Today, in CalPERS v. ANZ Securities, Inc. (pdf), the Supreme Court recognized a crucial limitation on the doctrine that allows a class action to toll the deadline for absent class members to bring their own separate individual suits. We’ve been following this issue in the CalPERS appeal for some time. (See our previous reports on this appeal.)

In a 5-4 decision authored by Justice Kennedy, the Court held that the American Pipe tolling doctrine does not apply to statutes of repose. As a result, the three-year statute of repose in the Securities Act of 1933 barred a suit that CalPERS had filed against the underwriters for certain Lehman Brothers debt securities more than three years after the securities were issued, but while a timely class action bringing similar claims was pending.

Continue Reading Supreme Court Refuses To Allow Class Action To Extend Deadline For Filing Suit

Yesterday afternoon, the Supreme Court heard oral argument (pdf) in CalPERS v. ANZ Securities, a case that asks whether a plaintiff asserting violations of Section 11 of the Securities Act of 1933 can file suit after the three-year outer limit for such suits has passed, if a class action encompassing the plaintiff’s claims was timely filed and remained pending. The answer to that important question, which has divided the federal courts of appeals, will tell defendants facing suit over the issuance of securities whether the Securities Act’s three-year repose period is a real protection against belated lawsuits or simply a limited protection that dissolves once a timely class action is filed. Yesterday’s argument suggested the Court, too, may be divided about how to resolve this debate.

Continue Reading Can Opt-Out Plaintiffs File Suit After Expiration of a Statute of Repose? Supreme Court Hears Oral Argument in CalPERS v. ANZ Securities

In NECA-IBEW v. Goldman Sachs, the Second Circuit arguably opened up a new door in class action litigation when it held that investors in one securities offering had standing to represent a putative class of investors in other offerings, as long as the fraud claims on both securities gave rise to “the same set of concerns.” (Our past coverage of that decision is here.) The Second Circuit’s recent decision in Policemen’s Annuity and Benefit Fund v. The Bank of New York Mellon, argued by our colleague Charles Rothfeld, clarifies and narrows that ruling, especially as to claims for breach of contract.

At issue in Policemen’s Fund were a series of residential mortgage-backed securities (RMBS) trusts. These trusts hold pools of mortgages and thus receive the stream of interest and principal payments from mortgage borrowers; beneficial ownership interests in the trusts are then sold to investors. The Policemen’s Fund plaintiffs are investors in 15 residential mortgage securitizations who sued the trustee (the Bank of New York Mellon) for alleged breaches of the trust agreements, state law duties, and the federal Trust Indenture Act. The question in the case was whether the named plaintiffs—who had invested in some RMBS trusts within the class definition but had not invested in many others —nonetheless had standing to sue on behalf of putative class members who had invested in those other trusts. (The case also involved questions about the scope of the Trust Indenture Act; the court ultimately decided that the TIA doesn’t apply to most RMBS; please see our report on the securities-law aspects of the decision for more details.)

The Second Circuit held that the named plaintiffs did not have standing to sue on behalf of the putative class members who had invested in trusts that the named plaintiffs had not. And helpfully for defendants, the court held that the named plaintiffs’ claims did not implicate the “same set of concerns” as those of the other class members by focusing on the proof required for each claim. Specifically, the court observed that “the absent class members’ claims” in NECA “were similar to those of the named plaintiffs in all essential respects,” because the alleged misstatements were in a shelf registration statement, and all of the securities were issued from the same shelf. In other words, the court explained, “the defendants’ alleged Securities Act violations inhered in making the same misstatements across multiple offerings.” By contrast, the court explained, the claims at issue in Policemen’s Fund required that the alleged misconduct “be proved loan-by-loan and trust-by-trust”; the claims depend upon the potentially varying conduct of the trustee and the entities the trustee purportedly should have supervised.

