COMMENTARY
How will Halliburton affect securities class action defense?
By H. David Kotz and Emre Carr, Ph.D.
Berkeley Research Group
Most observers have viewed the U.S.
Supreme Court’s June 23 ruling in Halliburton
Co. v. Erica P. John Fund, 134 S. Ct. 2398,
as a split or mixed decision. The court did
not overrule the previous Supreme Court
case of Basic Inc. v. Levinson, 485 U.S. 224
(1988), as Halliburton Co. sought, which
had established a presumption of reliance
for securities fraud claims, making it easier
for securities class-action plaintiffs to
demonstrate the impact of the alleged fraud
on the price of the stock.
However, the Supreme Court agreed with
Halliburton that defendants should be
allowed to provide evidence of the lack of
price impact at the class certification stage,
rather than waiting to the stage where the
merits of the lawsuit are considered.
AN OPPORTUNITY,
NOT A SEA CHANGE
While the Halliburton decision did not
radically change the securities class-action
landscape, it did provide defendants with
an earlier opportunity to challenge the
Basic presumption and attempt to deny
plaintiffs the ability to have their class
certified by establishing that the alleged
misrepresentation would not have affected
the price of the stock.
Using the Basic presumption of reliance, a
proposed class action was able to achieve
class certification under Federal Rule of
Civil Procedure 23(b)(3), a significant hurdle
that it needed to overcome. Without this
presumption, reliance could have been
difficult to establish in a particular case.
While the Halliburton decision did not radically change the
securities class action landscape, it did provide defendants with
an earlier opportunity to challenge the Basic presumption.
Under the Basic rationale, investors who buy
or sell stock at the price set by the market
do so in reliance on the integrity of that
price, and because the stock prices reflect
publicly available information, including any
misrepresentations, by definition, a material
misrepresentation will be reflected in a
security’s price and investors therefore may
H. David Kotz (L) is as a director at Berkeley Research Group, a leading global expert services
and consulting firm, where he focuses on internal investigations and matters relating to Foreign
Corrupt Practices Act and anti-money laundering regulations. He also serves as a compliance
monitor for firms that have entered into deferred prosecution agreements and similar arrangements
with government agencies, and as an expert witness in securities and fraud-related litigations. Kotz
previously served for over four years as inspector general of the Securities and Exchange Commission.
During his tenure, he wrote the report investigating the SEC’s failure to uncover Bernard Madoff’s
$50 billion Ponzi scheme. Emre Carr (R) is a principal at the financial institutions practice at Berkeley
Research Group. He is an economist specializing in securities, regulatory and accounting matters
related to financial institutions and financial instruments. He joined BRG from the SEC, where he led
the economic analyses for Dodd-Frank regulations on ABS and CDS markets and was the financial
reporting expert in a modeling initiative to detect financial statement fraud in registrant filings.
Before joining the SEC, Carr was a full-time faculty member at the Columbia University and University
of Southern California business schools.
© 2014 Thomson Reuters
REUTERS/Kevin Lamarque
The U.S. Supreme Court building is seen June 23, the day the
court issued its decision in Halliburton.
rely on that misrepresentation. In essence,
Basic does not require plaintiffs to have to
prove that they personally relied on alleged
misstatements in purchasing a stock if they
can show that the statements were known by
the investing public.
In the Halliburton case, Halliburton
shareholders, led by the Erica P. John Fund
Inc., sued the company in 2002, alleging it
understated its asbestos-related liabilities
while overstating revenues in its engineering
and construction business and the benefits of its
merger with Dresser Industries. The trial court
declined to grant class certification, saying the
plaintiffs failed to allege loss causation. The
5th U.S. Circuit Court of Appeals affirmed.
However, a previous Supreme Court decision
reinstated the action, concluding that loss
causation need not be shown to obtain
class certification. On remand, Halliburton
renewed its opposition to class certification,
arguing that the class should not be certified
because the company’s alleged fraud did not
affect the market price of its securities.
The second time, the trial court concluded
that price-impact evidence had no bearing
on whether common issues predominated
under the Federal Rules of Civil Procedure,
and the 5th Circuit upheld the decision.
The Supreme Court granted Halliburton’s
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certiorari petition Nov. 15, 2013, and held oral
argument March 5.
In the June 23 decision the Supreme Court
held that defendants should be allowed
to defeat the presumption of reliance
at the class certification stage through
evidence that the misrepresentation did
not in fact affect the stock price. The court
found the Basic principle does not require
courts to ignore a defendant’s direct and
salient evidence showing that the alleged
misrepresentation did not actually affect the
stock’s market price.
Chief Justice John Roberts, writing for the
majority, said the decision was consistent
with the ruling in Basic because it allows
direct evidence when such evidence is
available and that there is no reason to
artificially limit the inquiry at the certification
stage to indirect evidence of price impact.
insignificant when it is revealed, then the
information is not material. If the price
impact is insignificant on the corrective
disclosure, then it is immaterial at that time.
