either plaintiffs or defendants.
Now it is possible that modesty will not carry the day when the Halliburton opinion comes down. As I noted in my introductory post, Halliburton is being decided in the same term as the Wal-Mart v. Dukes class action case. But, at least in Halliburton, I doubt that the Court will go the route of the 5th Circuit in Halliburton and Oscar and be motivated by policy concerns about class actions in general. The Federal Rules of Civil Procedure have to have some meaning and can't be rewritten in the middle of cases. And, Congress demonstrated with the PSLRA that it can act if it is concerned about securities class actions.
I'm still mulling over yesterday's oral argument; Erik Gerding's two insightful posts have helped me to work through some issues. Perhaps it's rash, but I'm going to suggest the framework for the Court's opinion, one that I think there is a reasonable chance of getting at least a majority of the Justices to agree to.
First, it will reverse the 5th Circuit and find that loss causation is not an appropriate issue at the class certification stage. There was no support for the 5th Circuit's opinion, not even from the Halliburton attorney. Loss causation is the ultimate merits determination, as Dura makes clear. The plaintiff will have to establish that there was both a misrepresentation that caused an artificially inflated price and a corrective disclosure that removed that artificial inflation. Moreover, under Rule 23(b)(3), loss causation is a common issue.
Second, it will reaffirm Basic and state that in order to obtain the rebuttable presumption of reliance (thus making reliance a common issue), plaintiff must, at the class certification stage, establish an efficient market for the stock. This can be done by plaintiff's showing that the stock prices generally react promptly to material information. Courts have required plaintiffs to do this since Basic, and, as Erik noted, there are any number of ways that this can be done, such as event studies and expert testimony.
What else, if anything, should the Court say about reliance and loss causation, beyond emphasizing that they are separate elements?
As Erik identified, the problem is when can the defendants rebut the presumption of reliance and should the Supreme Court address this? Suppose that, at the class certification stage, plaintiffs introduce evidence that stock prices generally respond to new information, and defendant wants to introduce evidence that the price did not react to the particular corrective disclosure at issue. So, he argues, this proves that the market was inefficient as to this particular type of information! Should the court allow this? Plaintiff's attorney argued that Basic requires rebuttal of reliance (other than general disproving market efficiency) at the merits stage, but Justice Alito, at least, was skeptical of this. If defendants can introduce this evidence at the class certification stage, it would allow the 5th Circuit on remand to reach the loss causation issue via the reliance route. Justice Scalia made this point explicitly.
If defendants have an event study that demonstrates that the price did not react to this particular corrective disclosure, why not allow it at the class certification stage? Wouldn't that save time and expense of going forward with a claim that will ultimately lose on the merits? Erik sets forth the reasons why it may appear that the stock price did not move in response to the corrective disclosure because the defendant can bundle good news and bad news to mask the effect of the corrective disclosure. Unfortunately, the plaintiff's attorney and the government attorney did not make this point as persuasively as Erik does.
So this may be, after all, a Pyrrhic victory for plaintiffs.
My post may be a bit late in the day, but to me this case is also a few years late. The parties, counsel and amicii trace the Fifth Circuit's stance back to Oscar, but to me this all goes back to another little Houston firm called Enron. In 2007, a few months before Oscar, the Fifth Circuit de-certified an Enron shareholder class action suit against four banks who were involved in the Nigerian Barge transaction, alleging a violation of 10b-5 (Regents of the U. of Calif. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372 (5th Cir. 2007). The suit, even in a post-Central Bank world, had survived a motion to dismiss based on the theory that the banks were secondary actors, not primary violators. Both the denial of the MTD and the certification of the class were appealed from the Southern District of Texas to the Fifth Circuit. The Fifth Circuit issued an opinion on the class certification first, stopping the lawsuit in its tracks.
What was interesting to me, being a measly corporate law scholar and no civil procedure expert, was that the Fifth Circuit said that certification was not possible because the banks were secondary actors. OK, which part of Rule 23 is that? Well, eerily similar to Oscar and Halliburton, the court held that certification of the class depended on whether the presumption of reliance found in Basic applied. In order for Basic to apply, the plaintiff must show that the defendant made public, material misrepresentations, the defendant's shares were traded in an "efficient market" and the plaintiff traded shares at the relevant time. Here, the Fifth Circuit said that Basic didn't apply because as secondary actors, the banks made no public statements, merely aided and abetted Enron's public misstatements. At the time, my question was Why here? Why not reverse the MTD denial? The case was appealed to the Supreme Court, was told to wait until Stoneridge, then was forgotten forever as just another secondary actor case.