The Second Circuit’s analysis thus represents a rejection of a free-floating and malleable approach, which some commentators have argued that NECA permits, to the question whether the claims involve the “same set of concerns.” Indeed, the court shot down the plaintiffs’ arguments that relied on such a nebulous conception of class standing. First, the plaintiffs had suggested that it was the trustee’s allegedly common “policy of inaction” that was at issue, not its loan-specific conduct. That doesn’t solve the standing problem, the Second Circuit held, because “they would still have to show which [securitization] trusts actually had deficiencies that required BNYM to act in the first place.” Second, the plaintiffs proposed to use statistical sampling to show defects across securitizations. But the court held that such a methodology, (which we have criticized before) would require that plaintiffs “augment” the proof that they would have offered on their own claims; that prospect “does nothing to reassure us that Plaintiffs themselves have any real interest in litigating the absent class members’ claims.”

Policemen’s Fund is an important step toward reining in what—if NECA-IBEW were interpreted the wrong way—could have been an unbounded test for class standing (itself a novel and amorphous doctrine). Now, if the proof that the plaintiff would present on its own claim does not—at a minimum—go a long way toward proving the claims of absent class members, then the tag-along claims may be dismissed at the pleading stage for lack of standing rather than waiting for class certification. That aspect of the Policemen’s Fund ruling significantly limits the ability of plaintiffs’ firms to leverage small investor clients who are not representative of a proposed class to bring overly broad class actions.

In ERISA stock-drop class actions, plaintiffs routinely allege that their employers breached a duty of prudence by permitting employees to invest their retirement assets in their company’s stock.  Until today, defendants typically defended against such claims by invoking a judicially crafted presumption that offering company stock was prudent.  Today, in Fifth Third Bancorp v. Dudenhoeffer, No. 12-751 (pdf), the Supreme Court rejected that presumption.

But all hope is not lost for stock-drop defendants.  Much of the work previously done by the presumption of prudence will now be done by the substantive requirements of the duty of prudence.  The Court offered guidance as to what plaintiffs must demonstrate to survive a motion to dismiss—and the standards suggested by the Court will not be easy to satisfy.

As a starting point, fiduciaries who administer retirement plans governed by the Employee Retirement Income Security Act (ERISA) owe a duty of prudence to plan participants.  See 29 U.S.C. § 1104(a).  To comport with that duty, fiduciaries are generally required to “diversify[] the investments of the plan so as to minimize large losses, unless under the circumstances it is clearly prudent not to do so.”  Id. § 1104(a)(1)(C).  But because Congress wanted to encourage employees to invest in their own companies, it waived the duty of prudence “to the extent it requires diversification” for fiduciaries of an “employee stock ownership plan” (ESOP).  Id. § 1104(a)(2).

Several federal courts of appeals had inferred from this exemption that an ESOP fiduciary’s decision to hold or buy employer stock should be presumed prudent, and that the fiduciary could not be held liable unless the company was in such dire financial straits that its viability as a going concern was in doubt.  In today’s unanimous opinion by Justice Breyer, the Court held that ERISA’s text provides no presumption—in particular, although Section 1104(a)(2) expressly exempts ESOP fiduciaries from the duty of prudence, to the extent that duty requires diversification, it makes no reference to any special presumption.

Having resolved the question presented, the Court proceeded to “consider more fully one important mechanism for weeding out meritless claims, the motion to dismiss for failure to state a claim,” and explained how, in light of the substance of the duty of prudence, motions to dismiss should be assessed.

The Court effectively ruled out stock-drop claims based on publicly available information, invoking its two-day-old decision in Halliburton Co. v. Erica P. John Fund, Inc. (pdf) (previously discussed on the blog), in which the Court opined that investors may reasonably rely on the market to incorporate public information into a stock’s price.  For circumstances in which fiduciaries are alleged to possess nonpublic information that suggests it was imprudent to hold company stock, the Court held that “a plaintiff must plausibly allege an alternative action that the defendant could have taken that would have been consistent with the securities laws and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the fund than to help it.”  The Court emphasized that ERISA fiduciaries cannot be required to trade on insider information in violation of the securities laws.  And the Court cast doubt on other theories sometimes offered by ERISA stock-drop plaintiffs—that fiduciaries should have ceased making new investments in company stock or disclosed the previously nonpublic information.  The Court noted that ERISA’s requirements must be in harmony with “the complex insider trading and corporate disclosure requirements imposed by the federal securities laws” and the objectives of those laws, and indicated that ERISA’s fiduciary breach requirements do not require plan fiduciaries to take actions that “would do more harm than good to the fund by causing a drop in the stock price and a concomitant drop in the value of the stock already held by the fund.”

