The business community had high hopes for Halliburton v. Erica P. John Fund, a case before the United States Supreme Court that could have overturned a two-decades old precedent that’s made it easier for plaintiffs to negotiate large settlements in cases alleging securities fraud. But when the high court issued its unanimous ruling on Monday, it failed to meet those lofty expectations.
While the justices disappointed the business community by failing to wipe out the precedent entirely, they did give corporations another weapon to mount an early challenge to securities class actions.
The business community “took a home run swing but only hit a single,” said John Donovan, a litigator at law firm Ropes & Gray, who did not work on the Halliburton case.
The legal doctrine Halliburton sought to overturn in its case is called “fraud on the market,” which--since being blessed by a 1988 Supreme Court decision--has turned the process of garnering class certification in securities lawsuits into a cakewalk. The doctrine assumes--first--that there is an efficient market in which a company’s statements are incorporated into its share price, and–second--that every investor relies on the integrity of the share price. Those assumptions save a plaintiff who’s seeking class action certification the trouble of having to prove what, in theory, should be a tall order: that every potential member of the class knew about an allegedly fraudulent company statement and attached significance to it.
Garnering class certification in a securities lawsuit significantly amplifies the potential negative consequences for the defendant and makes a settlement much more appealing. Exhibit A: the class-action shareholder-suit industry has extracted $73 billion in settlements from corporation between 1997 and 2012.
It’s easy to see why Halliburton wanted to overturn the “fraud on the market” precedent and why the case was touted as a potential “Armageddon for shareholder class actions.”
But the Supreme Court didn't buy into the hype. Instead of overturning the "fraud on the market" doctrine, Chief Justice John Roberts, in writing for the court, issued a compromise: companies should have a chance to show that any alleged fraud was not responsible for movement in its stock price.
The implications of that decision will be most critical to companies with large market capitalizations, says Donovan. These corporations issue such a high volume of SEC filings, press releases, and CEO comments that they will have an easier time arguing that no single statement caused the share price to go up or down. On the flip side, the “price” defense won’t do as much for small and medium cap issuers since they disclose less information, which makes pinning movement in share prices to one statement a much easier task for plaintiffs.
Regardless of the size, when it comes to securities class action suits, companies still face a tough battle.
“The defendants lost the class certification fight 20 years,” Donovan says. “Today, they got a little skirmish on their side, but the war is still largely against them.”