July 29, 2015
On July 27, 2015, the U.S. District Court for the Northern District of Texas issued its anticipated decision on remand from Halliburton, Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (“Halliburton II“), where the United States Supreme Court held that a defendant in a securities fraud class action could introduce evidence of a lack of price impact at the class certification stage to show the absence of predominance. Although the case involved facts that arguably are unique to Halliburton’s particular public disclosures, the plaintiffs’ bar may look to the decision as a roadmap for how to meet the Supreme Court’s price impact test in future cases.
Based on the expert evidence presented on remand, the District Court granted the Plaintiffs’ motion for class certification as to one alleged corrective disclosure but denied the motion as to the other five alleged corrective disclosures. Erica P. John Fund, Inc. v. Halliburton Co., No. 3:02-CV-1152-M, slip op. at 1 (N.D. Tex. July 25, 2015). And as to that one disclosure, the court declined to entertain at the class certification stage Halliburton’s argument that the disclosure was not corrective of the alleged misrepresentation. While there may be continued debate regarding certain of the court’s legal conclusions–including whether a court may properly consider at class certification whether a disclosure was even corrective–the opinion demonstrates what most defendants argue Halliburton II requires: a careful and thorough analysis of defendant’s evidence of a lack of price impact. Beyond that, the court’s ruling may raise more questions than it answered.
As discussed in our June 2014 Client Alert, Halliburton II was the third of a series of Supreme Court decisions addressing burdens at the class certification stage of a securities fraud action. In prior decisions, the Supreme Court clarified that, at the certification stage, securities plaintiffs need not prove that the alleged misstatement caused investor losses, Erica P. John Fund, Inc. v. Halliburton Co. (Halliburton I), 131 S. Ct. 2179, 2183 (2011), nor that the alleged misstatement was material, Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 133 S. Ct. 1184, 1195–96 (2013). In Halliburton II, the Supreme Court re-affirmed its prior precedent in Basic v. Levinson, 485 U.S. 224, 243 (1988) establishing the “fraud on the market” rebuttable presumption of reliance, but held that the presumption may be defeated at the class certification stage by evidence that the defendants’ challenged misrepresentation(s) did not affect the market price of the security at issue. Halliburton II, 134 S. Ct. at 2416–17.
On remand from the Supreme Court’s decision in Halliburton II, the only issue for class certification in the District Court was predominance–whether “questions of law or fact common to class members predominate over any questions affecting only individual class members.” Erica P. John Fund, Inc. v. Halliburton Co., No. 3:02-CV-1152-M, slip op. at 1 (N.D. Tex. July 25, 2015) (citing Fed. R. Civ. P. 23(b)). To show reliance on a class-wide basis, the Plaintiffs demonstrated that the fraud-on-the-market presumption of Basic applied by showing (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 the misrepresentations were made and when the truth was revealed. Id. at 5 (citing Halliburton II, 134 S. Ct. at 2408).
As directed by the Supreme Court in Halliburton II, Halliburton was then given an opportunity on remand to rebut the Basic presumption “with evidence that the asserted misrepresentation (or its correction) did not affect the market price.” Id. at 6 (citing Halliburton II, 134 S. Ct. at 2414). The parties submitted event studies by their respective experts to show whether Halliburton’s stock was, or was not, affected on days when an alleged misrepresentation or corrective disclosure reached the market. Id. at 7.
Before beginning its analysis of the expert evidence, the District Court addressed two threshold legal issues that had not been previously addressed by the courts. First, the District Court assessed the parties’ respective burdens of production and persuasion as a result of the Supreme Court’s decision in Halliburton II. Second, the District Court determined whether certain other non-price impact considerations, such as whether a certain disclosure was corrective, can properly be determined at the class certification stage.
Acknowledging that the Supreme Court in Halliburton II did not expressly state which party carries the burden of persuasion to show price impact, the District Court determined that both the burden of production and persuasion remained on the defendant in a fraud-on-the-market class action. Slip Op. at 7. Thus, the District Court found that, to overcome the presumption, “Halliburton must ultimately persuade the Court that its expert’s event studies are more probative of price impact than the Fund’s expert’s event studies.” Id. at 11.
In reaching this conclusion, the District Court rejected Halliburton’s argument that placing the burden of persuasion on the plaintiff would be consistent with Federal Rule of Evidence 301, which provides the general rule for burden shifting for presumptions. Id. at 7. In what some may argue is an unsound legal conclusion, the District Court found that the fraud-on-the-market presumption is atypical and does not fit into the Rule 301 framework. It reasoned that once the defendant produced evidence to rebut the presumption, a literal application of Rule 301 would leave the burden of persuasion on the plaintiff and force the plaintiff to prove reliance without the aid of the presumption. If Rule 301 applies, the court reasoned, the defendant’s mere production of evidence of lack of price impact would essentially doom the class on predominance grounds. Id. at 11. The District Court found that the Supreme Court would not have modified the fraud-on-the-market presumption so substantially without explicitly saying so. Id.
