ATTORNEY: MURIELLE J. STEVEN WALSH
POMERANTZ MONITOR MAY/JUNE 2016
In a case called Halliburton II, the Supreme Court reaffirmed the validity of the presumption of reliance under the fraud on the market theory,” which is critical to securities plaintiffs’ ability to show class-wide reliance on a company’s misstatements. But it also held that a defendant may rebut the presumption of reliance by showing that the alleged misstatements had no “price impact,” i.e. did not affect the price of the stock in question. Under Fed. R. Evid. 301, “the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption,” but the rule does not specify how much evidence must be produced, and Halliburton II did not shed any light on this issue, either. This raises the question: how much evidence is enough to rebut the presumption? Is any showing enough?
In Best Buy, the Eighth Circuit recently handed down the first federal appellate decision to attempt to answer those questions. It is widely accepted that price impact may be proven by evidence showing that either the price increased after an alleged misstatement or that the price decreased after the truth was revealed. In Best Buy, plaintiffs met one but not both of these elements. Specifically, plaintiffs challenged three statements the company made on September 14, 2010. First, it issued an early morning earnings release saying that it was increasing its EPS guidance by ten cents. In response, the stock price opened for trading at a price higher than the previous day’s close. The next two statements were made later that morning in a conference call with analysts, when the CEO and CFO stated that the company’s earnings were “essentially in line with our original expectations for the year” and that it was “on track to deliver and exceed our annual EPS guidance.” The stock price did not increase after the conference call statements. The allegedly corrective disclosure occurred on December 14, 2010, when Best Buy announced a decline in its fiscal third quarter sales and a reduction in its 2011 fiscal year EPS guidance, causing a 15% stock price drop.
In an earlier decision, the district court held that the first misstatement, the early morning earnings release, was not actionable because it was a “forward-looking statement” with appropriate “cautionary language,” and was therefore covered by an Exchange Act “safe harbor” provision. The other two misstatements survived that motion and were the focus of the class certification motion, where defendants claimed that the misstatements did not move the market and that the presumption of class-wide reliance had therefore been rebutted.
In support of its class certification motion, plaintiffs submitted an expert report saying that Best Buy’s stock price had increased in reaction to all three September 14th statements, but did not parse how much of the increase was attributable to each individual statement. Defendants’ expert report said that there was no price impact from the conference call statements because the stock price increased only after the earlier morning press release, and not after the conference call occurred several hours later. In reply, plaintiff’s expert conceded that the conference call statements did not cause an immediate stock price increase, because it essentially just confirmed the representations in the previous early morning release. However, he said that the false statements that came afterwards maintained the artificially inflated price caused by that release.
The district court certified the class, recognizing that price impact (and therefore reliance) can be shown by a price decline in response to a corrective disclosure, and that defendants had failed to make any showing that Best Buy’s stock price did not in fact decrease after the negative news released on December 14th. The district court also found that the alleged misrepresentations could have prolonged the inflation of the price, or slowed the rate of fall, satisfying the “price maintenance” theory of “price impact.”
The Eighth Circuit reversed, pouncing on plaintiffs’ expert’s concession that the conference call statements did not move the stock price, and found that this was “strong evidence” sufficient to negate price impact and therefore class- wide reliance. The majority flatly rejected plaintiffs’ additional contention that the conference call statements caused a gradual increase in the stock price between September and December as “contrary to the efficient market hypothesis.” And the court largely ignored plaintiffs’ additional evidence of price impact, shown by the stock price decline after the corrective disclosure.
This decision is troublesome for several reasons. Courts have generally found a presumption of reliance exists when shareholders show stock prices fell in response to a corrective disclosure. The Eighth Circuit did not follow that principle, focusing instead only on the front end of the supposed fraud, when misstatements had no obvious impact on the share price. The Eighth Circuit also explicitly rejected the price maintenance theory, which has been heavily relied upon by plaintiffs seeking to prove price impact where misstatements did not move the price of a company’s stock.
A decidedly pro-defendant decision, Best Buy shows that defendants facing securities fraud class actions can significantly narrow or eliminate liability during the class certification phase based on price impact arguments. If followed by other circuits, the decision could have significant negative consequences for securities actions, because false positive statements by a company often have little or no immediate impact on the company’s stock price.