In its 2014 decision in Halliburton v. Erica P. John Fund, the U.S. Supreme Court reaffirmed the presumption of reliance under the fraud on the market theory. The Court also held that at defendant may rebut the presumption of reliance by showing that the alleged misrepresentation at issue did not affect the defendant company’s share price. In the following guest post, David Topol and Jennifer Williams of the Wiley Rein law firm take a look at the way that the lower courts have applied the Court’s holding in the 2014 decision, and review some pending cases that could have important implications for this way that the decision is applied in the lower courts. I would like to thank David and Jen for their willingness to publish their article on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is David and Jen’s guest post.
One of the most litigated issues in securities cases in recent years concerns the rebuttable presumption of reliance available to plaintiffs at the class certification stage, first set forth in Basic Inc. v. Levinson, 485 U.S. 224 (1988), and reaffirmed in Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (Halliburton II). The Basic presumption assumes that the price of stock traded in an efficient market reflects all public, material information—including the defendants’ alleged misstatements. In Halliburton II, the Supreme Court explained, however, that a defendant may rebut the presumption by showing, among other things, that the particular misrepresentation at issue did not affect the price of the stock.
Since Halliburton II, courts have grappled with how exactly the rebuttable presumption operates, and several cases that are currently on appeal—before the Second and Fifth Circuits—highlight some of the key issues that have emerged. We are watching these cases closely because they are likely to provide additional guidance on the viability of the price maintenance theory, the necessary links between corrective disclosures and earlier misrepresentations, and the burdens of proof and persuasion in challenging the Basic presumption of reliance on an efficient market. In this article, we identify the key issues to be addressed in these upcoming appellate decisions.
Rebutting the Basic Presumption on the Front End: What About a Price Maintenance Theory?
One piece of the price impact puzzle is a front-end question: Did the defendants’ misrepresentation create artificial inflation in the price of the stock? In Halliburton II, the Supreme Court declined to upend its prior ruling from Basic that “[b]ecause most publicly available information is reflected in [the] market price, an investor’s reliance on any public material misrepresentations … may be presumed for purposes of a Rule 10b-5 action.”
Basic, 485 U.S. at 247; Halliburton II, 134 S. Ct. at 2417 (“We adhere to that decision and decline to modify the prerequisites for invoking the presumption of reliance.”). Significantly, however, the Supreme Court has explained that the “presumption of reliance [is] rebuttable rather than conclusive.” Halliburton II, 134 S. Ct. at 2408. Therefore, “[a]ny 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.” Basic, 485 U.S. at 248-49.
Thus, while the focus on securities cases is often on the corrective disclosures at the back end of the putative class period, defendants may also be able to challenge on the front end of the class period whether the stock price was inflated by misrepresentations. The recent Eighth Circuit decision in IBEW Local 98 Pension Fund v. Best Buy Co., 818 F.3d 775 (8th Cir. 2016), the first appellate case to examine the rebuttable presumption post-Halliburton II, illuminates this issue. In Best Buy, the plaintiffs alleged that statements in press releases and on a conference call at the start of the class period artificially inflated and maintained Best Buy’s publicly traded stock price until the misstatements were disclosed a few months later in conjunction with the disclosure of quarterly earnings. The Eighth Circuit, in a 2-1 decision, held that a class should not have been certified because the defendants, through expert testimony, had demonstrated that the plaintiffs could not link the alleged misstatements to any increase or inflation in the stock price.
The dissent argued that the majority improperly rejected the plaintiffs’ “price maintenance” theory, which stands for the proposition that the company had disclosed “confirmatory information …[w]hich fraudulently maintained its stock at a constant price and counteracted expected price declines.” Id. at 784. It also noted that the Seventh and Eleventh Circuits have recognized price maintenance theories to be cognizable under the Securities Exchange Act of 1934. See FindWhat Inv’r Grp. v. FindWhat.com, 658 F.3d 1282, 1314-15 (11th Cir. 2011) (“[C]onfirmatory information that wrongfully prolongs a period of inflation—even without increasing the level of inflation—may be actionable under the securities laws. That is, defendants can be liable for knowingly and intentionally causing a stock price to remain inflated by preventing preexisting inflation from dissipating from the stock price.” (emphasis in original)); Schleicher v. Wendt, 618 F.3d 679, 683 (7th Cir. 2010) (“when an unduly optimistic statement stops a price from declining (by adding some good news to the mix): once the truth comes out, the price drops to where it would have been had the statement not been made”).