In light of that history, the Fifth Circuit seems to be waging a war on securities fraud class actions by introducing various elements of 10b-5 at the class certification stage, even though those issues are ones in which common issues predominate -- whether someone is a secondary actor or primary actor and loss causation. And, the method to the madness is shoehorning these elements into the Basic/reliance inquiry. In the Enron case, the secondary actor issue was used to defeat one prong of reliance, but in the Halliburton case it is the second prong -- whether the market is efficient. According to the Fifth Circuit, plaintiffs have to prove loss causation in order to prove that the market is efficient (or else the price would not go up and down with disclosures). My former boss David Sterling of Baker Botts rephrases this as "price impact," but it's hard to prove a price impact but not loss causation or vice versa. Now of course, the rather convoluted first part of the SCOTUS hearing proves how circular securities fraud elements are -- materiality can hinge on a price drop, as does loss causation, as does whether the market is efficient.
So, my question still is Why here? Why not just dismiss the same case for failure to prove loss causation? The justices seem to be asking Mr. Sterling whether wouldn't it be better to explore merits questions with full discovery at the MSJ stage. But wouldn't all this be decided at the MTD stage during the discovery stay anyway? Are we really saving this cases by getting all this stuff out of class certification or just merely making the two inquiries cleaner and neater, even if at the end of the day the outcome will be the same?
It is easy to armchair quarterback a Supreme Court argument, but there are a number of issues I wished had been more fleshed out.
The difference between proving loss causation and proving fraud-on-the-market reliance. The justices seemed to look for a way to distinguish requiring plaintiffs to prove that a market for a particular security was efficient from requiring plaintiffs to prove loss causation. As Professor Black and I both noted earlier, even Halliburton’s counsel conceded that the Fifth Circuit went way past Basic in requiring that plaintiffs prove loss causation as a condition to the fraud-on-the-market presumption of reliance.
The Supreme Court has been clear in Dura and more recently this term in Matrixx that reliance and loss causation are separate issues. Again, I don’t find Halliburton’s efforts to distinguish “price impact” from loss causation to be persuasive. I doubt the Court will want to want to re-muddle the issue by conflating proof of “price impact” with proof of reliance.
To be clear, plaintiffs still have to prove that a market is efficient in order to get the fraud-on-the-market presumption of reliance. What does this proof look like? It ranges from event studies to expert testimony that show that prices in a market for particular security typically change in response to new public information. Trial courts have managed to sift through this kind of proof for two decades.
Halliburton’s attorneys are now recasting their litigation at trial and the two lower court opinions to say that they rebutted this presumption of an efficient market by asserting that prices did not respond to particular corrective disclosures.
Aside from the time travel issue of trying to retry a case on appeal, what’s the problem with that? Well for one thing, requiring plaintiffs to prove that a particular disclosure – whether a misleading disclosure or a corrective one – caused a particular price movement would undermine the distinction between proving loss causation and reliance.
There is a larger practical problem for investors: mixed disclosures. Even if plaintiffs can prove that market prices for a company’s securities typically react to new information, it is very difficult for plaintiffs to prove that a particular statement had a particular effect on price. Companies tend to make statements in bunches making it difficult to distill the effects of the first false statement on the stock price.
Let’s assume Gerding Enterprises is publicly traded and I am the chief executive officer. A particular false material statement (“Professor Gerding was born in Texas”) may be bundled with other statements false (“Professor Gerding robbed a bank yesterday”) and true (“Professor Gerding lives in New Mexico”). (I’ll leave it to the reader to determine whether the lie of being born in Texas would increase or decrease the price of my stock.)
Similarly, corrective disclosure may be made in bunches – with corrective truths mixed with other statements either true or false. “Professor Gerding was in fact born in New Jersey, not far from the birthplace of Justices Scalia and Alito. He won the 2011 Nobel Prize for Literature. He was convicted yesterday of arson.” Correcting the misstatement of my birthplace may cause the stock price of Gerding Enterprises to move back to where it would have been had the lie not been made. But the fresh lie about my non-existent Nobel might inflate the price, and the false news of my criminal conviction would depress the price. If the price of my stock doesn’t move, doesn't move enough, or moves in an odd direction after this second bundle of disclosure, does that mean that the market for Gerding Enterprises stock was not efficient with respect to the lie about my birthplace? Or does it mean there is a mess with untangling the effects of all the statements made.
