Market intermediation, publicness, and securities class actions.

AuthorSale, Hillary A.
PositionAbstract through III. Twenty-First Century Supreme Court Securities Jurisprudence A. The Four Cases 2. Halliburton I: The Proof of Loss Causation Is Not Required to Show Reliance at Time 1 or for Class Action Certification, p. 487-514 - New Directions for Corporate and Securities Litigation

ABSTRACT

Securities class actions play a crucial, if contested, role in the policing of securities fraud and the protection of securities markets. The theoretical understanding of these private enforcement claims needs to evolve to encompass the broader set of goals that underlie the securities regulatory impulse and the publicness of those goals. Further, a clear grasp of the modern securities class action also requires an updated understanding of how the role of market intermediation in securities transactions has reshaped the realities of securities litigation in public companies and the evolution of the fraud cause of action in the context of open-market transactions. The Supreme Court's embrace of market efficiency as a mechanism to establish reliance in its 1988 decision, Basic Inc. v. Levinson, illustrates the necessary adaptation of common-law fraud to the modern market setting, and congressional enactment of the PSLRA in 1995 exemplifies the efforts to respond to the litigation risks inherent in that adaptation. Together, Basic and the PSLRA provide a framework for understanding both a series of recent Supreme Court decisions on securities class actions and a different understanding of the theory undergirding those class actions. To develop this understanding, we expand the conversation about the goals of securities regulation to include the set of goals that are rooted in publicness and focus on market protection, innovation, and growth, as well as stability and systemic considerations. We posit that this broader theoretical understanding explains why the Court rejected a challenge to the fraud-on-the-market doctrine and, instead, permitted the continued use of market efficiency: the Court chose to preserve the deterrence and enforcement role of these cases in promoting market growth and innovation. We then apply this understanding of publicness and market intermediation to the interpretation of the Court's limited, but ambiguous, use of "price impact" in securities-fraud cases. Our analysis reveals that the practical balance established by Basic and the PSLRA has prevailed over pure doctrinal approaches to issues like reliance or other, more incomplete, theoretical explanations focused solely on compensation, deterrence, and investor protection, but neglects the role of publicness in the securities markets.

Table of Contents INTRODUCTION I. THE COMMON-LAW FOUNDATION OF SECTION 10(B) AND RULE 10B-5 II. SECURITIES-FRAUD CLASS ACTIONS A. Class Actions as a Response to the Economics of Individual Shareholders B. Class Actions and Litigation Agency Costs C. The Role of Insurance D. Causation and Impersonal Market Transactions E. PSLRA Provisions to Regulate Class Actions F. Class-Certification Procedures in Securities Class Actions G. Class Actions and Theories About Securities Regulation III. TWENTY-FIRST CENTURY SUPREME COURT SECURITIES JURISPRUDENCE: MATERIALITY, RELIANCE, LOSS CAUSATION, AND PRICE IMPACT A. The Four Cases 1. Dura Pharmaceuticals: Pleading Front-End (Time 1) Facts Does Not Meet the Standard for Pleading Loss at the Back End (Time 2) 2. Halliburton I: Proof of Loss Causation Is Not Required to Show Reliance at Time 1 or for Class Certification 3. Amgen: Materiality Need Not Be Proved at Class Certification Before Basic Is Invoked 4. Halliburton II; Affirming the Basic Presumption and Rejecting Proof but Allowing Rebuttal, of Presumption at Class Certification B. The Growth of Price Impact IV. Market Intermediation and the Securities Class Action A. The Publicness of Securities Regulation and Enforcement B. Market-Efficiency Theory, Market Intermediation, Deterrence, and Securities Regulation C. The Role of Market Intermediation in Reliance and Price Impact 1. Market Intermediation and the Evolution of l Ob-5 Claims 2. Market Intermediation and Price Impact Conclusion INTRODUCTION