The Court’s decision fundamentally reconfigures the landscape for ERISA stock-drop class actions.  Although the rejection of the presumption of prudence is likely to result in more suits against retirement plan fiduciaries, the Court’s substantive guidance arms class-action defendants with potent defenses that can be invoked at the motion-to-dismiss stage.  The main issue left open by the Court—when, if at all, fiduciaries must act on nonpublic information—will be litigated extensively in the lower courts, and may ultimately percolate back up to the Supreme Court again.

Yesterday’s Supreme Court ruling in the Halliburton case leaves the securities class action system pretty much unchanged. And that isn’t because the Supreme Court examined the system and concluded it is working well and makes sense.  Instead,  the Court simply didn’t address those questions.

That’s very good news for the lawyers who make their living representing plaintiffs and defendants in these cases.  The gravy train will continue:  $1.1 billion in fees and expenses awarded to plaintiffs’ counsel in 2013, with hourly rates up to $1370.  Defense counsel likely took home a multiple of that amount, given that securities class actions routinely target multiple defendants with separate counsel, and that defense fees pile up in those cases that don’t reach the settlement stage.

But it’s very bad news for investors, who are forced to foot the bill for this economically-irrational litigation system that—in the words of Joseph Grundfest, former SEC Commissioner and current Stanford Law professor— “is broken” because it “fails to efficiently . . . deter fraud and fails [to] rationally compensate those harmed by fraud.”  Professor Donald Langevoort of Georgetown has said: “Were this system sold as an insurance product, consumer-protection advocates might have it banned as abusive because the hidden costs are so large.”  (More information about the dysfunctionality of the securities class action system is collected here.)

Indeed, the Court’s decision almost certainly will make this litigation even more expensive by increasing the scope of the class certification inquiry (while not changing the result in many cases).  That means even more money out of the pockets of shareholders and into the pockets of lawyers and economic experts.

Why did the Court refuse to revisit the correctness of the fraud-on-the-market presumption recognized in Basic Inc. v. Levinson and decline even to consider the mountain of evidence that securities class actions hurt shareholders?  And why is the Court’s tweak of the presumption unlikely to have any real-world effect?

The Punt to Congress

Stare decisis—respect for precedent—is the reason why this potential blockbuster case fizzled.  Ordinarily, the Supreme Court is very reluctant to overrule a prior decision interpreting a federal statute. The Court’s view is that Congress has the power to correct errors in statutory construction.

But Basic is far from a conventional statutory interpretation case: courts, not Congress, created the private cause of action for securities fraud; courts, not Congress, specified the elements that a plaintiff must prove to recover damages; and courts, not Congress, formulated the fraud-on-the market presumption as a substitute for proof of reliance.  For that reason, many observers (including me) thought that the Supreme Court would examine Basic under the different, more flexible stare decisis standard applicable to judge-made federal common law (and decisions under statutes like the antitrust laws that delegate common-law authority to courts). That standard permits the overruling of precedent in a broader range of circumstances, recognizing that Congress has allocated to the courts principal responsibility for supervising those areas of law.

Justice Thomas, writing for himself and Justices Scalia and Alito, applied that more expansive approach.  As he explained, Basic “concerned a judge-made evidentiary presumption for a judge-made element of the implied 10b−5 private cause of action, itself ‘a judicial construct that Congress did not enact in the text of the relevant statutes.’”  For that reason the high bar to overruling precedent that governs statutory construction cases should not apply:

[W]hen it comes to judge-made law like “implied” private causes of action, which we retain a duty to superintend[,] . . . . we ought to presume that Congress expects us to correct our own mistakes—not the other way around. That duty is especially clear in the Rule 10b–5 context, where we have said that “[t]he federal courts have accepted and exercised the principal responsibility for the continuing elaboration of the scope of the 10b–5 right and the definition of the duties it imposes.”

