ATTORNEY: H. ADAM PRUSSIN
POMERANTZ MONITOR, JULY/AUGUST 2014
At the end of its term in June, the Supreme Court issued two significant rulings relating to securities laws issues.
The main event was the decision in Halliburton, which addressed the continued viability of the “fraud on the market” presumption in securities fraud cases. Without the benefit of that presumption, most securities cases could not be certified as class actions.
After the oral argument in Halliburton in March, we predicted that the Court would not throw out the fraud on the market presumption, but would probably allow defendants to try to rebut that presumption at the class certification stage, if they could show that the fraud did not actually distort the market price of the company’s stock. Our prediction was right. In June, the Court issued its ruling, and now “price impact” will be a potential issue on class certification motions. If the company made significant misrepresentations about its business or financial results, it will be strange indeed if that had no effect on the price of its stock.
Typically, when allegedly false statements are released by the company, they do not have any immediate effect on the stock price, because they do not deviate much from previously disclosed information. It is the bad information, which is covered up or falsified, that has the impact, and that impact can be measured when the truth finally does come out, in the so-called “corrective disclosure.” We believe that defendants, in order to rebut the fraud on the market presumption, are going to have a heavy burden to prove that the corrective disclosures had no significant effect on the market price of the company’s stock, and that any price movements that did occur at that time were caused completely by market-wide fluctuations in share prices, by general market conditions, or by some other “bad news” unrelated to the fraud.
The Court’s other decision came in Fifth Third Bancorp, which concerns the requirements for pleading a breach of fiduciary duty claim under ERISA against retirement plan trustees who continued to invest assets into stock of the employer company despite warning signs of impending catastrophe.
Under ERISA, trustees of retirement plans have an obligation to act with prudence in investing plan assets or in making investment recommendation to plan participants. In one sense, such claims are easier to win than run of the mill securities fraud claims because there is no scienter requirement.
But what level of knowledge actually is needed to trigger culpability for trustees? In the past, the courts gave the trustees of an employee stock ownership plan (“ESOP”) a “presumption of prudence” when they decided to invest, or continue to invest, in company stock. To overcome that presumption, they previously required that plaintiff plead, with particularity, that the trustees ignored facts showing that the company was on the brink of financial collapse. The only open question, we thought, was whether the presumption of prudence applied at the motion to dismiss stage, or only later, at trial.
We thought wrong. To everyone’s surprise, the Court has now thrown the presumption of prudence out the window not only at the pleading stage of the case, but at every stage of the case.
Instead, the Court set forth a new set of considerations. It held that ERISA claims cannot be based on the theory that the trustees ignored publicly available information about the company or its line of business. But where, as in most cases, the trustees (who are typically company executives) had adverse non-public information about the company, courts must balance the requirements of prudence with the laws against trading on inside information, and with the possible adverse consequences to the company if its ESOP suddenly stops buying company shares.
In other words, it is going to take years to figure this out.