Securities Fraud Class Action Certification:
Halliburton Co. v. Erica P. John Fund, Inc.
Michael V. Seitzinger
Legislative Attorney
August 15, 2014
Congressional Research Service
7-5700
www.crs.gov
R43686
Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.
Summary
On June 23, 2014, the U.S. Supreme Court decided a much-anticipated case in the area of federal
securities law: Halliburton Co. v. Erica P. John Fund, Inc. The history of the case spans more
than a decade, through two complete rounds in federal district court, court of appeals, and the
Supreme Court. All of the cases so far have dealt with the issue of class certification for securities
fraud plaintiffs. The merits of the case have not yet been considered.
Class certification is important in the area of securities law because the merits of the case cannot
be considered until after the class of plaintiffs has been certified. A class of many plaintiffs suing
a company for fraud that has allegedly resulted in investment losses may be a formidable
plaintiff, and a significant amount of money may be involved. So much money may be involved
in these lawsuits that proponents and opponents have been very vocal. Proponents of such suits
believe that certification requirements should be kept to a minimum to protect investors and the
marketplace. Opponents of minimum certification requirements have argued that class action
suits are often frivolous and are brought to pressure companies to settle rather than incur large
litigation costs. They also argue that plaintiffs’ attorneys, who may receive large legal fees, are
the only ones who benefit from class actions.
The Halliburton cases illustrate the importance of class certification. There have been two rounds
of decisions in the Federal District Court for the Northern District of Texas, the U.S. Court of
Appeals for the Fifth Circuit, and the U.S. Supreme Court.
The Erica P. John Fund accused Halliburton of violating federal securities fraud statutes by
making material misstatements with respect to its liabilities, revenues, and cost savings. In the
first round of cases, the Federal District Court for the Northern District of Texas declined to
certify the class on the basis that the plaintiffs had not proved reliance on material misstatements
made by Halliburton. The U.S. Court of Appeals for the Fifth Circuit refused to certify the class
on the basis that the class had not shown loss causation at the class certification stage. The
Supreme Court reversed, holding that the proving of loss causation at the class certification stage
is not required. The Court refused to address any other questions which Halliburton might have,
such as the presumption of reliance under the “fraud-on-the-market theory” (a theory recognized
in the Supreme Court case Basic v. Levinson—that, in an efficient, well-developed securities
market, all material information is available to the public and this information is reflected in the
stock price, resulting in presumptive reliance by plaintiffs on the material misstatements).
In the second round, the district court certified the class, believing that the class certification
requirements of Rule 23 of the Federal Rules of Civil Procedure had been met. The Fifth Circuit
affirmed certification and concluded that Halliburton could not introduce evidence that its alleged
misrepresentations had no impact on the stock price. The Supreme Court held that price impact
evidence could be introduced at the class certification stage to rebut the presumption that the
shareholders had relied on the alleged misstatements. However, the Court refused to overrule
Basic v. Levinson’s presumption of reliance provided by the fraud-on-the-market theory.
Halliburton II is not the end of the Erica P. John Fund v. Halliburton saga. It may not even be the
end of the class certification challenges. Once the class is finally certified, the courts may then
face the merits of the case. It seems that another 10 years could easily pass before final resolution
occurs. This report will be updated as needed.
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Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.
Contents
Introduction ...................................................................................................................................... 1
Class Certification ........................................................................................................................... 2
Section 10(b) Private Right of Action ....................................................................................... 2
Class Action ............................................................................................................................... 3
Halliburton Cases ............................................................................................................................. 6
Federal District Court Decision—I ............................................................................................ 6
Fifth Circuit Decision—I ........................................................................................................... 6
Supreme Court Decision—I ...................................................................................................... 7
Federal District Court Decision—II .......................................................................................... 8
Fifth Circuit Decision—II ......................................................................................................... 8
Supreme Court Decision—II ................................................................................................... 10
Conclusion ..................................................................................................................................... 13
Contacts
Author Contact Information........................................................................................................... 14
Congressional Research Service
Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.
Introduction
On June 23, 2014, the Supreme Court decided a much-anticipated case in the area of federal
securities law. The case, Halliburton Co. v. Erica P. John Fund, Inc.,1 presented to the Court the
following two questions, both dealing with the certification of a class of securities fraud
plaintiffs:
1. Whether the Court should overrule or substantially modify the holding of Basic,
Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognized a
presumption of class-wide reliance derived from the fraud-on-the-market theory.
2. Whether, in a case where the plaintiff invoked the presumption of reliance to seek
class certification, the defendant might rebut the presumption and prevent class
certification by introducing evidence that the alleged misrepresentations did not
distort the market price of its stock.
Class certification is important in the securities area, and lawsuits are often brought to challenge
the class of plaintiffs attempting to be certified. Class certification is necessary before the case
can go forward to be decided on the merits. In addition, the amount of money involved in a class
action securities lawsuit may be significant. Individuals with small claims may not be willing to
pursue individual lawsuits, but individuals who create a class of plaintiffs may result in a
formidable plaintiff. A securities class action lawsuit often presents a stronger case and a case
better able than small, individual cases to obtain major attorney representation.
Proponents and opponents of securities class actions have actively argued their points.2
Proponents believe that certification requirements must be kept to a minimum because investors
should be able easily to pursue companies that have committed fraud. They argue that investor
protection benefits both individual investors and the securities markets in general by maintaining
the integrity of the marketplace. Opponents of minimum certification requirements argue that too
often investors bring lawsuits that are frivolous, such as when the share price drops for reasons
unrelated to fraud, and that companies may feel pressured to pay out large settlements rather than
risk even higher litigation costs. They also argue that the only people who benefit from securities
class actions are the attorneys who receive large legal fees.