The Second Circuit is now considering a case that raises the viability of the price maintenance theory. In In re Vivendi Universal, S.A. Securities Litigation, No. 15-180 (2d Cir.), the defendants argue that the plaintiffs’ expert failed to demonstrate loss causation because he failed to show that any particular alleged misstatement by the defendants was tied to the inflation of the price of Vivendi’s stock. The district court in Vivendi, like the dissent in Best Buy, embraced the plaintiffs’ “maintenance” theory of price impact: “The Court … holds that a statement can cause inflation by causing the stock price to be artificially maintained at a level that does not reflect its true value.” In re Vivendi Universal, S.A. Secs. Litig., 765 F. Supp. 2d 512, 562 (S.D.N.Y. 2011). Under the price maintenance theory, alleged misstatements can cause loss by maintaining existing price inflation, even if the misstatements did not cause the price inflation in the first place. That is, if the stock price remains steady when it otherwise would have declined, there is inflation present.
The defendants in Vivendi argue to the Second Circuit that this price maintenance theory contravenes the Supreme Court’s requirement that there must be a direct causal connection between the misrepresentation and the loss, citing Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336, 341-42 (2005). They also note that the Supreme Court in Halliburton II made clear that an alleged misstatement must “actually affect” stock price. 134 S. Ct. at 2405. In their opening Second Circuit brief, the defendants argue that “adopting the district court’s approach here would make a mockery of Dura’s loss-causation requirement. A plaintiff would need only identify an ordinary public statement, point to a subsequent price drop, and declare that the statement had ‘maintained’ inflation until the drop.” Final Principal Br. for Vivendi at 75, No. 15-180 (filed Aug. 19, 2015).
The Second Circuit will thus have to grapple with whether “price maintenance” is still a viable theory, especially in light of the Eighth Circuit’s seeming rejection of the argument in Best Buy. If it agrees with the plaintiffs and accepts “price maintenance” as a valid theory, the holding would afford plaintiffs in that circuit with more latitude in pleading price inflation.
Argument was held in Vivendi on March 3, 2016, and the court’s ruling is pending.
Rebutting the Basic Presumption on the Back End: Is It Price Impact or Loss Causation?
Price maintenance cases raise a fundamental question about the ways in which the rebuttable Basic presumption can be rebutted. When a plaintiff argues that the defendants’ misrepresentations did not increase the stock price but only maintained a now-artificially high price, there is no way to prove price impact or a lack thereof at the beginning of the class period. Rather, the only point at which the effect on the price is visible is at the back end, when the subsequent corrective disclosures cause the price to fall. The back end is also the point at which loss causation is demonstrated, however, and plaintiffs are not required to prove loss causation at the class certification stage. Thus, courts must consider whether evidence that goes to the issue of loss causation can also be used to show lack of price impact to rebut the presumption of reliance.
This issue is now before the Fifth Circuit, which once again considers the Halliburton securities litigation. Erica P. John Fund, Inc. v. Halliburton Co., No. 15-11096 (5th Cir.). On remand from Halliburton II, the district court addressed how defendants may actually go about rebutting the Basic presumption with evidence of no price impact. Erica P. John Fund, Inc. v. Halliburton Co., 309 F.R.D. 251 (N.D. Tex. 2015), leave to appeal granted, No. 15-90038, 2015 WL 10714013 (5th Cir. Nov. 4, 2015). Halliburton attempted to rebut the Basic presumption at the back end—by arguing that the particular disclosures at issue were not in fact corrective of misrepresentations at the start of the class period. In seeking to defeat class certification, the defendants argued that, while the company may have disclosed adverse news that resulted in stock drops, the plaintiffs could not connect those announcements to any misrepresentation that inflated the stock price in the first place. The district court held that these arguments were inappropriate at the class certification stage and, rather than showing evidence of lack of price impact, were a veiled attempted at a truth-on-the-market defense, which goes to materiality (not an issue for class certification).
In the appeal before the Fifth Circuit, the defendants argue that to assume that all disclosures are “corrective” deprives defendants of their right to rebut the Basic presumption with evidence that there is no link between the price decline and the earlier misrepresentation: “In effect, the district court irrebuttably presumed price impact, reneging on the Supreme Court’s promise that Basic created a rebuttable presumption.” Br. of Appellants at 21-22, No. 15-11096 (filed Feb. 8, 2016) (emphasis in original). According to the defendants, the fundamental premise of Basic is that the misrepresentation—not the disclosure—is reflected in the stock’s price, and so a price decline following a disclosure that is not actually corrective of the alleged misrepresentation would reveal nothing about that misrepresentation’s earlier effect on the price. In their petition for interlocutory review, the defendants also argued that simply assuming that the disclosure is corrective, and therefore reflects the price impact of the alleged misrepresentation, “opens the floodgates to class certification based on any price decline caused by negative news.” Defs.’ Pet. at 2, No. 15-11096 (filed Aug. 12, 2015).
