On Friday the Supreme Court agreed to hear a case that threatens to kill securities class actions. Petitioners in Halliburton Co. v. Erica P. John Fund, Inc. have asked the Court to reconsider a quarter-century-old precedent that has served as investors’ most effective tool in prosecuting securities fraud.
In Basic v. Levinson, 485 U.S. 224 (1988), the Court established the now-foundational rule that a class of investors who have lost money due to misrepresentations about a stock do not need to show, on an individual basis, that they relied on the misrepresentations. This is because of the then-ascendant and now-conventional understanding that capital markets efficiently incorporate all publicly available material information (including misrepresentations) into a stock’s price. (It’s now so widely regarded, in fact, that Eugene Fama, the father of the efficient markets hypothesis, was recently awarded the Nobel Prize in Economics for his work in this area.) Without this presumption, each and every investor would need to prove actual reliance on the company’s misrepresentations, which could make many securities class actions virtually impossible.
Four Justices may have already made up their minds. Last term in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 133 S. Ct. 1184 (2013), Justice Alito, in a three-sentence concurrence, wrote that the Basic presumption “may rest on a faulty economic premise” and its “reconsideration…may be appropriate.” And Justice Thomas, in a dissent that Justices Scalia and Kennedy joined, noted that the Court “has not been asked to revisit Basic’s fraud-on-the-market presumption,” but nonetheless commented that the “Basic decision itself is questionable.”
The case may turn on whether Chief Justice Roberts shares in his conservative colleagues’ apparent disapproval of the economic underpinnings of the Basic presumption, or whether principles of stare decisis and deference to Congress (which has considered but refused to eliminate the Basic presumption on several occasions) win the day. Investors’ ability to keep Wall Street honest may hang in the balance.
Photo Credit: Helico