Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Congressional research reportNov 12, 2015

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Securities Fraud Class Action Certification:

Halliburton Co. v. Erica P. John Fund, Inc.

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November 12, 2015

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R43686

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Summary

On June 23, 2014, the U.S. Supreme Court decided a much-anticipated case in the area of federal

securities law: Halliburton Co. v. Erica P. John Fund, Inc. The history of the case spans more

than a decade, through three rounds in federal district court and two rounds in the court of appeals

and the Supreme Court. All of the cases so far have dealt with the issue of class certification for

securities fraud plaintiffs. The merits of the case have not yet been considered.

Class certification is important in the area of securities law because the merits of the case cannot

be considered until after the class of plaintiffs has been certified. A class of many plaintiffs suing

a company for fraud that has allegedly resulted in investment losses may be a formidable

plaintiff, and a significant amount of money may be involved. So much money may be involved

in these lawsuits that proponents and opponents have been very vocal. Proponents of such suits

believe that certification requirements should be kept to a minimum to protect investors and the

marketplace. Opponents of minimum certification requirements have argued that class action

suits are often frivolous and are brought to pressure companies to settle rather than incur large

litigation costs. They also argue that plaintiffs’ attorneys, who may receive large legal fees, are

the only ones who benefit from class actions.

The Halliburton cases illustrate the importance of class certification. There have been two rounds

of decisions in the Federal District Court for the Northern District of Texas, the U.S. Court of

Appeals for the Fifth Circuit, and the U.S. Supreme Court.

The Erica P. John Fund accused Halliburton of violating federal securities fraud statutes by

making material misstatements with respect to its liabilities, revenues, and cost savings. In the

first round of cases, the Federal District Court for the Northern District of Texas declined to

certify the class on the basis that the plaintiffs had not proved reliance on material misstatements

made by Halliburton. The U.S. Court of Appeals for the Fifth Circuit refused to certify the class

on the basis that the class had not shown loss causation at the class certification stage. The

Supreme Court reversed, holding that the proving of loss causation at the class certification stage

is not required. The Court refused to address any other questions which Halliburton might have,

such as the presumption of reliance under the “fraud-on-the-market theory” (a theory recognized

in the Supreme Court case Basic v. Levinson—that, in an efficient, well-developed securities

market, all material information is available to the public and this information is reflected in the

stock price, resulting in presumptive reliance by plaintiffs on the material misstatements).

In the second round, the district court certified the class, believing that the class certification

requirements of Rule 23 of the Federal Rules of Civil Procedure had been met. The Fifth Circuit

affirmed certification and concluded that Halliburton could not introduce evidence that its alleged

misrepresentations had no impact on the stock price. The Supreme Court held that price impact

evidence could be introduced at the class certification stage to rebut the presumption that the

shareholders had relied on the alleged misstatements. However, the Court refused to overrule

Basic v. Levinson’s presumption of reliance provided by the fraud-on-the-market theory.

Halliburton II was clearly not the end of the Erica P. John Fund v. Halliburton saga. A third

round in federal district court fleshed out some of the particulars of the Supreme Court’s

Halliburton II decision. It approved the use of event studies by both parties to attempt to

determine whether alleged misstatements caused a drop in share price. However, even this case is

not the end of the class certification challenges because the Fifth Circuit has granted Halliburton

leave to appeal. If the class is finally certified, the courts may then face the merits of the case.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Contents

Introduction ..................................................................................................................................... 1

Class Certification ........................................................................................................................... 2

Section 10(b) Private Right of Action ....................................................................................... 2

Class Action .............................................................................................................................. 3

Halliburton Cases ............................................................................................................................ 6

Federal District Court Decision—I ........................................................................................... 6

Fifth Circuit Decision—I .......................................................................................................... 6

Supreme Court Decision—I ...................................................................................................... 7

Federal District Court Decision—II .......................................................................................... 7

Fifth Circuit Decision—II ......................................................................................................... 8

Supreme Court Decision—II..................................................................................................... 9

Federal District Court Decision—III....................................................................................... 13

Conclusion ..................................................................................................................................... 14

Contacts

Author Contact Information .......................................................................................................... 15

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Introduction

On June 23, 2014, the Supreme Court decided a much-anticipated case in the area of federal

securities law. The case, Halliburton Co. v. Erica P. John Fund, Inc.,1 presented to the Court the

following two questions, both dealing with the certification of a class of securities fraud

plaintiffs:

1. Whether the Court should overrule or substantially modify the holding of Basic,

Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognized a

presumption of class-wide reliance derived from the fraud-on-the-market theory.

