Directors and officers: don’t put down your swords (or your D&O insurance limits); the U.S. Supreme Court just ruled that securities class action lawsuits under Section 10(b) of the Securities Exchange Act are here to stay. However, in a piece of good news, it may be easier to quash the most frivolous suits earlier.
In the case of Halliburton v. Erica P. John Fund, Halliburton asked that a 1988 ruling, Basic, Inc. v. Levinson, be overturned. This was a fundamental challenge to the ability of plaintiffs to bring class action lawsuits when it came to securities claims.
Basic makes it easy for plaintiffs to certify a class in a securities case by giving plaintiffs a rebuttable presumption of reliance on a defendant’s alleged misrepresentation (sometimes referred to as the “fraud on the market presumption”).
Basic reasoned that in an efficient market, such as the market for publicly traded stocks, a stock’s price immediately reflects all known public information (known as the “efficient market theory”).
The efficient market theory has since come under a lot of criticism, just one of the reasons that some thought the Supreme Court might use the Halliburton challenge as an opportunity to overrule Basic.
If the Supreme Court had agreed with the plaintiffs in Halliburton, plaintiffs could have ended up in a world in which certifying a class would have required showing that each class member was aware of the defendant corporation’s alleged material misstatement (reliance) at the time he or she purchased the defendant corporation’s stock.
This enormous burden would likely have been the end of Section 10(b) securities class action lawsuits.
However, in its June 23 Halliburton ruling, the Supreme Court stated it would not overrule Basic, leaving the rebuttable presumption of reliance in place. However, there is a piece of good news for defendants: in Halliburton, the Court clarified that it was appropriate at the class certification stage to allow defendants to present evidence that the alleged misrepresentations had no price impact.
This potentially gives defendants the ability to make the weaker cases go away much earlier than if the presumption were not rebuttable.
From The New York Times:
Companies facing class actions prefer to address as many issues as they can before judges decide whether to certify a class. Once a class is certified . . . the damages sought are often so enormous that the only rational calculation [for defendants] is to settle even if the chances of losing at trial are small.
When I first wrote about Halliburton, I gave a word of caution for those who were considering lowering their D&O insurance limits in response to the case. In my post, “Time to Reduce D&O Insurance Limits?” I suspected the Supreme Court would leave Basic’s fraud-on-the-market presumption in place.
My reasoning was that there have been major revisions to federal securities laws by U.S. Congress since Basic. When Congress passed Sarbanes-Oxley or Dodd-Frank, Congress could have clarified that the fraud-on-the-market presumption was inappropriate. Yet, it didn’t.
As it happens, Chief Justice Roberts agrees with this reasoning, writing:
. . . Halliburton and its amici contend that, by facilitating securities class actions, the Basic presumption produces a number of serious and harmful consequences. Such class actions, they say, allow plaintiffs to extort large settlements from defendants for meritless claims; punish innocent shareholders, who end up having to pay settlements and judgments; impose excessive costs on businesses; and consume a disproportionately large share of judicial resources. These concerns are more appropriately addressed to Congress . . .
So the presumption of reliance rule still stands; however, we expect to see some defendants attempt to rebut the presumption by arguing that the company’s allegedly fraudulent disclosure had no impact on price.
Enter “event studies,” which analyze things like the market impact of a company’s disclosures. If defendant corporations could show that the corporation’s disclosure had no impact on the corporation’s stock price, then they may be able to stop the plaintiffs’ class from being certified.
What does this mean for directors and officers?
Certainly no one should be running out to lower their D&O insurance limits; in this regard, it’s business as usual when it comes to D&O insurance. The Court’s ruling in Halliburton also means that there are now some new unknowns about the manner in which these suits will be defended. Plaintiffs and defendants will spend a lot of time (and money) attempting to determine what are the best strategic moves to make in a post-Halliburton world.
At Woodruff Sawyer, we’re looking very carefully at insurance carriers’ reactions. One carrier – AIG – chose to react even before the Court decided Halliburton by releasing a new endorsement that will pay for an event study on a first dollar, no self-insured retention (deductible) basis. At this time, AIG is not charging a premium for this endorsement.
Will other insurance carriers follow suit? It remains to be seen, and I think the answer is yes. A carrier whose client gets rid of a potential securities class action lawsuit at the early class certification stage is a carrier who just saved a ton of money.
For more resources on the topic of Halliburton, page through this collection of hand-picked content (in alphabetical order by authoring law firm):
- “Back to Basic: The Supreme Court Revisits a Landmark Securities Case and Eases Its Impact on Defendants” (Cooley LLP)
- “Securities Litigation Alert: The Supreme Court’s Halliburton Decision: Reliance Can Still Be Presumed In Securities Class Actions, But Defendants May Now Rebut The Presumption At An Earlier stage” (Fenwick & West LLP)
- “Supreme Court Rejects Calls to Overrule Fraud-on-the-Market Theory in Halliburton; Presumption of Reliance Still a Basic Part of Class Certification” (Orrick)
- “Supreme Court Declines to Overrule the Presumption of Reliance in Securities Class Actions” (Wilson Sonsini Goodrich & Rosati)