The Halliburton cases illustrate the importance of class certification. The history of the cases
leading to the second Supreme Court Halliburton decision is lengthy, spanning more than a
decade. Thus far, the courts have dealt only with the issue of class certification; they have not yet
had the opportunity to address the merits of the plaintiffs’ arguments. There have been two rounds
of decisions in the Federal District Court for the Northern District of Texas, the U.S. Court of
Appeals for the Fifth Circuit, and the U.S. Supreme Court. After its second decision, the Supreme
Court remanded the case for further proceedings consistent with its opinion. We cannot be certain
whether this is the end of the class certification issue, allowing the courts to proceed to the merits
of the case, or whether there will be additional Halliburton cases dealing with class certification.
1 No. 13-317, ___ U.S. ___ (2014).
2 See, e.g., Thomas Kayes, Jury Certification of Federal Securities Fraud Class Actions, 107 NW. U. L. REV. 1851
(2013).
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This report will first discuss requirements for securities fraud class action certification and then
go through the rounds of the Halliburton federal decisions, ending with the second Supreme
Court decision.
Class Certification
Section 10(b) Private Right of Action
Two major federal securities laws, which form the basis for the regulation of securities in the
United States, were enacted in the wake of the stock market crash of 1929. These laws are the
Securities Act of 1933,3 which makes it illegal to offer or sell securities to the public unless they
have been registered with the Securities and Exchange Commission (SEC), and the Securities
Exchange Act of 1934,4 which requires ongoing company disclosures to the investing public
through annual, quarterly, and other filings with the SEC.
Section 10(b)5 of the 1934 act is the general anti-fraud provision and the provision most
frequently used by plaintiffs to allege securities fraud. Rule 10b-5,6 issued to carry out and give
effect to Sction 10(b), makes it illegal “for any person ... [t]o make any untrue statement of a
material fact or to omit to state a material fact.”
Neither Section 10(b) nor Rule 10b-5 provides for a private cause of action for plaintiffs to sue.
Over the years, courts have established that private plaintiffs, not just the SEC or the Department
of Justice (DOJ), have the right to bring a cause of action for violation of Section 10(b) and Rule
3 15 U.S.C. §§ 77a et seq.
4 15 U.S.C. §§ 78a et seq.
5 15 U.S.C. § 78j(b). The provision states in pertinent part:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate
commerce or of the mails, or of any facility of any national securities exchange—
...
(b) To use or employ, in connection with the purchase or sale of any security registered
on a national securities exchange or any security not so registered ... any manipulative or
deceptive device or contrivance in contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate in the public interest or for the
protection of investors.
6 17 C.F.R. § 240.10b-5. Rule 10b-5 states:
It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the mails or of any facility of any national
securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the circumstances under which
they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate
as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
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10b-5. Kardon v. National Gypsum Company,7 a 1947 case from the Federal District Court for the
Eastern District of Pennsylvania, may be the earliest case to find a private cause of action for
plaintiffs to sue for fraud under section 10(b).8 In the 1971 case, Superintendent of Insurance of
the State of New York v. Bankers Life and Casualty Company,9 the Supreme Court confirmed the
private right of action10 and since then has reaffirmed the right.11
To establish securities fraud under Section 10(b), a plaintiff must typically prove (1) a material
misrepresentation or omission by the defendant; (2) scienter [knowledge]; (3) a connection
between the misrepresentation or omission and the purchase or sale of a security; (4) reliance
upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.12
Class Action
Although an individual may bring a private right of action under Section 10(b), a class action,
made up in a sense of many individuals combining their private rights of action into a class of
plaintiffs, may be a stronger suit than several individual suits. In order for a securities fraud class
action suit to go forward to consideration of the merits, the class of plaintiffs must be certified.
There is no presumption of class certification. In order to achieve class certification in the
securities area, indeed in any area of law, certain requirements must be met.
Rule 23 of the Federal Rules of Civil Procedure (FRCP) sets out requirements that class actions
must meet. One of the most important requirements for securities fraud class action certification,
as it is for class certification in any area of law, is the predominance requirement of Rule
23(b)(3). For the predominance requirement to be met, questions of law or fact which are
common to class members [must] predominate over any questions which affect only individual
members.13
7 73 F. Supp. 798 (E.D. Pa. 1947).
8 “On a motion to dismiss this Court held that, although not expressly provided for in the Statute, a remedy by civil
action to enforce such duties and liabilities was available to the plaintiffs. The duty created is that of disclosure and the
complaint and the evidence show that this suit was brought to enforce that liability. The liability to account for profits
is the liability attendant upon the breach of that duty.” Id. at 800.
9 404 U.S. 6 (1971).
10 “Section 10(b) must be read flexibly, not technically and restrictively. Since there was a ‘sale’ of a security and since
fraud was used ‘in connection with’ it, there is redress under § 10(b).... ” Id. at 12.
11 See, e.g., Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008).
12 Id.
13 FRCP 23(b)(3) states,
[T]he court [must] find that the questions of law or fact common to class members predominate over any
questions affecting only individual members, and that a class action is superior to other available
methods for fairly and efficiently adjudicating the controversy. The matters pertinent to these findings
include
(A) the class members’ interests in individually controlling the prosecution or defense of separate
actions;
(B) the extent and nature of any litigation concerning the controversy already begun by or against class
members;
(C) the desirability or undesirability of concentrating the litigation of the claims in the particular forum;
and
(D) the likely difficulties in managing a class action.
