Price impact, materiality, and Halliburton II.

• Author: Ferrell, Allen
• Position: New Directions for Corporate and Securities Litigation

Abstract

The Supreme Court decision in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014), reaffirmed the availability of the fraud-on-the-market presumption of "reliance" for purposes of a Rule 10b-5 class certification. At the same time, the Court held that defendants could rebut the presumption if they could provide "direct evidence" that the alleged misrepresentations did not in fact impact the price of the security (i.e., a lack of price impact). In this Article we discuss various issues that have arisen in lower court rulings that have addressed Halliburton price impact arguments. These issues include the relationship between materiality and price impact, the distinction between hypothetical versus actual changes in the total mix of information made available to the market, the use of event studies, and some lower courts ' refusal to consider certain types of economic evidence in the context of price impact arguments.

1. INTRODUCTION

   The showing placed on plaintiffs for obtaining class certification in a securities action is a matter of importance to all involved: plaintiffs, defendants, insurers, the legal profession, and--given the broad impact securities class action litigation can have--the business community as a whole. One of the showings plaintiffs need to make at class certification for claims involving Rule 1 Ob-5--the most important anti-fraud rule in securities law--is that class members "relied" on the veracity of the alleged misrepresentations. The fraud-on-the-market presumption, adopted by the Supreme Court in its landmark 1988 decision Basic Inc. v. Levinson,' enables plaintiffs to establish Rule 1 Ob-5 "reliance" on a class wide basis. The presumption that establishes class-wide "reliance" is that investors relied on the integrity of the security's price, a price which is presumed to have been distorted by the alleged misrepresentation. With such a presumption in place, plaintiffs are thereby relieved of having to show that all class members were even aware of the alleged misrepresentation, much less individually "relied" on the veracity of the alleged misrepresentation at the time of purchase. Given its central role in enabling plaintiffs to obtain class certification in Rule 1 Ob-5 matters, it is not surprising that the fraud-on-the-market presumption has been a mainstay of securities class action litigation ever since Basic Inc. v. Levinson was decided.

   It was therefore with much interest that the Supreme Court granted certiorari in Halliburton Co. v. Erica P. John Fund, Inc. (Halliburton II) in order to consider whether Basic Inc,'s endorsement of the fraud-on-the-market presumption should be overruled. Six Justices joined the majority opinion authored by Chief Justice Roberts reaffirming Basic Inc., with three Justices (Alito, Scalia, and Thomas) concurring but arguing for overruling Basic Inc. (3) While reaffirming the fraud-on-the-market presumption, the Court did modify the traditional understanding of the presumption. Specifically, the Court held that if defendants can show that a security's price was not in fact distorted by the alleged misrepresentation--that is, the alleged misrepresentation had no price impact--then the fraud-on-the-market presumption would be rebutted. (4)

   We will focus in this Article on the issue of "price impact." (5) We will frame our discussion by focusing on one of the most perplexing aspects of the Court's price impact discussion: the relationship between price impact arguments and arguments concerning the "materiality" of the alleged misrepresentations. The reason why this relationship is perplexing is that the Supreme Court in its Amgen decision, (6) decided just one year prior to Halliburton II, held that "materiality" arguments cannot be considered at class certification. Specifically, the Court held that "such proof [of materiality] is not a prerequisite to class certification," particularly in a securities fraud action based on the fraud-on-the-market presumption. (7) So what is the distinction between an argument concerning the "materiality" of an alleged misrepresentation, which clearly cannot be considered at class certification under Amgen, and an argument concerning whether an alleged material misrepresentation impacted the security's price, which clearly can be considered at class certification under Halliburton III In explaining this distinction, the Halliburton II Court merely said, "materiality is a discrete issue that can be resolved in isolation from the other prerequisites" and thus "can be wholly confined to the merits stage.... Price impact is different." (8) The distinction between materiality and price impact arguments is an issue that the lower courts applying Halliburton II have grappled with.