A straightforward example of the lack-ofprice-impact defense can be found in the
case against the publicly traded supply chain
management company Vertex Interactive
Systems Inc. and its auditor Ernst & Young
filed by the owners of the closely held
Applied Tactical Systems following the
acquisition of ATS by Vertex. At issue were
alleged misrepresentations made by Vertex
and vetted by E&Y in an unqualified audit
opinion.
E&Y’s expert provided testimony, using an
event study methodology, that Vertex’s prior
disclosure default did not move the stock price
in a statistically significant degree at the time
of the corrective disclosure. This implied that
In an efficient market, if the price impact of the misleading
information is statistically insignificant when it is revealed,
then the information is not material.
LIGHT FROM HALLIBURTON
In light of Halliburton, defendants now have
a greater opening to attempt to establish —
prior to the class certification stage of a class
action case — that any misrepresentation
did not affect the stock price. Defendants
will take advantage of this opportunity, likely
leading to fewer settlements of securities
class action cases.
In-depth discovery and expert testimony are
two effective ways to demonstrate lack of
price impact and to deny plaintiffs the ability
to have their class certified. While this was
in principle always available to defendants,
the Halliburton decision is likely to increase
the incidence and the success rate of a priceimpact defense. As a result, defendants are
likely to use the event study methodology to
demonstrate the lack of price impact on the
days of alleged misrepresentations or the
days of corrective disclosures.
Event studies are econometric analyses
that have been used in securities litigation
since the 1970s to demonstrate the market
price impact of any news announcement.
In an efficient market, if the price impact of
the misleading information is statistically
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DERIVATIVES
the information either was indeed immaterial
or was already somehow impounded in the
stock prices in an efficient market, and either
way the information did not have price
impact. Therefore, the disclosure defects had
no material effect on the Vertex share price,
and plaintiffs had incurred no damages as a
result of the omissions. E&Y won summary
judgment following the testimony. McCabe
et al. v. Ernst & Young et al., 2006 WL 42371
(D.N.J. 2006).
Traditionally, it has been difficult for
defendants to establish that the alleged
wrongdoing did not actually affect the
stock price at class certification.
An
excellent example of the combination of
effective discovery and expert analysis
was demonstrated in French multimedia
company Vivendi’s defense against a suit by
Gabelli Asset Management Inc. in the U.S.
District Court for the Southern District of
New York.
Gabelli had alleged that a number of
material misrepresentations and omissions
made by Vivendi, covering up a liquidity crisis
that followed a string of M&A transactions,
had artificially inflated the prices of certain
shares. In 2013 U.S. District Judge Shira
Scheindlin found that Vivendi was able to
rebut the presumption of reliance. GAMCO
Investors v. Vivendi S.A., 927 F. Supp. 2d 88
(S.D.N.Y. Feb. 28, 2013). After in-depth
discovery, Vivendi was able to present
evidence that Gabelli purchased Vivendi
shares relying on its own internal analyses.
Judge Scheindlin found that Vivendi was able
to establish that plaintiffs would not have
viewed Vivendi as a less attractive investment
if Vivendi had fully disclosed information
sought by plaintiffs. In fact, she found that
but for the alleged misrepresentations and
omissions, plaintiffs would actually have
been more likely to invest in Vivendi shares.
CONCLUSIONS
After Halliburton, the price-impact theories
plaintiffs use in securities litigation may also
expand to incorporate behavioral finance
ideas. Indeed, one of Halliburton’s main
arguments was that the Basic court’s robust
view of market efficiency is no longer tenable
in light of more recent empirical evidence
that material, public information does not
get incorporated into stock prices even in an
efficient market.
Today, even proponents of the “efficient
market” hypothesis claim that efficient
markets are correctly priced only on average
and acknowledge that any security maybe
mispriced for some time. For example, when
the defense shows no price impact following
an obscure, unnoticed disclosure, as was the
case in In re Merck & Co. Securities Litigation,
432 F.3d 261 (3d Cir. 2005), the plaintiffs’
experts may point to a news article or an
analyst report clarifying the disclosure that
had a price impact. Defendants, on the other
hand, may provide evidence of temporary
mispricing, even in an efficient market, in
response to an immaterial disclosure that
appears to affect share price.
It is still unknown how individual courts will
interpret the Halliburton decision and what
strategies defense attorneys will use in
attempting to challenge class certification in
class-action securities cases. However, the
opportunity now exists for a defendant, with
the proper expert, to take advantage of the
opportunity provided by the Supreme Court
in Halliburton, and to potentially provide
compelling evidence that may result in a
significant victory prior to the class action
being certified. WJ
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