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General Telephone Company of the Southwest v. Falcon,14 although not dealing with securities
fraud, is perhaps the case best known for setting out the predominance requirement. The Supreme
Court in General Telephone did not allow the certification of a class action brought by persons
claiming discrimination in promotion based on national origin and persons claiming
discrimination in hiring based on national origin. In its decision, the Court emphasized that, to be
successful in achieving class certification, the class must satisfy Rule 23(b)’s requirement that
“questions of law or fact common to class members [must] predominate over any questions
affecting only individual members.”15
Wal-Mart Stores, Inc. v. Dukes, also not a securities fraud class certification case but decided
thirty years after General Telephone, used much the same rationale that was used in General
Telephone for denying class certification. The Court stated,
Rule 23 does not set forth a mere pleading standard. A party seeking class certification must
affirmatively demonstrate his compliance with the Rule—that is, he must be prepared to
prove that there are in fact sufficiently numerous parties, questions of law or fact, etc.
In the area of securities fraud class action certification, Basic v. Levinson16 discussed the
predominance requirement. The Supreme Court stated:
The District Court adopted a presumption of reliance by members of the plaintiff class upon
petitioners’ public statements that enabled the court to conclude that common questions of
law or fact predominated over particular questions pertaining to individual plaintiffs.
What is especially important about Basic is that the Court stated that the requirement of reliance
may be met in some circumstances by allowing a presumption of reliance on material
misstatements, instead of requiring each plaintiff to prove direct reliance. “Misleading statements
will therefore defraud purchasers even if the purchasers do not directly rely on the
misstatements.”17 Basic introduced the fraud-on-the-market theory as the rationale behind the
presumption of reliance in certain circumstances. The fraud-on-the-market theory is based on the
14 457 U.S. 147 (1982).
15 The Court stated at 157-158:
[T]he allegation that such discrimination has occurred neither determines whether a class
action may be maintained in accordance with Rule 23 nor defines the class that may be certified.
Conceptually, there is a wide gap between (a) an individual’s claim that he has been denied a
promotion on discriminatory grounds, and his otherwise unsupported allegation that the company
has a policy of discrimination, and (b) the existence of a class of persons who have suffered the
same injury as that individual, such that the individual’s claim and the class claims will share
common questions of law or fact and that the individual’s claim will be typical of the class claims.
[footnote omitted] For respondent to bridge that gap, he must prove much more than the validity of
his own claim. Even though evidence that he was passed over for promotion when several less
deserving whites were advanced may support the conclusion that respondent was denied the
promotion because of his national origin, such evidence would not necessarily justify the additional
inferences (1) that this discriminatory treatment is typical of petitioner’s promotion practices, (2)
that petitioner’s promotion practices are motivated by a policy of ethnic discrimination that
pervades petitioner’s Irving division, or (3) that this policy of ethnic discrimination is reflected in
petitioner’s other employment practices, such as hiring, in the same way it is manifested in the
promotion practices. These additional inferences demonstrate the tenuous character of any
presumption that the class claims are “fairly encompassed” within respondent’s claim.
16 485 U.S. 224 (1988).
17 Id. at 242.
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belief that, in an efficient, well-developed securities market, all material information about a
company is available to the public and this information is reflected in the stock price. Courts will
allow plaintiffs under the fraud-on-the-market theory to show a rebuttable presumption of
reliance on material misstatements, instead of requiring all plaintiffs in all cases to prove direct
reliance which would, according to the Supreme Court in Basic, pose an undue burden on
plaintiffs.
Cases, notably the Halliburton cases, have set out additional parameters for securities fraud class
certification. Discussed later in this report, they include proof of loss causation and proof of
materiality only at the merits stage, not at the class certification stage, and the right of a defendant
to rebut the Basic presumption of reliance at the class certification stage.
It should be noted that, in response to the belief that too many frivolous class action securities
cases were being brought, particularly in the 1980s, Congress in the 1990s enacted two statutes.
The stated reasons for bringing all of these lawsuits were varied—fraud, mismanagement,
nondisclosure of material information—but practically all of the lawsuits involved the loss of
money by shareholders of the corporation. Some of the lawsuits no doubt had merit, but others
were deemed frivolous and were brought as a matter of course when, for example, the share value
of the stock of a corporation went down for reasons having nothing to do with the culpability of
corporate managers.
In 1995, Congress enacted the Private Securities Litigation Reform Act (PSLRA).18 The PSLRA
limits shareholder lawsuits in federal courts by such actions as the following: (1) having the court
appoint a lead plaintiff determined to be the most capable of adequately representing the interests
of class members; (2) prohibiting a person from being a lead plaintiff in any more than five class
actions in a three-year period; (3) guaranteeing that plaintiffs receive full disclosure of settlement
terms; (4) eliminating coverage of securities fraud by the Racketeer Influenced and Corrupt
Organizations Act; (5) providing a safe harbor for forward-looking statements; (6) providing for
proportionate liability; and (7) providing for auditor disclosure of corporate fraud.
The Securities Litigation Uniform Standards Act of 1998 (SLUSA)19 was enacted in response to
the perceived failure of the PSLRA to curb alleged abuses of securities fraud class action
litigation. PSLRA had set out a framework for bringing securities fraud class action cases in
federal courts. However, in many instances, plaintiffs circumvented PSLRA by bringing cases in
state courts on the basis of common law fraud or other non-federal claims.
SLUSA attempted to make certain that plaintiffs not be able to avoid the PSLRA requirements by
requiring a securities fraud case to be brought only in a federal court and only under a uniform
standard if certain criteria are satisfied, among them the following: (1) The lawsuit is a covered
class action; (2) The claim concerns a covered security; (3) The plaintiff alleges a
misrepresentation or omission of a material fact; and (4) The misrepresentation or omission is
made in connection with the purchase or sale of a covered security.
