Summary: Halliburton, Basic and Fraud on the Market: The Need for a New Paradigm

If defrauded securities plaintiffs cannot bring a class-action lawsuit, there often will be no effective remedy since the amount at stake for individual plaintiffs is not sufficient to warrant the substantial costs of litigation. To surmount the problem of individualized reliance and establish commonality, federal courts for twenty-five years have been employing the Basic fraud-on-the-market theory which posits that, in an efficient market, investors rely on the integrity of the market price.

While class certification at one time was a matter of course, today it is turning into a mini-trial, and corporations can defeat certification by the testimony of their experts as to market imperfections which purportedly undercut the “efficiency” of the market for the particular stock. Courts treat “efficiency” as a binary concept, without recognizing that there are degrees of efficiency.

In Halliburton I, the Supreme Court held that a plaintiff need not establish loss causation at the certification stage and, in Amgen, the Court held that a plaintiff need not establish materiality at the certification stage. However, in Halliburton II, the Court determined that defendants can establish a lack of price impact to rebut the Basic presumption of reliance at the certification stage. Since plaintiff will then need to respond to the issue of whether there is price impact, there will need to be a mini-trial on price impact, which necessarily implicates evidentiary matters of materiality and loss causation.

Justice Thomas, in recognizing what he sees as internal inconsistencies in the Court’s approach in Amgen and Halliburton II, would overrule Basic and eliminate the fraud-on-the-market theory, thereby leaving plaintiffs to individualized proof of reliance without the class-action remedy.

This article asserts that market efficiency is a dubious concept, with Nobel prize winners in economics on both sides of the issue. Moreover, efficiency is not a binary concept, as there are degrees of market efficiency. The article also asserts that the efficient market theory, as enunciated by many courts, requiring that information must be impounded rapidly – in as little as one day or less – is fantasyland, since this approach gives no credence to the facts that there are degrees of market efficiency, degrees of materiality, varying modes of communicating information to the market, varying probity of the sources of the information, and different degrees of complexity of the information so transmitted.

Thus, there is a need for a new paradigm for establishing commonality of reliance. The model proposed by this article relies on reality, not fantasy. Congress, through the securities laws, has established an extensive system of mandatory disclosure, complemented with voluntary disclosures by the corporation. Pursuant to the antifraud provisions of the securities laws, Rule 10b-5 requires that such corporate disclosures not be misleading. Consequently, the article asserts that investors appropriately rely upon the truthfulness of the mix of information that management has transmitted to the market. Adopting this approach simplifies the certification process, eliminates the unreal focus on market efficiency, and leaves the major factual issues of price distortion, materiality and loss causation to trial, where they belong.