Although the particular details I picked are fanciful, the problem of mixed and bundled disclosure is definitely not. The corrective disclosure in Halliburton itself involved "multiple pieces of negative news." In Oscar, the issuer (a telecom company) made a corrective disclosure that it had overstated the number of telephone lines it installed at the same time it disclosed that it missed analyst estimates on earnings. The Fifth Circuit rejected class certification in Oscar because the plaintiffs could not isolate the effects of the corrective disclosure from the other statements. But might lower earnings have some relationship to non-existent revenue from non-existent telephone lines?
Ultimately, Plaintiffs still have to untangle the causal effects of all the statements and prove that a particular misleading statement caused their loss. But, again, the issue is when. Not only is this causation issue common to all plaintiffs, but if investors have to prove it at class certification, they will have minimal discovery. The assertion by Halliburton’s counsel that trial judges have flexibility to allow for intensive discovery at the class certification stage did not sit well with Justice Scalia or Chief Justice Roberts.
Bad incentives. Moreover, companies can seek to obfuscate and frustrate plaintiffs from ever getting a class certified by mixing in extraneous true and false statements when they make either an initial misleading statement or a corrective disclosure. Professors Fisch and Spindler and Fisch, among others, have made this point persuasively. Disclosing the telephone book is the best way to defeat securities litigation if not to cloak outright fraud. Again, it would be hard to prove this kind of strategic obfuscation with minimal discovery.
Justice Sotomayor asked: [d]oesn’t a lack of response to a disclosure – couldn’t it be in some situations reflective of an inefficient market? It could, or it could have other explanations including that the market is indeed efficient but that either
• the market already learned the truth (the truth-on-the-market defense a la Judge Easterbrook in Schleicher); or that
• the disclosure was mixed with a number of positive and negative statements which could wash out the price effects of the correction.
Form and substance. Justice Scalia asked what if the 5th Circuit had simply rephrased its holding to have found that defendants rebutted the presumption of reliance by showing no movement in price. In essence, he was asking whether the difference between proving an efficient market and proving loss causation is merely semantic. Again, requiring plaintiffs to prove that prices in a market for a particular stock generally react to material information is quite a bit different (but still not easy) than requiring plaintiffs to prove that particular disclosures caused particular price changes.
The Court need not address the issue of how trial courts test for whether a market is efficient as a general matter. The Court certainly could – they could do an exhaustive look at things like the Cammer factors and review theoretical and empirical debates on finance theory. But it isn’t necessary.
Justice Alito and Speculation on Partially Inefficient Markets.David Boies did seem to flail a bit when Justice Alito asked about the beliefs of some economists that
even in a market that is generally efficient, there can be instances in which the market does not incorporate certain statements into the price of a stock.
If this were true, Justice Alito asked, shouldn’t defendants be allowed to rebut the presumption in Basic.
The Fifth Circuit in Oscar used similar logic citing a twenty year old Macey and Miller article (Oscar, 487 F.3d at 269). But, the Fifth Circuit used this argument without requiring defendants to offer any evidence at all. Under Oscar, plaintiffs essentially had to disprove that a market wasn’t inefficient with respect to certain kinds of information.
But let’s say that defendants could actually offer specific proof that a market was inefficient with respect to certain kinds of information. What would that proof look like in reality? A lack of a price movement in response to corrective disclosure has all the problems noted above: there may be other simultaneous disclosures that cloak the causal effects of the corrective statements. Or the market may also have learned about the falsehood previously. So trial courts would need lots of facts.
A fight over specific price effect of specific statements is then beginning to look a lot like loss causation. And to sort all of this out, it is beginning to look a lot like a trial on the merits at class certification. But don’t worry: Halliburton’s counsel said trial courts have powers to require more discovery.
Presumptions. Rather than turn class certification into a full blown trial, perhaps we could stick with what we have in Basic. As Justice Breyer indicated in his questions, fraud-on-the-market is about presumptions. This returns to the often overlooked passages in Justice Blackmun’s opinion in Basic on what are presumptions and why they are used. If plaintiffs can prove that market prices generally react to material information, then courts can presume that any material misstatement distorted the overall price for all investors who bought or sold during the period the misstatement was uncorrected. Without this presumption, there are not common issues to all investors.
Rather than open up a can of worms, perhaps a simple, dare-I-say Basic opinion is warranted.
In the interest of full disclosure, again, Professor Black and i joined 16 other law professors in an amicus brief arguing that the Fifth Circuit should be reversed.
