Supreme Court Upholds and Adjusts “Fraud on the Market” Theory
On June 23, 2014, the United States Supreme Court issued its ruling in the case of Halliburton v. Erica P. John Fund, Inc., closing the door on a question of extreme importance to securities fraud law.
At the heart of the Halliburton case was a legal theory known as “fraud on the market.” As a general rule, a plaintiff alleging fraud must somehow show that he or she relied on that fraud. As stated by the Supreme Court, “[i]nvestors can recover damages in a private securities fraud action only if they prove that they relied on the defendant’s misrepresentation in deciding to buy or sell a company’s stock.”
However, in 1988, the Court created something of an exception to this principle. In Basic v. Levinson, the Court held that investors could meet this requirement merely by showing that the market price of the stock was misleading. Essentially, the law assumes that people buy and sell stocks on reliance of price. Individual investors need not show evidence of some specific reliance on the manipulated security. In fact, under “fraud on the market,” investors do not even have to know about the alleged fraudulent statements made by the defendant(s).
This theory is particularly powerful in securities fraud class actions, where needing to show individual reliance by all the investors would be difficult, if not impossible. And, because “fraud on the market” opens the door to securities fraud litigation wider than it otherwise would be, it has long been a controversial doctrine.
Supreme Court Compromises on Securities Fraud
In Halliburton, the defendants wanted the Court to undo the “fraud on the market” theory entirely. The plaintiffs alleged that Halliburton made material misrepresentations between 1999 and 2001 that caused its stock to fraudulently inflate. When the misrepresentations were eventually corrected, the stock fell and the investors lost money. And they brought a lawsuit against Halliburton—showing reliance on its misstatements through “fraud on the market” theory.
Throughout the duration of this case, the company had numerous supporters in the business community, frustrated over their perception that the theory exposes them to lawsuits, as it exposed Halliburton. As USA Today reported, approximately 200 securities class actions are filed every year, and almost half of all companies on major stock exchanges have been sued in these lawsuits. But advocacy groups that represent investors say that “fraud on the market” is essential to protecting investors, especially those with less sophistication and expertise.
Compromising between the two positions, the Court declined to completely overrule the “fraud on the market” theory. Prior to last month’s decision, a company could eventually refute the presumption that investors relied on its fraud. But it could only do so during the main portion of the lawsuit. Now, it can refute “fraud on the market” at the outset of litigation, allowing securities class actions to be dismissed before they ever truly begin. This preserves the presumption of reliance for investors while allowing defendants to shake off lawsuits earlier and easier than before.
“The securities-fraud lawsuit isn’t dead,” the Wall Street Journal put it, “though [the Supreme Court] has left it wounded.”
Anyone that has been the victim of securities fraud should contact attorney Gregory Tendrich, P.A. immediately for an initial consultation, and to discuss the possible legal options available.