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Supreme Court to Hear Case with Big Stakes for Fraud Complaints

March 4, 2014

The Supreme Court is scheduled to hear arguments in Halliburton v. Erica P. John Fund, which challenges a landmark 1988 decision that underlies nearly all securities class-action lawsuits. Halliburton is asking the Court to overturn its findings in Basic v. Levinson, which lets shareholders use the “fraud-on-the-market presumption” when bringing class-action complaints. Business groups say shareholder class-actions exact too high a price on companies and investors. Some investor groups say a ruling in favor of Halliburton would be a severe blow to shareholder rights.

A case the Supreme Court is scheduled to hear on March 5, 2014, may determine the future of securities class-action lawsuits.

Halliburton Co. has appealed a lower court ruling that rests on a 1988 decision that underpins shareholders’ ability to bring class-action complaints.

Halliburton v. Erica P. John Fund challenges the High Court’s 1988 ruling in Basic v. Levinson, which established that shareholders don’t need to show that a purposeful misrepresentation by management drove their investment decisions. In Basic, the Court found that misleading statements from management materially affect the stock prices investors consider when making decisions. Four Supreme Court justices have recently questioned the earlier ruling.

The U.S. Chamber of Commerce, which supports overturning the Basic decision, held an event on February 28 that examined the case. Former SEC Commissioner Troy Paredes delivered the keynote address, in which he stressed why he feels it is crucial for the Court to find in favor of Halliburton.

“Whatever the potential benefits may be, class actions impose costs on investors in contravention of the ultimate goal,” Paredes said. “Shareholders ultimately foot the bill in a settlement payment. The threat of litigation can force companies to take a defensive posture when it comes to disclosure, resulting in an avalanche of trivial information. These and other costs are not only bad for investors, but harmful to employees and local communities, along with the competitiveness of the U.S.”

The Basic decision rested on what lawyers call the “fraud-on-the-market presumption,” which says that stock prices are a function of all available information and that there is a link between all information about a company and investor decisions to buy its stock. Under the presumption, shareholders can show that their claims are similar enough to let them enter into a class together. Paredes said shareholders should have to meet a higher standard to trigger presumption, insisting on an actual illustration of price distortion.

“The core argument here is that a showing of price distortion should be a predicate for class certification,” Paredes said. First, without price distortion there cannot be an indirect reliance based on fraud in market. If alleged misrepresentation did not distort the stock price, it is not accurate to say the shareholders relied on misrepresentation. The stock price may reflect alleged misrepresentation or it may not,” he said, but there’s no way to know for sure, which should preclude certification of a class.

The Obama administration supports upholding the precedent set out in Basic, as does the Council of Institutional Investors. Former SEC Chairmen William Donaldson and Arthur Levitt also filed a brief supporting the appeals court decision.

“This is the biggest securities law case in a generation,” said Ryan Bates, a member at Bates PLLC and former associate at Houston-based Yetter Coleman LLP. Bates was the counsel on record in the CII’s brief filed in support of the appeals court decision. “What Halliburton is really going to come down to is the question of, in no small measure, are we going to have securities fraud class actions or not?”

Bates, said that while there will be exceptions in the event of a Halliburton victory, using the presumption set forth in Basic is “by far the most common mechanism by which plaintiffs pursue securities fraud cases.”

“For the small investor to be able to see some recouping of losses due to fraud, a victory by Halliburton would, if not a death knell, would put a tremendous damper on the ability of ordinary people to get together in classes to seek recovery of losses.”

A ruling in favor of Halliburton may affect many types of securities litigation.

“Institutional investors rely on ‘fraud-on-the-market’ as well, even when they bring a direct action in an individual case,” said Jill Fisch, a law professor at the University of Pennsylvania. “The proof necessary, if the Court reinstates a direct reliance requirement, is going to be a lot more difficult.”