Trouble brewing here for class-action lawyers? (Photo credit: Wikipedia)The U.S. Supreme Court yesterday agreed to hear, for the second time, Halliburton's appeal of a securities class-action case that tests a judicially-created doctrine one group of influential critics called 'the most powerful engine of civil liability ever established in American law.' And given that doctrine's narrow escape in a decision earlier this year - Justice Samuel Alito said he would have given it closer scrutiny had it only been before the court - the 'powerful engine' may be in danger of running out of gas.
At issue in Halliburton v. Erica John Fund is the fraud-on-the-market theory, which allows plaintiff lawyers to construct a class action on behalf of all purchasers of a stock without first proving to the court those buyers relied on false information from the company to their detriment. Fraud-on-the-market entered the securities law book in 1988 with the Supreme Court's 1988 decision Basic v. Levinson, based on the then-new efficient markets hypothesis that a stock's price reflects all the public information that can be known about it.
Basic passed by a bare four-justice majority (three justices recused, presumably for financial conflicts) and was controversial even at the time. Justice Byron White, in dissent, called the efficient-markets theory 'a mere babe' and warned that it could create 'an investor insurance scheme' that Congress, not the courts, should establish.
White was right on both counts. I was an ardent fan of the efficient-markets theory after reading Burton Malkeil's A Random Walk Down Wall Street in the late 1980s, but five years of working at Bloomberg News in the 1990s beat it right back out of me. Researchers have identified so many exceptions - from the 'January effect' to the higher returns generated by low price-to-book stocks - that it is a theory in search of objective proof.
Halliburton notes also that many investors buy stocks because they think the market price is wrong. Otherwise it would make little sense to invest on anything other than a long-term, buy-and-hold basis. Class actions only reimburse investors who bought high and sold low, the opposite of patient, long-term investors.
And Basic did create a sort of loss-insurance scheme, as well as a wealth-creation machine of prodigious power for Democratic-leaning plaintiff lawyers. Armed with Basic, a negative press release and a stock chart, lawyers could and do file lawsuits accusing corporate executives of fraud and seeking hundreds of millions or billions of dollars to reflect the change in the market value of their company's stock.
Judges are supposed to analyze these claims skeptically and lawyers have to provide some evidence the stock fell because of a 'corrective' announcement supposedly revealing negative information the company should have released earlier. But in the real world, once a class is certified, companies settle. Between 1997 and 2012, to the tune of $73.1 billion, with lawyers collecting 10-20% of that in fees.
Halliburton already took the Erica John case to the Supreme Court once, challenging the certification of a class of investors who bought stock between 1999 and 2001 because they hadn't proved Halliburton's announcements caused their losses, as oppposed to other movements in the market. The Supreme Court rejected that argument and sent the case back for further proceedings. After the Fifth Circuit Court of Appeals reaffirmed class certification, Halliburton appealed again, this time arguing it should be given a chance to challenge the rebuttable presumption of reliance set out by Basic.
The fact the Supreme Court took cert in this case shows that at least some of the justices want to hear arguments on whether Basic should remain the law of the land. There may be the votes to overturn it, although even conservative justices have been wary about introducing wholesale changes to tort and class-action law.
In Halliburton I, they rejected the company's argument that plaintiff lawyers must prove, at the class certification stage, whether the company's statements caused investor losses.
Then in this year's Amgen v. Connecticut, the court rejected the idea plaintiffs must prove at the class-certification stage that company announcements had a material effect on inflating the stock price. Among other things, the majority noted that Congress had repeatedly tightened up securities class-action laws without upsetting the fundamental economic assumptions behind Basic.
That decision drew dissents from Justices Antonin Scalia, Anthony Kennedy and Clarence Thomas, however, who said plaintiff lawyers shouldn't be able to bind together a class of thousands or millions of shareholders without the firm glue of a shared explanation for their losses.
Those dissents included sharp attacks on Basic itself, including this one from Thomas:
Basic is a judicially invented doctrine based on an economic theory adopted to ease the burden on plaintiffs bringing claims under an implied cause of action.
More importantly, Alito signaled his willingness to sign on to the cause, voting with the majority against Amgen but saying:
As the dissent observes, more recent evidence suggests that the presumption may rest on a faulty economic premise.In light of this development, reconsideration of the Basicpresumption may be appropriate.
That time of reconsideration may have come.
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