Shareholders, listen up. Like the women seeking equal pay and cable subscribers before you, you could be in trouble. On Wednesday, the Supreme Court is set to hear arguments in a case that could cripple your ability to band together and sue companies for corporate frauds that lead you to lose money.
In Halliburton v. Erica P. John Fund, a group of Halliburton shareholders allege that the company (yes, it’s the one of Dick Cheney fame) falsified its financial results and misled the public about its liability for asbestos claims, among other things. Once the truth came to light, the shareholders say, the value of their shares plunged. They’re angry, and they’re suing.
To prove their case, the shareholders must show not only that the company lied, but that they themselves relied on those lies. This doesn’t mean that they literally relied on them, though, in the sense of buying or keeping shares because shareholders read the allegedly misleading corporate earnings reports. Since few shareholders do that (take a look at Apple’s recent one to see how riveting such reports can be), the Supreme Court recognized some 25 years ago, in a case called Basic Inc. v. Levinson, that requiring shareholders to show “eyeball” reliance would be “unrealistic.”
Instead, the court looked to economic theory and adopted a presumption that, if a market is generally efficient, publicly available information about a company will be factored into its share price. Any fraud thus affects that price. That rule, now ubiquitous in securities litigation, has come to be known as the “fraud on the market” presumption.
One way in which the rule is important is that it allowed shareholders to band together as a group to bring a class-action suit. Think of the “fraud on the market” presumption as the glue that holds the class together. Without that glue, it would make little sense for a court to let the shareholders sue as a class. Indeed, it’s only after Basic that the modern securities class action—lawsuits brought by shareholders claiming fraud by publicly traded companies—took off.
But now Halliburton says that the underlying economic theory that the court used in Basic is wrong. New economic thinking, the company argues, shows that the court’s “simplistic understanding of market efficiency is at war with economic reality.” Halliburton is asking the court to overturn Basic and throw out the “fraud on the market” rule. That would be the end of the securities class action as we know it.
The stakes are high for both sides—and for their lawyers. Over the past 10 years, settlements between corporations and shareholders have amounted to $62 billion, with roughly $10.5 billion of that going to the shareholders’ lawyers, according to a report from NERA, an economic consulting group. One shareholder-side lawyer put it this way: “I seldom lose sleep at night, but one of the things that keeps me up is what the Supreme Court is going to do in Halliburton. It’s a game changer.”
It’s no surprise, then, that both the company and the shareholders have filed briefs arguing the economics, properly understood, are on their side. Both can point to support from law professors, economists, and even former commissioners of the Securities and Exchange Commission, the agency that regulates securities.
But there’s good reason to believe the company may have an edge. The Supreme Court under Chief Justice John Roberts, as a recent study showed, has been far friendlier to business than any court since World War II. That spirit has been especially fervent in class-action cases, where the court has tightened the requirements that plaintiffs must meet before they can be certified as a class. That doesn’t look good for securities class actions, because certification is the main battleground, with few shareholder suits ever going to trial. To be exact, there have been only 20 trials since 1995 in 4,226 class actions filed, according to NERA.
The last time the Supreme Court took a look at securities class actions, Basic emerged alive, but bruised. Though the question of whether the case should be overruled wasn’t squarely before them, four justices nonetheless openly questioned its validity. Justice Antonin Scalia criticized the court for having “invented” the “fraud on the market” presumption and faulted his colleagues for allowing the consequences of the rule to grow from “the arguably regrettable to the unquestionably disastrous.” Justices Anthony Kennedy, Clarence Thomas, and Samuel Alito also chimed in with their doubts.
The missing conservative voice in that case was Chief Justice Roberts, who stayed silent. Roberts, however, has joined his conservative colleagues in both of the two major class-action cases that split the justice 5–4 in recent years, with the moderate-liberals on the other side. And that doesn’t bode well for shareholders.