2. Whether, in a case where the plaintiff invoked the presumption of reliance to seek

class certification, the defendant might rebut the presumption and prevent class

certification by introducing evidence that the alleged misrepresentations did not

distort the market price of its stock.

Class certification is important in the securities area, and lawsuits are often brought to challenge

the class of plaintiffs attempting to be certified. Class certification is necessary before the case

can go forward to be decided on the merits. In addition, the amount of money involved in a class

action securities lawsuit may be significant. Individuals with small claims may not be willing to

pursue individual lawsuits, but individuals who create a class of plaintiffs may result in a

formidable plaintiff. A securities class action lawsuit often presents a stronger case and a case

better able than small, individual cases to obtain major attorney representation.

Proponents and opponents of securities class actions have actively argued their points.2

Proponents believe that certification requirements must be kept to a minimum because investors

should be able easily to pursue companies that have committed fraud. They argue that investor

protection benefits both individual investors and the securities markets in general by maintaining

the integrity of the marketplace. Opponents of minimum certification requirements argue that too

often investors bring lawsuits that are frivolous, such as when the share price drops for reasons

unrelated to fraud, and that companies may feel pressured to pay out large settlements rather than

risk even higher litigation costs. They also argue that the only people who benefit from securities

class actions are the attorneys who receive large legal fees.

The Halliburton cases illustrate the importance of class certification. The history of the cases

leading to the second Supreme Court Halliburton decision is lengthy, spanning more than a

decade. Thus far, the courts have dealt only with the issue of class certification; they have not yet

had the opportunity to address the merits of the plaintiffs’ arguments. There have been three

rounds of decisions in the Federal District Court for the Northern District of Texas and two

rounds in the U.S. Court of Appeals for the Fifth Circuit and the U.S. Supreme Court. After its

second decision, the Supreme Court remanded the case for further proceedings consistent with its

opinion. The Federal District Court for the Northern District of Texas has issued a third decision

on class certification after the Supreme Court’s remand.

This report will first discuss requirements for securities fraud class action certification and then

go through the rounds of the Halliburton federal decisions, ending with the third federal district

court decision.

134 S. Ct. 2398 (2014).

See, e.g., Thomas Kayes, Jury Certification of Federal Securities Fraud Class Actions, 107 NW. U. L. REV. 1851

(2013).

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Class Certification

Section 10(b) Private Right of Action

Two major federal securities laws, which form the basis for the regulation of securities in the

United States, were enacted in the wake of the stock market crash of 1929. These laws are the

Securities Act of 1933,3 which makes it illegal to offer or sell securities to the public unless they

have been registered with the Securities and Exchange Commission (SEC), and the Securities

Exchange Act of 1934,4 which requires ongoing company disclosures to the investing public

through annual, quarterly, and other filings with the SEC.

Section 10(b)5 of the 1934 act is the general anti-fraud provision and the provision most

frequently used by plaintiffs to allege securities fraud. Rule 10b-5,6 issued to carry out and give

effect to Sction 10(b), makes it illegal “for any person ... [t]o make any untrue statement of a

material fact or to omit to state a material fact.”

Neither Section 10(b) nor Rule 10b-5 provides for a private cause of action for plaintiffs to sue.

Over the years, courts have established that private plaintiffs, not just the SEC or the Department

of Justice (DOJ), have the right to bring a cause of action for violation of Section 10(b) and Rule

10b-5. Kardon v. National Gypsum Company,7 a 1947 case from the Federal District Court for the

Eastern District of Pennsylvania, may be the earliest case to find a private cause of action for

plaintiffs to sue for fraud under section 10(b).8 In the 1971 case, Superintendent of Insurance of

15 U.S.C. §§77a et seq.

15 U.S.C. §§78a et seq.

15 U.S.C. §78j(b). The provision states in pertinent part:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate

commerce or of the mails, or of any facility of any national securities exchange—

...

(b) To use or employ, in connection with the purchase or sale of any security registered

on a national securities exchange or any security not so registered ... any manipulative or

deceptive device or contrivance in contravention of such rules and regulations as the

Commission may prescribe as necessary or appropriate in the public interest or for the

protection of investors.

