ATTORNEY: Joshua B. Silverman
POMERANTZ MONITOR, MARCH/APRIL 2015
When the Supreme Court issued its landmark decision in Halliburton v. Erica P. John Fund last summer, it did not give either side a total victory. Critically for investors, the Supreme Court reaffirmed the fraud-on-the-market presumption, which is necessary for class certification in most securities fraud actions. The presumption allows classwide proof of reliance, an element of Exchange Act claims, by demonstrating that the stock traded in an efficient market. In efficient markets, publicly-available information is incorporated into the stock price and traded on by all investors, so plaintiffs need not show that each class member actually heard or read the misrepresentations giving rise to the lawsuit. By reaffirming these principles, the Court ensured the continued viability of securities fraud class actions. However, at the same time, the decision offered defendants the ability to rebut the fraud-on-the-market presumption at the class certification stage by demonstrating that the alleged fraud did not affect the stock price.
Halliburton did not specify precisely how lower courts should determine market efficiency or lack of price impact. As lower courts begin to grapple with these issues, the early results are promising for investors. Thus far, district courts (and in one case, an intermediate court of appeals) have applied rational tests for both market efficiency and price impact, consistent with the principles set forth in Halliburton.
The most important consequence of Halliburton may be to stabilize the law over what constitutes an efficient market. In 1988, when the Supreme Court first recognized the fraud-on-the-market presumption, it declined to adopt any particular test for market efficiency. In the years that followed, most courts used the so-called “Cammer test,” which assessed, among other factors, trading volume, analyst coverage, and price movement following release
of important company-specific news.
However, more recently defendants and their experts have urged courts to stack on top of the Cammer factors a litany of additional requirements lifted from the extreme end of academic debates about market efficiency. A significant minority of courts accepted these arguments, resulting in a patchwork of inconsistent standards. For example, some courts refused to certify cases involving stocks that moved in trends, theorizing that such trending—or serial correlation—was inconsistent with the belief of some academicians that efficient markets must be wholly unpredictable. Other courts looked to related options markets, holding that a lack of parity input and call options demonstrated constraints on arbitrage activity, and therefore showed market inefficiency. A few other courts suggested that impairments to arbitrage could also be found if the stock was difficult or expensive to sell short.
Halliburton should put an end to these fringe academic tests. In its opinion, the Supreme Court emphasized that for purposes of the fraud-on-the-market presumption, market efficiency refers only to “the fairly modest premise that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.” As one law professor explained, Halliburton demonstrates that “the efficiency question is not meant to be particularly rigorous.” District courts appear to get the message. Since Halliburton, no district court has cited serial correlation, lack of put-call parity, or short-lending costs as a basis for denying class certification in a securities fraud class action.
Recently, Pomerantz won an important motion addressing the continued relevance of fringe academic market efficiency tests. In the Groupon securities litigation, where Pomerantz serves as lead counsel, defendants had argued that plaintiffs’ class certification expert was unreliable because he failed to conduct put-call parity and short lending fee analyses. After an extensive evidentiary hearing, the court sided with Pomerantz, holding that such tests were unnecessary because they addressed an extreme variation of market efficiency that “was squarely rejected by the Halliburton court.”
District courts have also applied reasonable, consistent tests when assessing the price impact defense recognized in Halliburton. They have thus far uniformly rejected defendants’ attempts to show lack of price impact by demonstrating that some or all of the misrepresentations did not move the stock at the time they were made. Instead, recognizing that misrepresentations are used to artificially maintain as well as boost share prices, courts in the Regions Financial, IntraLinks, and Best Buy litigations have all held that price impact can be found where the share price declines when the truth is revealed, even if the stock did not move at the time the false statements were issued. Best Buy has been appealed, so the Eighth Circuit will soon weigh in on the issue.
Defendants have been equally unsuccessful in attempts to persuade courts to disregard price movement, where it does occur, by claiming it was caused by something other than the alleged fraud. For example, in Catalyst Pharmaceuticals, the court rejected expert testimony that the truth was already known to the market. Such evidence, the court held, did not disprove price impact but instead addressed whether the omitted information was material, an issue reserved for the trier of fact. By strictly enforcing the Supreme Court’s requirement that defendants prove the absence of price impact instead of just proffering different explanations for price moves, lower courts have ensured that the exception to the fraud-on-the-market presumption did not swallow the rule.
Courts will continue to construe Halliburton in the coming months, particularly in the Best Buy appeal and Halliburton itself (where the issue of price impact was remanded to the district court). If they apply the measured reasoning seen in early cases, it will bring much-needed consistency and predictability to the class certification process.