Indeed, Justice Thomas pointed out that Congress in the Private Securities Litigation Reform Act had expressly declined to ratify the courts’ creation of a private cause of action, stating that “[n]othing in this Act . . . shall be deemed to create or ratify any implied private right of action.”  That language makes clear that Congress intended that questions regarding the standards for establishing liability remain the province of the courts.  In Justice Thomas’s words, “Basic’s presumption of reliance remains our mistake to correct.”

The majority in Halliburton did not even respond to these arguments, relying instead on the general rule that “[t]he principle of stare decisis has ‘“special force”’ ‘in respect to statutory interpretation,’” and citing a decision involving the interpretation of statutory language enacted by Congress, not a case relating to judge-made law.

Most importantly, the majority did not assess the merits of the arguments challenging Basic—instead dismissing them because they had been considered and rejected by the four-Justice majority in Basic or because they did not “so discredit[] Basic as to constitute ‘special justification’ for overruling the decision.” With respect to the harm to investors from the securities class action system, the Court also refused to engage, saying that “[t]hese concerns are more appropriately addressed to Congress.”

The three Justices concurring in the judgment did address these issues.  They determined that the two assumptions underlying Basic’s presumption of class-wide reliance simply “do not provide the necessary support” for that presumption:

The first assumption—that public statements are “reflected” in the market price—was grounded in an economic theory that has garnered substantial criticism since Basic. The second assumption—that investors categorically rely on the integrity of the market price—is simply wrong.

Moreover, they recognized the reality that “in practice, the so-called ‘rebuttable presumption’ is largely irrebuttable”—“[o]ne search for rebuttals on individual-reliance grounds turned up only six cases out of the thousands of Rule 10b-5 actions brought since Basic,” likely because of the “substantial in terrorem settlement pressures brought to bear by [class] certification.”  That is a critical failing, because “without a functional reliance requirement, the ‘essential element’ that ensures the plaintiff has actually been defrauded, Rule 10b–5 becomes the very ‘“scheme of investor’s insurance”’ [that] the rebuttable presumption was supposed to prevent.”

Of course, the economic burden of this “insurance” falls squarely on investors.  One recent study found that investors’ “total wealth loss” from securities class actions “averages to about $39 billion per year, in order to collect an average of $6 billion in settlements per year ($5 billion per year after plaintiff attorneys’ fees). In other words, because of the filing of securities class actions, shareholders incrementally lost more than six times the settlement amount (or more than seven and half times the amount that shareholders would receive after plaintiffs’ attorneys’ fees).”

The majority’s decision to disclaim responsibility for addressing these very real—and very harmful—consequences of judge-made law “‘places on the shoulders of Congress the burden of the Court’s own error.’”

The Tweak With Little Real-World Impact

After declining to reconsider Basic, the Supreme Court majority addressed what has been labeled the “middle ground” argument in the case:  whether the Court should modify the factual showing that a plaintiff must make at the class certification stage in order to gain the benefit of the fraud-on-the-market presumption.

Some news reports have called the Court’s decision on this point a “new burden” on securities class action plaintiffs or a “new hurdle” to obtaining class certification.  But the consensus of informed observers is that the Court’s ruling means more litigation and cost with little ultimate difference in the results of class certification decisions.  Perhaps in some cases class certification may become more difficult, but the big picture is bleak:  The securities class action engine will roll along essentially unchanged, continuing to drain away billions of dollars in shareholder value each year.

To begin with, here’s a bit of background on the Basic presumption.  The Court held in that case that, as an alternative to proving actual reliance on the defendant’s false material misstatement, a plaintiff may—as the Halliburton majority explained—“invok[e] a rebuttable presumption of reliance” by showing that the misrepresentations were publicly known and material, that the security purchased or sold by the plaintiff “traded in an efficient market” and that the plaintiff traded in the security “between the time the misrepresentations were made and when the truth was revealed.”