Like the Supreme Court’s decision in Halliburton II itself, the District Court decision signals that defendants will need to present compelling expert testimony at the class certification stage to convince a court that there was no price impact, by a preponderance of the evidence. To rebut defendants’ expert evidence, plaintiffs can be expected to offer their own expert testimony, but with no burden of proof per se. The District Court ruling underscores that the question of who bears the ultimate burden of proof is a critical swing factor in how the price impact issues will be adjudged in future cases. Parties in fraud-on-the-market cases can be expected to increase their use of event studies and economic analyses early on in these types of cases, and courts can be expected to engage in a rigorous analysis of those issues. As in the district court proceedings in Halliburton, that might require live testimony and an evidentiary hearing. While the outcome of such analyses may ultimately benefit defendants, the time, money, and effort required to engage in such a complex battle in the preliminary stages of a lawsuit may encourage future defendants to settle early.
Halliburton argued in its briefing on price impact that certain alleged corrective disclosures were not, in fact, corrective, and therefore, Halliburton had rebutted the presumption by showing that there was no correction that affected the market price. Id. at 12. After revisiting the Supreme Court’s decisions in Halliburton I, Amgen, and Halliburton II, the District Court concluded that “class certification is not the proper procedural stage for the Court to determine, as a matter of law, whether the relevant disclosures were corrective.” Id. at 13. Rather, the District Court found that this issue relates to materiality and loss causation, neither of which must be proven at the class certification stage. Id. at 13-14. Left unsaid is that materiality and loss causation are either won by defendants on a motion to dismiss–before class certification even occurs–or at the time of summary judgment or trial. Since virtually all securities class actions are settled if not dismissed, the district court’s ruling, if followed by other courts, leaves little opportunity for defendants to ever truly litigate materiality or loss causation at any other stage of the litigation.
Further, the District Court noted that “Basic presupposes that a misrepresentation is reflected in the market price at the time of the transaction.” Id. at 15 (emphasis in original). Thus, at the class certification stage, the District Court assumes that the asserted misrepresentations are, in fact, misrepresentations and assumes that the asserted corrective disclosures are, in fact, corrective. Id. The District Court concluded that to hold otherwise “would require the Court to pass judgment on the merits of the allegations after the dismissal stage and before summary judgment–in effect, giving a third bite at the apple to Halliburton.” Id.
Interestingly, while the District Court explicitly declined to rule on the issue of whether specific disclosures were corrective, the District Court’s language in finding no evidence of price impact mimics language that might have been used by the Court to find that a disclosure was not corrective. For example, in finding no price impact for the August 9, 2001 event, the District Court explained that, though it was “not determining as a matter of law that the disclosures were not corrective,” it did find that the information alleged to be corrective “was both already disclosed and caused no statistically significant price reaction.” Id. at 38. Likewise, with regard to an alleged corrective disclosure on October 30, 2001, the District Court acknowledged the presence of prior public announcements containing the same information as the alleged corrective disclosure, and it concluded that the Court was “required to assume that the market had already absorbed that information by the time Halliburton made its own announcement.” Id. at 41.
The potential consequences of the District Court’s interpretation of Halliburton II may be that a court will allow a class to be certified even where, on the face of the allegations and in light of expert evidence, there is no corrective disclosure. Thus, to the extent that the focus of the court’s inquiry is on price impact as measured by a stock price decline, plaintiffs any attempt to argue that they need show little more than a stock drop, with no burden to show that the stock drop is tethered to any accompanying corrective disclosure. The defendant would then be forced to move for summary judgment at a later proceeding. The only solace to be drawn from the District Court’s analysis of the paragraph cited above is that a defendant’s evidence that a disclosure is not corrective may at least influence a court’s determination of whether a particular stock price decline fails to establish price impact caused by a misrepresentation.
Implementing not one but two Supreme Court opinions, the District Court’s class certification decision in Halliburton, particularly its careful analysis of the expert economic approaches and evidence, should be instructive to litigants and courts in other securities fraud cases. The opinion highlights the importance of the statement-by-statement approach to price impact mandated by the Supreme Court, since the District Court declined to certify a class as to five of the six corrective disclosures identified by the plaintiffs. Other defendants, too, should be able to defeat or limit the scope of class certification by presenting persuasive expert evidence regarding the absence of a price impact for individual misstatements and/or corrective disclosures identified by the plaintiff in discovery. The District Court’s endorsement of rigorous expert methodologies, including the requirement of a 95% confidence level, rejection of a two-day window, and application of a multiple comparison analysis to adjust for cases where a large number of price reactions are tested, will encourage plaintiffs and defendants alike to present sophisticated economic analyses at the certification stage. And as the District Court did here, future courts will have to resolve differences in expert approach that bear on the question of price impact and thus reliance. The decision will likely pave the way for additional courts to dive into complex economic issues at the class certification stage, and it should become part of the toolkit for litigants and counsel facing questions of class certification in fraud-on-the-market cases.
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