The legitimacy and efficacy of Rule 1 Ob-5 (1) and the use of class actions to enforce it have been debated at great length. The initial judicial focus on the implication of a private right of action gave way to contests over the meaning of the elements of common-law fraud and other prerequisites necessary to prove the cause of action. (2) The seesaw pattern of the cases in the first half-century of federal securities laws were enough to give a reader whiplash. (3) Later congressional and judicial action, such as the Private Securities Litigation Reform Act of 1995 ("PSLRA"), inserted procedural hurdles to contain litigation agency costs and provided openings to vigorous contests over which elements of fraud are ripe for decision at early points in the litigation cycle. (4) Over time, the fact of the 10b-5 cause of action has become more clear and permanent, but the interpretation of it has become more opaque and procedurally focused. (5) A series of post-2010 US Supreme Court cases focused on how much of the 1 Ob-5 cause of action is fair game at the class-certification phase of the litigation. (6) In doing so, they illustrate the turn to procedure and the complexity and confusion that have come with it, while reaffirming the Court's commitment to the securities class action as an enforcement and deterrence mechanism.

But it was not just the law that changed; there were fundamental changes in the role of markets in securities transactions. The expanding role of market intermediation in securities transactions is important to understanding the evolution of the common-law tort of deceit into today's fraud-on-the-market-based 10b-5 class action, as well as to the specific issue of price impact. First, as the Supreme Court said in Basic Inc. v. Levinson, the market is an unpaid agent of the investors in modern securities transactions. (7) By adopting the fraud-on-the-market presumption, it recognized that the necessary connection between defendants' misrepresentations and plaintiffs' loss can be shown when, in an efficient market, the fraud is incorporated into the market price of a security and thereby impacts the investors' decision to buy or sell stock. (8) In doing so, the Court acknowledged the role of the market as an impersonal intermediary in the transmission of information in today's securities transactions. Second, modern financial learning, including, for example, diversification and portfolio theory, tells us that most shareholders own only a small percentage in any particular company and, thus, have little reason to be active investors, including, for example, suing when there is fraud. (9) The class action mechanism brings efficiencies to this setting and, as the Court has recognized, is practically the only way private actions are likely to be brought, providing an enforcement mechanism for securities regulations and, thereby, acting as a deterrant to wrongdoers.

These legal developments and the new market realities have combined to poke holes in traditional theories for private enforcement. Diversified investors, particularly those following more passive investment strategies of relying on the market, may seem just as likely to be hurt by private fraud suits (as their portfolio companies pay the costs of the litigation) as to benefit on the receiving end of those suits. Further, the law of the 10b-5 claim has lost any coherent connection to the traditional tort-based compensation rationale, and more generally, the case law has made a hash of the 1 Ob-5 jurisprudence. (10)

This Article develops a better theoretical understanding of these issues. In Part I, we focus on the Rule 10b-5 cause of action and its foundation in common-law fraud. The 10b-5 claim is ripe for confusion. Its fraud base means there are as many as eight elements the plaintiff must separately prove to prevail and an equal number of places where the defendant can mount an attack. (11) A judicial tendency to conflate the elements and their proof--for example, materiality with reliance, or reliance with loss causation--exacerbates the mess. (12) Further, the interaction of two key temporal dimensions of the 1 Ob-5 claim adds to the complexity:

(1) The front end and back end of litigation (i.e., matters to be addressed in pretrial motions versus those left to trial). Congress has chosen to move judicial review forward for some, but not all, of the elements that make up a Rule 10b-5 claim so that parties have ample incentive to characterize their claims to fit the procedural setting most favorable to their case.

(2) The front end and back end of a fraud. The nature of fraud is that there seemingly is a temporal division between when defendant's misrepresentation and plaintiffs reliance on it occur and when plaintiffs injury is ordinarily realized and measureable. This line turns out to be less real in a class action context, but has been subject to recurring battles in the class certification setting. (13) As to the first, defendants' natural inclination is to push issues forward to the earlier stages of litigation, where procedure reigns over substance. (14) In three cases before the Supreme Court since 2010, defendants sought to require the plaintiffs to prove three of the substantive elements of the 10b-5 cause of action--materiality, reliance, and loss causation--as a condition to class certification. (15) The defense bar has pressed the Court to accept that elements that might otherwise be subject to proof only at trial should be proved earlier in the litigation, thereby preventing a trial. The defendants came up short in each case, but those cases shifted the judicial focus to yet another issue: price impact. Defendants are now using the price impact element to contest reliance during the class-certification phase. We explore that debate later in the Article by examining its place in the larger theoretical debate about securities class actions. (16) We also discuss another key element of the class action, reliance, which is very different in open-market, anonymous transactions than in traditional face-to-face...

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