In that situation, the fraud-on-the-market theory holds that the market price “‘reflects all publicly available information, and, hence, any material misrepresentations’”; that “the typical ‘investor who buys or sells stock at the price set by the market does so in reliance on’ . . . the belief that it reflects all material public information”; and that the investor therefore may be presumed to rely on any misrepresentations.  The presumption can be rebutted “if a defendant could show that the alleged misrepresentation did not, for whatever reason, actually affect the market price, or that a plaintiff would have bought or sold the stock even had he been aware that the stock’s price was tainted by fraud.”

Halliburton’s “middle ground” argument—strongly supported by an amicus brief filed by law professors Adam Pritchard and Todd Henderson—was that Basic’s focus on market efficiency was misplaced, and that plaintiffs should be required to prove “price impact”—meaning that the defendant’s alleged misrepresentation actually affected the stock price—in order to invoke the presumption of reliance.  “In light of the [courts’] difficulties in evaluating efficiency,” the brief argued, “the Court should shift the focus of fraud on the market inquiries from a market’s overall efficiency to the question whether the alleged fraud affected market price.” (emphasis added) Pritchard and Henderson further urged the Court to “limit[]” the “out-of-pocket measure of damages . . . to cases in which the plaintiff can show actual reliance or that a material misstatement has distorted the market price for a security. If a plaintiff cannot make that showing, the remedy should be limited to disgorgement.”

The Supreme Court majority rejected these arguments and refused to alter the proof needed to invoke the presumption.  It held only that a defendant may submit price impact evidence prior to class certification to demonstrate “that the alleged misrepresentation did not actually affect the stock’s market price and, consequently, that the Basic presumption does not apply.”

Most observers believe that this ruling—which places the burden on the defendant to introduce price impact evidence sufficient to rebut the presumption—will do little to change class certification results, but definitely will increase the cost and complexity of the fight over class certification as defendants submit expert analyses demonstrating the lack of price impact and plaintiffs commission their own studies to prove the opposite.  (Economic consulting firms will do better than ever given the inevitable demand for competing price impact studies.  Come to think of it, investing in one might be a good bet—particularly a firm that is not publicly traded, and therefore would not likely be subject to a class action lawsuit.)

As Professor Henderson, one of the two proponents of the price impact approach, explained:

The ruling will make these cases more expensive…without targeting the worst corporate actors….My prediction is that the average case will get longer and cost more, since defendant corporations will put on evidence that plaintiffs will have to respond to….So, all in all, I think this is very disappointing.

His co-author, Professor Pritchard, said (subscription): “We are adding to the expense. We are not getting rid of any weak lawsuits.”

The plaintiffs’ bar has been unable to disguise its glee.  Salvatore Graziano (of the plaintiffs-side securities class action firm Bernstein Litowitz Berger & Grossmann) told one reporter: “I don’t see this decision having much impact at all.” “It’s a non-event.”  David Boies, who represents the plaintiffs in Halliburton, said: “Defendants have always been permitted to try to prove the absence of price impact, and permitting them to do so at the class-certification stage will not significantly limit securities lawsuits in the future.”

In sum, plaintiff and defense-side lawyers can breathe a sigh of relief—there will be little or no change in the status quo for them.

But for investors, there is a change for the worse: these lawsuits will be more expensive and impose an even greater burden on innocent shareholders, who ultimately pay all of the costs of the securities class action system. 

The securities class action industry was launched a quarter-century ago when the Supreme Court recognized the so-called “fraud-on-the-market” presumption of reliance in most putative securities class actions.  The result has been that—despite Congressional efforts at securities litigation reform—most securities class actions that survive the pleadings stage are likely to achieve class certification, forcing defendants to settle.  In the meantime, as explained in prior blog posts, the best economic thinking has shifted, calling the empirical assumptions underlying the fraud-on-the-market presumption into question.

In Halliburton Co. v. Erica P. John Fund, Inc. (pdf), decided today, the Supreme Court declined to abandon that presumption, instead largely maintaining the status quo.  The Court did clarify one key aspect of how class certification works in the securities context, holding that defendants are now entitled to attempt to rebut the presumption by introducing evidence at the class certification stage that there was no “price impact”—i.e., that misrepresentation alleged in a particular lawsuit did not affect the stock’s price.  This adjustment will make it possible for defendants to challenge class certification in a number of securities class actions, but is unlikely to alter the landscape of securities litigation significantly—a result that is troubling from a policy perspective because (for reasons we have previously stated) securities class actions generally benefit the lawyers who bring and defend them rather than the investors.