   Another interesting and related aspect of Halliburton II's price impact discussion is what type of economic evidence can be considered in addressing the issue of price impact at class certification? On this issue, the Halliburton II Court held that defendants can introduce "direct evidence" showing a lack of price impact, (9) but did relatively little to identify what that evidence might consist of. This is an issue that has also come up in the lower court rulings applying Halliburton II. We will explore these related aspects of Halliburton II's price impact discussion, and how they have played out in the lower courts to date, through a series of examples.

   Out of our discussion of Halliburton II's price impact holding, there are three particularly important lessons we wish to draw. First, the distinction between materiality and price impact made by the Supreme Court in Amgen and Halliburton II might functionally represent a way of sorting at class certification different types of materiality claims depending on their methods of proof. Second, it is difficult to justify the insistence of lower courts applying Halliburton II that while some disclosures, in addition to the actual disclosure containing the alleged misrepresentation, can be examined in determining whether there is price impact for class certification purposes, other additional disclosures cannot be so considered. Third, the potential conceptual importance when defining price impact of the distinction between actual changes in the total mix of information available to the market (10) and hypothetical changes in the total mix of information available to the market. (11) As we will discuss, the economic evidence relevant to assessing price impact can be a function of whether it is the price impact of actual or hypothetical changes in the total mix of information available to the market that is at issue.

   We will begin our discussion in Part II by examining in more detail the Halliburton II opinion. Part III describes the lower court opinions to date applying Halliburton II's price impact framework. Part IV focuses on the relationship between materiality and price impact arguments from both a legal and economic perspective. Part V then considers assessing price impact (and materiality) arguments using an event study (i.e., a statistical analysis of whether there were firm-specific price movements on a particular date). We will consider event study results and their relationship to the question of price impact for examples in which there are no statistically significant firm-specific changes in the security's price, and event study results for examples in which there is a potentially important distinction between actual and hypothetical changes in the total mix of information available to the market. Finally, Part VI will conclude with some parting thoughts.

2. THE HALLIBURTON II DECISION

   In Halliburton II, the Supreme Court refused to overrule Basic Inc. and its endorsement of the fraud-on-the market presumption, explaining:

   Halliburton urges us to overrule Basic's presumption of reliance and to instead require every securities fraud plaintiff to prove that he actually relied on the defendant's misrepresentation in deciding to buy or sell a company's stock. Before overturning a long-settled precedent, however, we require [a] "special justification," not just an argument that the precedent was wrongly decided. Halliburton has failed to make that showing. (12) Rather, the Court held that plaintiffs can avail themselves of the Basic Inc. fraud-on-the-market presumption, and hence satisfy the requirement of establishing Rule 10b-5 reliance for purposes of class certification, if plaintiffs show: (1) the alleged misrepresentations were publicly known; (2) the alleged misrepresentations were material; and (3) the stock traded in an efficient market. (13) The Court explained that these prerequisites collectively establish, albeit via indirect proof, the "fundamental premise" of the fraud-on-the-market presumption: that the alleged misrepresentation did in fact have an impact on the security's market price. (14) With such a showing, the "fundamental premise" of Basic Inc. is presumed to be satisfied, thus entitling plaintiffs to invoke the fraud-on-the-market presumption of "reliance." The Court explained that a plaintiffs reliance on "indirect proof' is a sufficient basis for plaintiffs' invocation of the presumption, as requiring direct proof "would place an unnecessarily unrealistic evidentiary burden on the ... plaintiff who has traded on an impersonal market." (15)

   So how difficult is it for plaintiffs to show that these three prerequisites are satisfied? The answer in many cases is not very. Whether the alleged misrepresentation was publicly known (prerequisite 1) is rarely contested. As for materiality (prerequisite 2), the Supreme Court in its Amgen decision, decided the prior year, held that "[b]ecause the question of materiality is common to the class ... [plaintiffs are] not required to prove the materiality of [defendant]'s alleged misrepresentations and omissions at the class-certification stage." (16) Instead, the Court held that materiality...