There has been considerable controversy concerning securities fraud class action certification.
Passions run high among both supporters and opponents of class action certification over what
standards should be met. Some believe that many securities fraud class actions are frivolous and
18 P.L. 104-67, codified in a number of provisions of 15 U.S.C. §§ 78a et seq.
19 P.L. 105-353, codified in a number of provisions of 15 U.S.C. §§ 78a et seq.
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that the only winners are the attorneys who bring the suits and who reap large legal fees. These
opponents of class actions argue that the lawsuits are often brought to pressure companies into
large settlements because companies are afraid of the expenses associated with defending class
action suits. People who support easing requirements for securities fraud class action suits believe
that the suits are necessary to hold companies accountable and that, otherwise, companies will be
more likely to engage in fraudulent behavior with the belief that plaintiffs will be reluctant to risk
the costs associated with certification and suing on the merits. Lawsuits have been brought,
settlements have been reached, and federal statutes have been enacted, but the issue of securities
fraud class action certification is far from being settled. The Halliburton cases will make this
clear.
Halliburton Cases
Federal District Court Decision—I
The Erica P. John Fund (Fund), which exists to support the Archdiocese of Milwaukee, originally
brought suit against Halliburton in 2002, with accusations that Halliburton had committed
securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 and
Securities and Exchange Commission (SEC) Rule 10b-5 by understating its asbestos liabilities,
overstating its revenues by including billings whose collections were unlikely, and exaggerating
cost savings and efficiencies derived from a 1998 merger. Plaintiffs alleged that the
misrepresentations inflated the price of Halliburton stock and that, when the truth was later
revealed, the stock price dropped and they lost money.
In September 2007, the Fund moved to certify a class of persons who owned Halliburton stock
during the appropriate time period. In an unpublished opinion, the Federal District Court for the
Northern District of Texas declined to certify the class to bring the lawsuit on the basis that the
plaintiffs had not proved reliance (one of the necessary elements for proving a Section 10(b)
claim, as mentioned above) on material misstatements made by Halliburton.
Fifth Circuit Decision—I
The U.S. Court of Appeals for the Fifth Circuit (Fifth Circuit) affirmed.20 In its decision, the Fifth
Circuit began its analysis by stating that the case involved a private fraud-on-the-market
allegation. The fraud-on-the-market theory, as discussed earlier, was set out in the Supreme Court
case Basic, Inc. v. Levinson. It is based on the assumption that, in an efficient, well-developed
securities market, all material information about a company is available to the public and that this
information is reflected in the stock price. In order to use the fraud-on-the-market presumption of
reliance, according to the Fifth Circuit, a plaintiff must show that an alleged misstatement
“actually moved the market.”21 The court stated that it was necessary for the plaintiff to show loss
causation and to show it “at the class certification stage by a preponderance of all admissible
evidence.”22 In addition, the court required that the plaintiff show that the decline in the stock’s
20The Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330 (5th Cir. 2010).
21 Oscar Private Equity Investments v. Allegiance Telecom, Inc. 487 F.3d 261, 269 (5th Cir. 2007).
22 Id.
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price actually resulted from the disclosure of the truth concerning the earlier misstatements rather
than from the release of unrelated negative information. In response to the plaintiff’s claim that it
had identified specific misrepresentations by Halliburton and that it had linked those
misrepresentations, at least partially, to corrective disclosures, the Fifth Circuit stated that it was
unconvinced. After going through the plaintiff’s claims of Halliburton’s misrepresentations and
finding fault with all of the plaintiff’s arguments about their impact on the decline of the stock
price once Halliburton had issued corrective statements, the court concluded that the plaintiff had
failed to meet the Fifth Circuit’s requirements for proving loss causation at the class certification
stage.
Supreme Court Decision—I
The Supreme Court in 2011 reversed the Fifth Circuit’s decision. In Erica P. John Fund, Inc. v.
Halliburton Co.,23 the Court began its opinion by stating what is required to prevail on the merits
in a private securities fraud action:
To prevail on the merits in a private securities fraud action, investors must demonstrate that
the defendant’s deceptive conduct caused their claimed economic loss. This requirement is
commonly referred to as “loss causation.
”
In contrast, the question presented to the Court in this case and in the lower court cases was
whether securities fraud plaintiffs had to prove loss causation for class certification. The merits of
the plaintiffs’ case were not at issue. What was at sole issue, according to the Court, was whether
the plaintiffs satisfied the class action certification predominance requirement of FRCP 23(b)(3).
In determining whether the FRCP 23(b)(3) requirement of common questions of law or fact has
been met, the element of reliance by a plaintiff must often be examined. The Court discussed
how, in Basic v. Levinson, it had recognized that requiring a plaintiff to demonstrate that he was
actually aware of a company’s statement and engaged in purchasing stock based upon that
statement would be too limiting and “would place an unnecessarily unrealistic evidentiary burden
on the Rule 10b-5 plaintiff who has traded on an impersonal market.”24 Thus, in Basic, as
discussed earlier, the Court allowed the plaintiffs to invoke a rebuttable presumption of reliance
based on the fraud-on-the-market theory.25
The Supreme Court concluded by stating that the Court of Appeals erred when it required the
Erica P. John Fund to prove loss causation at the certification stage. The Court refused to address
23 No. 09-1403, 563 U.S. ___ (2011).
24 Basic v. Levinson, 485 U.S. 224, 242 (1988).
25 At 245-248, the Court in Basic stated:
The presumption of reliance employed in this case is consistent with, and, by facilitating Rule 10b-5
litigation, supports the congressional policy embodied in the 1934 Act. In drafting that Act, Congress expressly
relied on the premise that securities markets are affected by information, and enacted legislation to facilitate an
investor’s reliance on the integrity of those markets....