We provide more details about the decision below. Continue Reading Supreme Court Refuses To Overturn Fraud-On-The-Market Presumption, But Adjusts Presumption To Allow Evidence of Absence Of “Price Impact” At Class Certification Stage

A recent decision denying certification of a securities-fraud class action underscores that plaintiffs must prove with evidence that they satisfy the requirements of Federal Rule of Civil Procedure 23, not merely allege that they do so or promise that they can.

The decision in In re Kosmos Energy Limited Securities Litigation arose from a class action filed in the Northern District of Texas by plaintiffs challenging certain statements made in connection with the defendant’s initial public offering (“IPO”). The court denied the plaintiff’s motion to certify a putative class of stock purchasers.

In its opinion, the court provided a useful overview of class-certification law, explaining that courts have moved “away from the presumptively pro-plaintiff view” of class actions that had prevailed decades ago. The court explained that “[g]oing forward, the clear directive to plaintiffs seeking class certification—in any type of case—is that they will face a rigorous analysis by the federal courts, will not be afforded favorable presumptions from the pleadings or otherwise and must be prepared to prove with facts—and by a preponderance of the evidence—their compliance with the requirements of Rule 23” (emphases added)

The court concluded that the plaintiff had failed to provide evidence establishing that it would be an adequate class representative or that common issues of law or fact would predominate over individualized ones. The plaintiff had attempted to rest in large part on allegations in the complaint and broad statements in dicta in past decisions. The court didn’t buy it.

The court first explained that “adequacy is the plaintiff’s burden to prove—not the defendant’s burden to disprove.” The court also criticized the plaintiff’s declaration attesting in impossibly vague terms that she had “reviewed” the pleadings and “supervised” her lawyers. As the court put it, “this type of generic detail is really no detail at all, for it provides naught by which to assess [the plaintiff’s] credibility, her knowledge about the underlying facts of the case, or how much of what she has stated may have been prompted by counsel. Indeed, any potential class representative in any securities case could make almost identical assertions.”

With respect to predominance, the court concluded that the plaintiffs were effectively asking for an assumption that securities class actions are certifiable. That “assumption,” the court explained, was “ill-founded.” The court also emphasized that “[w]hile Defendants offered a 107-page Expert Report demonstrating the need for individual inquiries into investor knowledge, Lead Plaintiff offered no proof from which to draw an inference that individual inquiries may not be required if the Court were to certify this putative class . . . .”

This decision is good news for businesses—and not just in the context of securities-fraud class actions. True, those suits are subject to heightened pleading requirements set forth in the Private Securities Litigation Reform Act (“PSLRA”). But the court’s denial of class certification rested on fundamental principles arising from Rule 23 itself, which applies to all class actions in federal court.

Last year, we reported on the Second Circuit’s ruling in Police & Fire Retirement System of City of Detroit v. IndyMac MBS, Inc. (pdf), 721 F.3d 95 (2d Cir. 2013), that the filing of a class action does not toll the statute of repose in the Securities Act of 1933 for would-be class members who later seek to intervene or file their own suits. On Monday, the Supreme Court announced that it has chosen to review the Second Circuit’s ruling. Now, the Supreme Court has an opportunity to establish a uniform national rule that the tolling principles applicable to statutes of limitation under American Pipe and Construction Co. v. Utah, 414 U.S. 538 (1974), do not apply in the very different statute-of-repose context.