Argument was held in Halliburton on August 31, 2016, and the court’s ruling is pending.
How Much Evidence Is Required to Rebut the Presumption of Reliance?
In two cases on appeal, In re Goldman Sachs Group, Inc. Securities Litigation, No. 16-250 (2d Cir.), and Strougo v. Barclays PLC, No. 16-1912 (2d Cir.), the Second Circuit will face the question of how much evidence defendants must put forward in order to rebut the presumption of reliance (and relatedly, how the burdens of proof and persuasion work in the context of the rebuttable Basic presumption). In Basic, the Supreme Court held: “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.” 485 U.S. at 248. Defendants have argued that “any showing” means just that—once they put forward evidence in any amount indicating that there is no price impact, the burden of persuasion remains on the plaintiff to show that the underpinnings of the Basic presumption still apply.
However, several district courts, including the Southern District of New York in Barclays and Goldman Sachs, have imposed more rigorous evidentiary burdens on defendants. In Barclays, the court acknowledged that “defendants’ arguments suggest that the post-disclosure price movement does not support a strong inference or provide compelling evidence of price impact,” but found that Barclays did not sufficiently demonstrate lack of price impact because the defendants did not “foreclose plaintiffs’ reliance on the price maintenance theory.” Strougo v. Barclays PLC, 312 F.R.D. 307, 325 (S.D.N.Y. 2016). The court held that “[t]o succeed, defendants must prove by a preponderance of the evidence that the price drop on the corrective disclosure date was not due to the alleged fraud.” Id. at 326 (emphasis added).
In Goldman Sachs, the court likewise observed that “Defendants’ attempt to demonstrate a lack of price impact merely marshals evidence which suggests a price decline for an alternate reason, but does not provide conclusive evidence that no link exists between the price decline and the misrepresentation.” In re Goldman Sachs Grp., Inc. Secs. Litig., No. 10-cv-3461, 2015 WL 5613150, at *7 (S.D.N.Y. Sept. 24, 2015) (emphasis added). The plaintiffs’ claims in Goldman Sachs are based on statements Goldman Sachs made about its business practices and how it handled conflicts of interest. The plaintiffs assert that these statements were revealed as untrue when information regarding the company’s conflicts in certain collateralized debt transactions reached the marketplace through SEC and DOJ announcements of investigations and enforcement actions. In considering the defendants’ price impact evidence to rebut the Basic presumption, the district court concluded that they had “failed to demonstrate a complete lack of price impact” and could not “show that the total decline in the stock price on the corrective disclosure dates is attributable simply to the market reaction to the announcement of enforcement actions and not to the revelation to the market that Goldman had made material misstatements about its conflicts of interest policies and business practices.” Id. at *6. The court also extended this rationale into its discussion of the plaintiffs’ damages methodology: “The possibility that Defendants could prove that some amount of the price decline is not attributable to Plaintiffs’ theory of liability does not preclude class certification. Comcast [Corp. v. Behrend, 133 S. Ct. 1426 (2013),] speaks to measuring damages stemming from the accepted theory of liability, and not the extent to which that liability can be proven.” Id. at *8. The court also observed that any failure in the damages model to account for other causes of the stock price drop would affect the entire class uniformly.
The Fifth Circuit will also confront the issue of the burden of persuasion in Halliburton. The defendants in Halliburton argue that the district court erred in stating that they bore the burden of persuasion on price impact. Rather, according to the defendants, plaintiffs bear the burden of persuasion on all class certification requirements, including predominance. The Basic presumption allows plaintiffs to satisfy the predominance requirement with respect to the element of reliance only by showing that the entire market relied on the defendants’ alleged misrepresentation because it was reflected in the stock price. In support, the defendants cite to Halliburton II: “The Basic presumption does not relieve plaintiffs of the burden of proving—before class certification—that [the predominance] requirement is met. Basic instead establishes that a plaintiff satisfies that burden by proving the prerequisites for invoking the presumption—namely, publicity, materiality, market efficiency, and market timing. The burden of proving those prerequisites still rests with plaintiffs and (with the exception of materiality) must be satisfied before class certification.” 134 S. Ct. at 2412.
Briefing is complete in both Goldman Sachs and Barclays. Oral argument has not yet scheduled in either case.