The Supreme Court on Wednesday seemed open to the possibility of making it harder for investors to join together to sue corporations for securities fraud — but maybe not as hard as companies that have to defend such lawsuits would like.
Most justices appeared unwilling to completely overturn a quarter-century-old decision that has helped investors launch class-action cases based on the effect misleading statements have on a company's stock price.
But some conservative justices — including Justice Anthony Kennedy, who has often been a swing vote — suggested a middle ground that would force investors to show earlier in a case that the alleged fraud actually caused the stock price to drop.
The justices heard arguments in an appeal by Halliburton Co. that seeks to block a class-action lawsuit claiming the energy services company inflated its stock price. A group of investors say they lost money when Halliburton's stock price dropped after revelations the company misrepresented revenues, understated its liability in asbestos litigation and overstated the benefits of a merger.
'Fraud on the market' theory
Halliburton lawyer Aaron Streett urged the court to overturn its 1988 decision in Basic v. Levinson — a case that sparked a tidal wave of securities-related, class-action lawsuits against publicly traded companies and has led to billions in settlements.
The Basic case says shareholders who claim they were defrauded by false statements in securities filings don't have to prove they actually relied on the statements. Rather, the court reasoned that any misrepresentation would be reflected in the current stock price. Even if investors are not aware of the misstatements, they are presumed to be aware of them because they affect the stock price.
This presumption, known as the "fraud-on-the-market theory," has become the driving force for modern class-action securities cases. But Streett said "it was wrong when it was decided and it is even more clearly erroneous today," because it doesn't account for the sometimes random and arbitrary nature of modern stock trading.
Four of the Supreme Court's conservative justices — Antonin Scalia, Clarence Thomas, Kennedy and Samuel Alito — said in a ruling last year that they were willing to reconsider the Basic decision.
But during the arguments Wednesday, Chief Justice John Roberts questioned whether overturning the case entirely was practical, saying different economists have opposing arguments over whether Basic remains sound.
"How am I supposed to review the economic literature and decide which of you is right on that?" Roberts asked.
Kennedy suggested seeking a middle ground that would leave the precedent largely intact but place another hurdle for investors to certify a class. The compromise, proposed by a group of law professors in a friend of the court brief, would require a special "event study" before a class is approved. The study would determine whether the company's alleged fraud actually had an effect on the stock price. If it did, then the class could be certified and the case could move forward. If not, then investors cannot win class certification.
David Boies, attorney for the investors suing Halliburton, argued that such event studies are time-consuming and costs and expenses for investors would "increase enormously." He argued that the court should keep the Basic decision intact because Congress has passed legislation over the past two decades assuming it is the law of the land.
More than 3,000 private class-action securities fraud lawsuits have been filed since 1997, generating more than $73 billion in settlements, according to a group of former Securities and Exchange Commission members who filed a brief urging the court to overturn the 1988 precedent.
The U.S. Chamber of Commerce and the National Association of Manufacturers argue in court briefs that the current doctrine has led to significant costs for investors and businesses and bred confusion in the courts. But the Obama administration has urged the court not to overrule Basic, saying its premise remains sound.
The justices are expected to make a ruling before summer.
The case is Halliburton Co. v. Erica P. John Fund Inc., 13-317.