The transcript of this morning’s oral argument in Hailliburton is now online. It was a hot bench with eight out of the nine justices participating. Professor Black has already weighed in with her reactions. Here are a few quick thoughts based on the oral argument, some of which echo hers:
1. The Fifth Circuit had no friends. Halliburton’s attorneys seem to be changing their litigation strategy midstream and cutting themselves loose from portions of the 5th Circuit opinion for their client. Perhaps that was the only sound strategy, but for the Court to rule for Halliburton they would have to reconstruct the 5th Circuit opinion from the remnants that have not been cut loose.
It seems that Halliburton is now conceding that loss causation is not part of class certification, but that the company successfully rebutted the presumption that a market was efficient. That might be some creative recharacterization of how Halliburton litigated the case.
Justice Sotomayor picked up on this, “So you’re not defending the rationale of the Fifth Circuit now? You’re sort of backing yourself into the reliance element?”
Halliburton’s counsel responded that the issue they are arguing “is not loss causation; it’s price impact.”
I’m not sure there is much difference in that distinction. Justice Kagan appears to have thought the same. She asked:
One possible argument you could be making is that the plaintiffs have to show a price impact. Another possible argument you could be making is that you have to have the opportunity to rebut the plaintiff’s use of the Basic presumption by yourself showing that there was no price impact.
Halliburton’s counsel asserted they were arguing the latter. But Justice Ginsburg said that the 5th Circuit opinion appears to put the burden of proving price impact on the plaintiff. At this point, counsel hung the 5th Circuit out to dry and conceded that that lower court opinion was contrary to Basic.
2. What does “rebuttable presumption” mean? What does it mean for a presumption to be rebuttable? According to Halliburton’s counsel, it don’t take much. Under questioning from Justice Kagan, Halliburton’s counsel asserted that all defendants have to do is put an expert witness on the stand.
I agree with Professor Black (and Justice Kagan), that that doesn’t seem to be treating the Basic presumption as more than a paperweight. Nevertheless, it is more than the 5th Circuit seems to require. After re-reading both the 5th Circuit opinions in Halliburton and the earlier case of Oscar on which it is based, a mere assertion that something else caused the price change might rebut Basic’s presumption.
In describing the rebuttable presumption, the Basic Court wrote:
Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance.
Halliburton and the Fifth Circuit emphasize the “any showing” but not the “severs the link.”
What does it take for a presumption of reliance to be rebuttable? Surprisingly, the lawyers today did not focus much on the examples that Basic itself gave. For example, market makers who heard a false statement may not have believed it. Alternatively, Judge Frank Easterbrook, in his opinion in Schleicher criticizing the Fifth Circuit in Oscar, touted the truth-on-the-market defense. According to this theory, if a company made a false statement but sophisticated investors learned the truth before investors suffered a loss, there is no reliance. Judge Easterbrook argues that an efficient market may also cut against plaintiffs.
When can defendants rebut the presumption? David Boies, arguing for petitioner, argued it should occur after a class has been certified at the merits stage. When pressed by Justice Alito for support, he asserted that the type of situations that would rebut the presumption would be common to an entire group of investors. Barbara: do you think the Court has to address the question of when the presumption can be rebutted?
3. This is about Rule 23(b). As much as I love securities law, this case is really about civil procedure and reading the text of the Federal Rules of Civil Procedure.
Justices Breyer and Scalia focused much of their questions on one of the core issues of the case, namely whether the Rule 23(b) standard for certifying a class has been met. My guess is that, unlike the Fifth Circuit, the Court will focus the bulk of its reasoning on whether the predominance standard of Rule 23. If the absence of an element would mean common issues do not predominate, plaintiffs must prove it to certify a class. Conversely, if an element is common to all investors of a putative class, it ought to be decided at the merits stage.
I agree with Professor Black that the justices will not look to revisit Basic and will seek a narrow holding. My bet would be that this will push the judges to a rather straightforward holding that issues of loss causation would be common to an entire class, and thus loss causation (or “price impact” by any other name) is not an appropriate condition to certifying a class under Rule 23(b).
Did Halliburton’s counsel make a strategic blunder when he argued the following:
Rule 23 makes clear that the district court has ample discretion at the class certification stage to allow discovery into the merits to the extent that they are relevant to the class certification issue.
That line invited a teasing rebuke by Justice Scalia that Halliburton was inviting the Court to move costly discovery up to the class certification stage. Jokes aside, I have got to believe many of the justices – including some of the more “conservative” members of the Court-- are not going to favor arguments for more discretion in trial courts in conducting class certification inquiries. Don’t the Federal Rules mean something?
In the interest of full disclosure, again, Professor Black and i joined 16 other law professors in an amicus brief arguing that the Fifth Circuit should be reversed.