In American Pipe, the Supreme Court held that the filing of a class action suspends the statute of limitations as to all putative class members so long as they remain members of the proposed class. But lower courts have reached different conclusions on whether this American Pipe tolling applies to the three-year statute of repose for claims under Sections 11, 12(a)(2), and 15 of the Securities Act. As our previous post described, in the IndyMac case, the Second Circuit rejected an effort by putative class members to revive class claims under Section 11 of the Securities Act after the period of repose had expired. (The district court had first concluded that the named plaintiffs lacked standing to assert the claims.) The Second Circuit reasoned that the American Pipe rule cannot be applied to the Securities Act’s statute of repose because the Supreme Court held in Lampf, Pleva, Lipkind, Prupis & Petigrow v. Gilbertson, 501 U.S. 350 (1991), that equitable tolling does not apply to a repose period and because the Rules Enabling Act does not allow a court to use Rule 23—the source of any legal tolling—to “abridge, enlarge or modify” the repose promised by the Securities Act.

One of the absent class members who had sought to intervene petitioned for a writ of certiorari. It argued that IndyMac conflicted with a Tenth Circuit decision, Joseph v. Wiles, 223 F.3d 1155 (10th Cir. 2000), which held that American Pipe tolling applied to the Securities Act’s statute of repose. The petitioner also asserted a conflict with Federal Circuit decisions applying American Pipe to time limits for suits against the United States. In my view the claimed conflicts are mirages. That said, the Supreme Court—having now granted certiorari—has a perfect opportunity to bless the Second Circuit’s well-reasoned conclusion that there is no basis for American Pipe tolling of the repose period created by Section 13 of the Securities Act. That provision is an absolute bar to stale claims. Would-be plaintiffs should not be able to use American Pipe to bring such claims after Section 13 has cut off liability for a challenged securities offering.

Does today’s oral argument before the Supreme Court in the Halliburton case provide any clues regarding the Court’s likely decision?  (For background regarding the case, see yesterday’s post.)

Not necessarily.

“Court-watchers” are often quick to predict a case’s outcome based on the argument—and are very often wrong.  Remember the health care law that was certain to be declared unconstitutional, except it actually was upheld?  (I’ve had a similar experience.  After my argument on behalf of the petitioner in AT&T Mobility v. Concepcion, a number of press reports confidently predicted that Justice Scalia was going to vote “against the business community”; he wrote the Court’s opinion upholding the enforceability of AT&T’s arbitration clause.)

Today, as is often the case, the Justices’ questions explored a variety of issues, but most Members of the Court did not show their hands.

To be sure, the questions asked by Justices Ginsburg, Breyer, Sotomayor, and Kagan seemed to indicate strong support for the plaintiff’s position. But that is no surprise based on those Justices’ views regarding legal issues in the class certification arena (including Wal-Mart Stores v. Dukes, Comcast Corp. v. Behrend, and other cases).

But the questions and comments by Chief Justice Roberts and Justices Scalia, Kennedy, and Alito are much harder to pigeonhole.

Those Justices focused almost exclusively on the second question presented by the certiorari petition:  whether the decision in Basic v. Levinson should be modified if the Court does not overrule it. (The principal modification proposed by Halliburton—and echoed in the “law professors’ amicus brief” that received much attention during the argument—is that plaintiffs should be required to prove at the class certification stage not only that the securities in question traded on an efficient market but also that the alleged misrepresentations in fact distorted the securities’ market price.)

That discussion could mean that these Justices have little interest in overruling Basic—the view expressed in a number of early press reports.

But it also could mean that the Justices had no unanswered questions about that part of the case.  After all, large sections of the parties’ briefs, along with many of the amicus filings, set forth the pros and cons of the fraud-on-the-market doctrine, battled over the applicable stare decisis principles, and disputed whether passage of the Private Securities Litigation Reform Act locked Basic in place.  And the consequences of a decision to overrule Basic are clear: the pre-Basic reliance standard would apply.

A number of issues regarding the proposed modification of Basic are much less clear. First, its practical effect—in terms of what that approach would require plaintiffs to establish and whether it would screen out illegitimate class actions— is uncertain.  Many of the questions focused on that issue.

Second, whether requiring proof of an actual price impact at the class certification stage is consistent with the Court’s decisions rejecting arguments that other issues in securities class actions must be determined at the class certification stage because they are prerequisites for application of the fraud-on-the-market doctrine.  Those decisions include the Court’s earlier ruling in this case (addressing loss causation) and in Amgen v. Connecticut Retirement Plans and Trust Funds (addressing materiality). Many of the questions today asked whether a price-impact requirement could be distinguished from these other prerequisites—if it cannot, this option might be rejected on the ground that it is inconsistent with the Court’s recent precedents.