The presumption is also supported by common sense and probability. Recent empirical studies have tended to
confirm Congress’ premise that the market price of shares traded on well-developed markets reflects all publicly
available information, and, hence, any material misrepresentations. [footnote omitted] It has been noted that “it is
hard to imagine that there ever is a buyer or seller who does not rely on market integrity. Who would knowingly
roll the dice in a crooked crap game.... ” [citation omitted]
Any showing that severs the alleged misrepresentation and either the price received (or paid) by the plaintiff,
or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance.
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any other questions which Halliburton might have, such as the presumption of reliance under the
fraud-on-the-market theory or how and when the presumption might be rebutted. The Supreme
Court vacated the judgment of the Fifth Circuit and remanded it for further proceedings consistent
with the opinion.
Federal District Court Decision—II
On remand, Halliburton argued that the class should still not be certified because it had
discovered evidence that the alleged fraud did not affect the market price of the stock. Halliburton
contended that, by demonstrating the absence of any “price impact,”26 it had complied with the
guidance set out in Basic that a defendant must have the opportunity to rebut the presumption of
reliance allowed by the fraud-on-the-market theory. Without the benefit of the Basic presumption,
according to Halliburton, investors would have to prove reliance on an individual basis; thus,
individual issues would predominate over common ones, precluding class certification.
According to statements in the decision later issued by the Fifth Circuit, the district court on
remand declined to consider the evidence which Halliburton claimed to have discovered. The
district court found that the price impact evidence did not have a bearing on the important issue of
whether common issues predominated so as to satisfy FRCP 23(b)(3). Instead, believing that
common issues predominated and that the other requirements of Rule 23 were met, the district
court certified the class.
Fifth Circuit Decision—II
Halliburton appealed to the Fifth Circuit, and in April 2013 the Fifth Circuit in Erica P. John
Fund, Inc. v. Halliburton Co.27 affirmed the district court’s decision to certify the class. Only two
months before the Fifth Circuit’s decision, the Supreme Court decided another case, Amgen, Inc.
v. Connecticut Retirement Plans (Amgen),28 which the Fifth Circuit referenced in the Halliburton
decision.
In Amgen, the Supreme Court held that a plaintiff in a securities fraud Section 10(b) case is not
required to prove prior to certification of a class action that a defendant made a material
misstatement. The case resolved a significant split among the federal circuit courts on the issue of
whether proof of materiality (reliance upon a material29 misstatement or omission) is required for
class certification.30
26 “Price impact” is the effect of a misrepresentation on a stock price.
27 718 F.3d 423 (2013).
28 No. 11-1085, 568 U.S. ___ (2013).
29 Courts have sketched out a definition of material information as information that a reasonable investor would need to
make an informed investment decision. See, e.g., TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976) and Mills
v. Electric Auto-Lite Co., 396 U.S. 375 (1970).
30 Over the years, cases, notably Matrixx Initiatives, Inc. v. Siracusano (No. 09-1156, 563 U.S. ___ (2011), have
established the requirement that a plaintiff must prove in a securities fraud claim that there was reliance upon a material
misstatement or omission by the defendant. As stated above, in Basic the Supreme Court endorsed a fraud-on-the-
market theory allowing a plaintiff in an efficient market to invoke a rebuttable presumption of reliance upon a public,
material misrepresentation. Connecticut Retirement in Amgen invoked the fraud-on-the-market theory in seeking class
action certification under FRCP 23(b)(3) against Amgen for alleged material misstatements. Amgen defended that
Connecticut Retirement had not proved the misstatements to be material and could not therefore be certified as an
(continued...)
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After discussing the Amgen case, the Fifth Circuit examined Halliburton’s claim that the question
before the court was whether price impact was an issue which a defendant might use at class
certification in order to rebut the fraud-on-the-market presumption that the stock price was
affected by a misstatement that was later corrected. Halliburton argued that, in spite of the proof
provided to support invoking the fraud-on-the-market presumption of reliance, its own evidence
showed that the misrepresentation did not actually have an impact on the price which the
purchaser paid for the stock. The Fifth Circuit agreed with Halliburton that, if there was no price
impact, then that evidence could be used at the trial on the merits to refute the fraud-on-the-
market reliance of presumption. Although the Fifth Circuit believed that the Supreme Court in
Amgen did not discuss whether this evidence could be considered at class certification, the Fifth
Circuit stated that the Supreme Court did provide a framework for resolving the question. That
framework, according to the Fifth Circuit, was based simply on whether resolution of the matter
was necessary for determining whether questions of law or fact common to the class would
predominate over questions affecting only individual members.
The Fifth Circuit then examined whether price impact evidence was common to the class and
whether there was any risk that a later failure to prove the common question of price impact
would result in the predominance of individual questions. The Fifth Circuit disagreed with
Halliburton’s argument that in this particular case the plaintiff class could not show price impact
and should lose the class-wide presumption of reliance, leaving individuals, according to
Halliburton, with possibly still viable fraud claims which they could pursue on an individual
basis. According to the Fifth Circuit, if Halliburton could successfully rebut the fraud-on-the-
market presumption by showing no price impact, not only could there be no class certification but
the individual plaintiffs would also have no claims because they could not establish loss
causation, an essential element of a Section 10(b) fraud action. Thus, the Fifth Circuit affirmed
(...continued)
appropriate class.
In holding that proof of materiality is not required for certification of a securities fraud class action, the Court reasoned
that the plaintiffs’ assertion was sufficient for the purpose of class certification because at that particular stage of the
proceedings the issue was not whether there had actually been a material misstatement or omission by the defendant.
The Court believed that that determination could occur at a later time when the certified class presented its evidence of
material misstatements to a court. The Supreme Court was not persuaded by Amgen’s rebuttal argument that policy
considerations militated in favor of proof of materiality because class certification might place pressure on a defendant
to settle rather than to risk significant costs in defending its actions. The Court believed that the pivotal inquiry in the
case was whether proof of materiality was necessary to satisfy the requirement of Rule 23(b)(3) that questions of law or
fact common to the class would predominate over any individual questions of law or fact. The Court stated,
The District Court did not err, we agree with the Court of Appeals, by disregarding Amgen’s
rebuttal evidence in deciding whether Connecticut Retirement’s proposed class satisfied Rule
23(b)(3)’s predominance requirement. The Court of Appeals concluded, and Amgen does not
contest, that Amgen’s rebuttal evidence aimed to prove that the misrepresentations and omissions
alleged in Connecticut Retirement’s complaint were immaterial.... As explained above, however,
the potential immateriality of Amgen’s alleged misrepresentations and omissions is no barrier to
finding that common questions predominate.... If the alleged misrepresentations and omissions are
ultimately found immaterial, the fraud-on-the-market presumption of classwide reliance will
collapse. But again, as earlier explained ... , individual reliance questions will not overwhelm
questions common to the class, for the class members’ claims will have failed on their merits, thus
bringing the litigation to a close. Therefore, just as a plaintiff class’s inability to prove materiality
creates no risk that individual questions will predominate, so even a definitive rebuttal on the issue
of materiality would not undermine the predominance of questions common to the class. No. 11-
1085, 568 U.S. ___, slip op. at 11.
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the district court decision, concluding that price impact fraud-on-the-market rebuttal evidence
could not be addressed at class certification. The Court stated,
Proof of price impact is based upon common evidence, and later proof of no price impact
will not result in the possibility of individual claims continuing. Accordingly, Halliburton’s
price impact evidence does not bear on the question of common question predominance, and
is thus appropriately considered only on the merits after the class has been certified.31
Supreme Court Decision—II
Halliburton filed a writ of certiorari with the Supreme Court. The Court granted the petition, and
on June 23, 2014, the Court issued its decision, Halliburton Co. v. Erica P. John Fund, Inc. The
Court in its decision could have invalidated the fraud-on-the-market theory and overruled Basic,
or it could have prevented the defendants from being allowed to rebut evidence at the class
certification stage. It did neither; instead, it chose a middle ground, giving, in a sense, something
to everyone but everything to no one. The Court decided, with respect to the first question stated
at the beginning of this report, not to overrule the presumption of reliance provided by the fraud-
on-the-market theory but that, with respect to the second question, defendants in a class action
may attempt to rebut the presumption of reliance at the class certification stage by introducing
evidence that the alleged misrepresentations did not distort the market price of its stock. Chief
Justice Roberts wrote the opinion and was joined by Justices Kennedy, Ginsburg, Breyer,
Sotomayor, and Kagan.
The Court first examined Halliburton’s argument to overrule the presumption of reliance in Basic,
thereby requiring every securities fraud plaintiff to prove actual reliance on the defendant’s
misrepresentation when deciding whether to buy or sell a company’s stock. The Court stated that
before overturning a long-settled precedent, it must, according to Dickerson v. United States,32
find “special justification,” not simply an argument that the precedent was “wrongly decided.”
The Court then recapped its rationale and holding in Basic v. Levinson. According to the fraud-
on-the-market theory developed in Basic, when an investor buys or sells stock at the market price,
his reliance on any public material misrepresentations may be presumed for a securities fraud
action. Based on this theory, the Halliburton Court emphasized, a securities fraud plaintiff must
show: 1. that the alleged misrepresentations were publicly known; 2. that they were material; 3.
that the stock traded in an efficient market; and 4. that the plaintiff traded the stock between the
time that the misrepresentations were made and when the truth was disclosed. Basic also made
clear that the presumption of reliance was rebuttable and not conclusive.
Any showing that severs the link between the alleged misrepresentation and either the price
received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be
sufficient to rebut the presumption of reliance.33
Halliburton argued before the Supreme Court that securities fraud plaintiffs should always be
required to prove direct reliance and that the Supreme Court in Basic mistakenly allowed
plaintiffs to invoke a presumption of reliance. Halliburton claimed that the Basic presumption is
31 718 F.3d 423, 435 (2013).
32 530 U.S. 428 (2000).
33 485 U.S. 224, 248 (1988).
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opposed to Congress’s intent in the Securities Exchange Act and that subsequent developments in
economic theory have undermined the Basic presumption. The Court concluded that neither of
these arguments constituted “special justification” for overruling Basic.
With respect to the argument that the Basic presumption contravened congressional intent in the
Securities Exchange Act, Halliburton stated that the private right of action under Section 10(b) is
a judicial construct that Congress did not enact and that the Court must identify some provision
from the Securities Exchange Act which does provide for a private right of action and interpret
any private right of action allowed under Section 10(b) in an analogous way. The provision which
Halliburton identified as most similar was Section 18(a),34 which creates a private right of action
for investors to allow recovery of damages based on misrepresentations in regulatory filings. That
provision requires an investor to prove that he bought or sold stock by relying upon a defendant’s
misrepresentation. The defendant disputed Halliburton by arguing that Congress has actually
affirmed Basic’s construction of Section 10(b) and that, further, Section 9 of the Securities
Exchange Act,35 which does not require actual reliance, is the closest analogue to Section 10(b).