So it is equally likely—perhaps even more likely—that the questioning focused on this area because the possibility of modifying Basic generated more uncertainties that required clarification before the Justices could decide how to resolve the case—not because they already have decided that overruling Basic is off the table.

It also is worth emphasizing two points that do seem clear from the argument.  At least four Members of the Court (the Chief Justice and Justices Scalia, Kennedy, and Alito) have real concerns about the current state of securities class action litigation, including the fact that class actions that are certified almost always settle—and virtually never are decided on the merits—as well as the burdens that such litigation imposes on investors.  (Justice Thomas’s past opinions suggest that he shares those concerns.)

And there seemed to be little acceptance by these Justices of the plaintiff’s argument that the PSLRA placed reconsideration of Basic off-limits to the Court. Justice Alito quoted Section 203 of the Act (not cited in the parties’ briefs), which states, “[n]othing in this Act or the amendments made by this Act shall be deemed to create or ratify any implied private right of action.”  Justice Scalia said:  “As I understand the history of these things, there was one side that wanted to overrule Basic and the other side that wanted to endorse Basic, and they did neither one. They simply enacted a law that assumed that the courts were going to continue Basic. I don’t see that is – is necessarily a ratification of it. It’s just an acknowledgement of reality.”

Later in the argument, Justice Scalia hypothesized that the PSLRA might have no impact if Basic were overruled, but Halliburton’s counsel corrected that erroneous impression: “The PSLRA includes securities class actions under both the [Securities Act of 1933 and the Securities Exchange Act of 1934]. It’s not just limited to 10(b)(5). So to Justice Scalia’s point, there is actually not a single provision of the PSLRA that would be rendered inoperable.”

With these Members of the Court concerned about the problems entailed by securities class actions and apparently concluding that Congress has not codified Basic, reports of Basic’s survival may be premature.  We will have to wait until June to see which path the Court chooses.

 

The Supreme Court will grapple with private securities class actions when it hears oral argument tomorrow in Halliburton v. Erica P. John Fund, Inc. The principal question in the case is the continuing validity of the fraud-on-the-market doctrine, endorsed by the Court twenty-five years ago in Basic Inc. v. Levinson, which relieves plaintiffs asserting claims under Section 10(b) of the Securities Exchange Act of the obligation to prove actual reliance, and permits the reliance element of a securities fraud claim to be satisfied presumptively by proof that the securities at issue traded on an efficient market.

A significant part of the debate in the Halliburton briefs addresses new scholarship contradicting the views of economists who developed the hypothesis underlying fraud-on-the-market. That is precisely what Justice White predicted in his Basic dissent: “[W]hile the economists’ theories which underpin the fraud-on-the-market presumption may have the appeal of mathematical exactitude and scientific certainty, they are—in the end—nothing more than theories which may or may not prove accurate upon further consideration. . . . I doubt we are in much of a position to assess which theories aptly describe the functioning of the securities industry.”

But the defenders of fraud-on-the-market, perhaps recognizing the doctrine’s tenuous status based on the economic learning over the past quarter-century, focus considerable attention on three arguments unrelated to the doctrine’s merits:

  • Principles of stare decisis prevent the Court from overturning Basic;
  • Congress ratified Basic’s endorsement of fraud-on-the-market when it enacted the Private Securities Litigation Reform Act; and
  • Securities class actions benefit investors and, because they would be harder to bring if Basic were overturned, the Court should leave fraud-on-the-market in place.

To spare readers (and myself) an exegesis into economic analysis, this post focuses on these contentions, explaining why a fair appraisal of these arguments in fact demonstrates that the Court is obligated to assess Basic on the merits, and overrule the decision if the fraud-on-the-market presumption can no longer be justified.

Continue Reading Does Precedent or Congressional Action Prevent the Supreme Court from Reconsidering the Fraud-on-the Market Doctrine in Halliburton?