The Supreme Court stated that Halliburton’s argument had been made in Basic and that it was
unconvincing then and unconvincing now.
Halliburton then argued that the economic premises upon which Basic rested—the “robust view
of market efficiency” and investor reliance upon the integrity of the marketplace—are no longer
tenable. The Court refuted these arguments by stating that the Basic decision did not rest upon a
binary view of market efficiency but, rather, that it recognized that market efficiency is a matter
of degree. Further, Basic did not state that all investors rely upon the integrity of the marketplace
but that, instead, it is reasonable to presume that most investors rely upon the security’s price as
an assessment of its value in light of all publicly available information.
The Court next discussed that the principle of stare decisis (the doctrine of precedent) has
“special force” in the interpretation of statutes because of the fact that at any time Congress may
undo a court decision by enacting legislation.36 The Court mentioned other decisions, such as
Central Bank of Denver, N.A. v. First Interstate Bank of Denver37 and Stoneridge Investment
Partners, LLC v. Scientific Atlanta, Inc.,38 which have dealt with the Section 10(b) cause of
action, and found no inconsistency between them and the presumption of reliance allowed in
Basic.
34 15 U.S.C. § 78r(a).
35 15 U.S.C. § 78i.
36 The Court stated at page 13 of the slip opinion:
The
principle
of
stare decisis has “special force” in respect to statutory interpretation because
Congress remains free to alter what we have done. [citations and quotations omitted] So too with
Basic’s presumption of reliance. Although the presumption is a judicially created doctrine,
designed to implement a judicially created cause of action, we have described the presumption as
“a substantive doctrine of federal securities-fraud law.” Amgen, supra, at ___ (slip op., at 5). That is
because it provides a way of satisfying the reliance element of the Rule 10b-5 cause of action.
[citation omitted] As with any other element of that cause of action, Congress may overturn or
modify any aspect of our interpretations of the reliance requirement, including the Basic
presumption itself. Given that possibility, we see no reason to exempt the Basic presumption from
ordinary principles of stare decisis.
37 511 U.S. 164 (1994).
38 552 U.S. 148 (2008).
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The Court also discussed recent decisions such as Wal-Mart Stores, Inc. v. Dukes, which have
governed class action certification and the requirement that plaintiffs prove that their class
satisfies FRCP 23. It found that the Basic presumption of reliance did not relieve plaintiffs from
meeting the class certification requirements and that Halliburton’s claims that the Basic
presumption leads to unnecessary lawsuits should be addressed by Congress. In fact, according to
the Court, Congress did address some of the securities class action frivolous lawsuit concerns in
the Private Securities Litigation Reform Act and the Securities Litigation Uniform Standards Act,
discussed earlier in the report.
Halliburton proposed two alternatives to overruling Basic. The first alternative would require that
a plaintiff actually prove that a defendant’s misrepresentation affected the stock price (“price
impact”) before invoking the Basic presumption of reliance. The Court found this alternative
unacceptable for the same reasons that it refused in general to overrule Basic’s presumption of
reliance. As stated before, according to Basic, if a plaintiff can show that the defendant’s
misrepresentation was publicly known and material, that the stock traded in an efficient market,
and that the plaintiff traded the stock between the time when the misrepresentations were made
and the truth was revealed, he is allowed to invoke the Basic presumption of reliance. If a
plaintiff were required to prove, as Halliburton urged, price impact directly, he would be
foreclosed from showing that the stock was trading in an efficient market, thus overruling an
important element set out by Basic in its presumption of reliance doctrine.
Halliburton’s second proposed alternative would allow a defendant to rebut the Basic
presumption of reliance by showing a lack of price impact and to show the lack of price impact
not only at the merits stage but, more importantly according to Halliburton, before the class is
certified. If a defendant were able to show a lack of price impact at the time that the class is
arguing for certification, Halliburton claimed, it could prevent the class from being certified.
The Supreme Court was receptive to Halliburton’s second proposed alternative to overruling
Basic. According to the Court, it makes no sense to forbid defendants from using the same
evidence about price impact before class certification that they would be able to use at the merits
stage to rebut the presumption of reliance. The Court stated that this prohibition would actually be
inconsistent with its decision in Basic.39
The Court disagreed with the Fifth Circuit’s interpretation of Amgen as not allowing the
consideration of price impact fraud-on-the-market rebuttal evidence at class certification. Amgen,
according to the Supreme Court in Halliburton II, held that, although materiality is required for
39The Court stated at pages 18-19 of the slip opinion:
There is no dispute that defendants may introduce such evidence at the merits stage to rebut the
Basic presumption. Basic itself “made clear that the presumption was just that, and could be
rebutted by appropriate evidence,” including evidence that the asserted misrepresentation (or its
correction) did not affect the market price of the defendant’s stock. [citation omitted]
Nor is there any dispute that defendants may introduce price impact evidence at the class
certification stage, so long as it is for the purpose of countering a plaintiff’s showing of market
efficiency, rather than directly rebutting the presumption. As EPJ Fund acknowledges, “[o]f course ...
defendants can introduce evidence at class certification of lack of price impact as some evidence that
the market is not efficient.” [citations omitted]
After all, plaintiffs themselves can and do introduce evidence of the existence of price impact in
connection with “event studies”—regression analyses that seek to show that the market price of the
defendant’s stock tends to respond to pertinent publicly reported events. [citation omitted]
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invoking the Basic presumption of reliance, the question of whether material misrepresentation
actually occurred should be left to the merits stage of the case. However, the Amgen decision did
not forbid, for purposes of class certification, the presenting of evidence that an alleged
misrepresentation did not affect the price of the stock. In fact, according to the Court in
Halliburton II, in order to maintain the consistency of the presumption of reliance as set out in
Basic with the class certification requirements of FRCP 23, defendants must have the opportunity
before the class is certified to provide evidence that an alleged misrepresentation did not affect
the price of the stock.40
The Court vacated the Fifth Circuit’s judgment and remanded the case for further proceedings
consistent with the opinion.
Justice Ginsburg, joined by Justices Breyer and Sotomayor, wrote a brief concurring opinion,
stating that “it is incumbent upon the defendant to show the absence of price impact,” thereby
imposing “no heavy toll on securities fraud plaintiffs with tenable claims.”41
Justice Thomas, joined by Justices Scalia and Alito, filed an opinion concurring in the judgment
but calling for overruling Basic.42
Conclusion
It appears that over the past thirty years the Supreme Court has struck something of a middle
ground in setting out the parameters for securities fraud class action certification, finding for
neither plaintiffs nor defendants in all challenges. The Court has held that there must be
predominance of common issues of fact or law (General Telephone Company of the Southwest v.
Falcon, as affirmed by Basic v. Levinson), a burden which plaintiffs must meet. Presuming
reliance on material misstatements is allowed under certain circumstances (Basic v. Levinson), a
development opposed by defendants, who have argued for direct reliance. Limiting or eliminating
proof of materiality at the class certification stage (Amgen, Inc. v. Connecticut Retirement Plans)
is another development which defendants opposed. Not having to prove loss causation at the class
certification stage (Supreme Court’s first Halliburton decision) was another favorable decision
for class action plaintiffs. Requiring proof of market efficiency (Basic v. Levinson) is a burden
40 The Court stated at page 22 of the slip opinion:
Price impact is different [from materiality]. The fact that a misrepresentation “was reflected in the
market price at the time of [the] transaction”—that it had price impact—is “Basic’s fundamental
premise.” [citation omitted] It thus has everything to do with the issue of predominance at the class
certification stage. That is why, if reliance is to be shown through the Basic presumption, the publicity
and market efficiency prerequisites must be proved before class certification. Without proof of those
prerequisites, the fraud-on-the-market theory underlying the presumption completely collapses,
rendering class certification inappropriate.
41 Id., Ginsburg, R., concurring, at 1.
42 At page 18 of his concurring opinion, Justice Thomas stated,
Basic took an implied cause of action and grafted on a policy-driven presumption of reliance based
on nascent economic theory and personal intuitions about investment behavior. The result was an
unrecognizably broad cause of action ready made for class certification. Time and experience have
pointed up the error of that decision, making it all too clear that the Court’s attempt to revise securities
law to fit the alleged “new realities of financial markets” should have been left to Congress. [citation
omitted]
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which the plaintiffs may find difficult at times to meet. Allowing defendants at the class
certification stage to rebut the presumption of reliance (Basic v. Levinson) is a decision which
plaintiffs may oppose.
In the same way, the Supreme Court struck a kind of middle ground in its decision of Halliburton
II. The Court did not overrule Basic v. Levinson and its fraud-on-the-market theory which allows
a presumption of reliance, rather than required direct reliance, under certain circumstances, but
the Court did allow defendants to rebut this presumption of reliance at the class certification stage
by introducing evidence that the alleged misrepresentations did not distort the stock’s market
price. Basic had stated that the defendants could rebut the presumption of reliance, and in
Halliburton II the Court recognized that one way to rebut the presumption of reliance is to show
an absence of price impact caused by defendant’s alleged misstatements.
Despite the Court’s not jettisoning the fraud-on-the-market reliance presumption of reliance set
out in Basic, some commenters believe that defendants achieved a significant victory in
Halliburton II. An attorney who represented Halliburton stated that “[T]he defense has argued for
the ability to rebut the presumption with price impact evidence since the case went up to the court
the first time in 2010.”43 When she stated that the defendant has the burden of showing the
absence of price impact, Justice Ginsburg in her brief concurring opinion may have anticipated
that many will believe that the Halliburton II decision will make class action certification more
difficult.
The Halliburton II decision has already begun to have an impact on class certification. In a case
decided not long after Halliburton II, the U.S. Court of Appeals for the Eleventh Circuit on
August 6 vacated the certification of a plaintiff class in a lawsuit brought against Regions
Financial Corporation so that the lower court could consider Regions’ evidence of lack of price
impact caused by allegedly fraudulent statements about real estate investments.44
Halliburton II is not the end of the Erica P. John Fund v. Halliburton saga. It may not even be the
end of the class certification challenges. A major issue for class certification after Halliburton II
now seems to be what kind of evidence is sufficient for defendants to show that the alleged
misstatements had no price impact on the stock. Will it, for instance, be necessary to show results
of econometric studies and will these studies be rebuttable by the involved parties? Finally, once
the class is finally certified, the courts may then face the merits of the case. It seems that another
ten years could easily pass before final resolution occurs.
Author Contact Information
Michael V. Seitzinger
Legislative Attorney
mseitzinger@crs.loc.gov, 7-7895
43 http://www.bna.com/halliburton-lawyer-case-n17179893183.
44 Local 703, I.B. of T. Grocery & Food Employees Welfare Fund v. Regions Financial Corporation, No. 12-14168
(11th Cir. Aug. 6, 2014).
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