17 C.F.R. §240.10b-5. Rule 10b-5 states:

It shall be unlawful for any person, directly or indirectly, by the use of any means or

instrumentality of interstate commerce, or of the mails or of any facility of any national

securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact

necessary in order to make the statements made, in the light of the circumstances under which

they were made, not misleading, or

as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

73 F. Supp. 798 (E.D. Pa. 1947).

“On a motion to dismiss this Court held that, although not expressly provided for in the Statute, a remedy by civil

action to enforce such duties and liabilities was available to the plaintiffs. The duty created is that of disclosure and the

complaint and the evidence show that this suit was brought to enforce that liability. The liability to account for profits

is the liability attendant upon the breach of that duty.” Id. at 800.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

the State of New York v. Bankers Life and Casualty Company,9 the Supreme Court confirmed the

private right of action10 and since then has reaffirmed the right.11

To establish securities fraud under Section 10(b), a plaintiff must typically “prove (1) a material

misrepresentation or omission by the defendant; (2) scienter [knowledge]; (3) a connection

between the misrepresentation or omission and the purchase or sale of a security; (4) reliance

upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.”12

Class Action

Although an individual may bring a private right of action under Section 10(b), a class action,

made up in a sense of many individuals combining their private rights of action into a class of

plaintiffs, may be a stronger suit than several individual suits. In order for a securities fraud class

action suit to go forward to consideration of the merits, the class of plaintiffs must be certified.

There is no presumption of class certification. In order to achieve class certification in the

securities area, indeed in any area of law, certain requirements must be met.

Rule 23 of the Federal Rules of Civil Procedure (FRCP) sets out requirements that class actions

must meet. One of the most important requirements for securities fraud class action certification,

as it is for class certification in any area of law, is the predominance requirement of Rule

23(b)(3). For the predominance requirement to be met, questions of law or fact which are

common to class members [must] predominate over any questions which affect only individual

members.13

General Telephone Company of the Southwest v. Falcon,14 although not dealing with securities

fraud, is perhaps the case best known for setting out the predominance requirement. The Supreme

Court in General Telephone did not allow the certification of a class action brought by persons

claiming discrimination in promotion based on national origin and persons claiming

discrimination in hiring based on national origin. In its decision, the Court emphasized that, to be

successful in achieving class certification, the class must satisfy Rule 23(b)’s requirement that

404 U.S. 6 (1971).

“Section 10(b) must be read flexibly, not technically and restrictively. Since there was a ‘sale’ of a security and since

fraud was used ‘in connection with’ it, there is redress under §10(b).... ” Id. at 12.

See, e.g., Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008).

Id at 157.

FRCP 23(b)(3) states,

[T]he court [must] find that the questions of law or fact common to class members predominate over any

questions affecting only individual members, and that a class action is superior to other available

methods for fairly and efficiently adjudicating the controversy. The matters pertinent to these findings

include

(A) the class members’ interests in individually controlling the prosecution or defense of separate

actions;

(B) the extent and nature of any litigation concerning the controversy already begun by or against class

members;

and

(D) the likely difficulties in managing a class action.

457 U.S. 147 (1982).

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

“questions of law or fact common to class members [must] predominate over any questions

affecting only individual members.”15

Wal-Mart Stores, Inc. v. Dukes, also not a securities fraud class certification case but decided

thirty years after General Telephone, used much the same rationale that was used in General

Telephone for denying class certification. The Court stated,

Rule 23 does not set forth a mere pleading standard. A party seeking class certification

must affirmatively demonstrate his compliance with the Rule—that is, he must be

prepared to prove that there are in fact sufficiently numerous parties, questions of law or

fact, etc.

In the area of securities fraud class action certification, Basic v. Levinson16 discussed the

predominance requirement. The Supreme Court stated:

The District Court adopted a presumption of reliance by members of the plaintiff class

upon petitioners’ public statements that enabled the court to conclude that common

questions of law or fact predominated over particular questions pertaining to individual

plaintiffs.

What is especially important about Basic is that the Court stated that the requirement of reliance

may be met in some circumstances by allowing a presumption of reliance on material

misstatements, instead of requiring each plaintiff to prove direct reliance. “Misleading statements

will therefore defraud purchasers even if the purchasers do not directly rely on the

misstatements.”17 Basic introduced the fraud-on-the-market theory as the rationale behind the

presumption of reliance in certain circumstances. The fraud-on-the-market theory is based on the

belief that, in an efficient, well-developed securities market, all material information about a

company is available to the public and this information is reflected in the stock price. Courts will

allow plaintiffs under the fraud-on-the-market theory to show a rebuttable presumption of

reliance on material misstatements, instead of requiring all plaintiffs in all cases to prove direct

reliance which would, according to the Supreme Court in Basic, pose an undue burden on

plaintiffs.

The Court stated at 157-158:

[T]he allegation that such discrimination has occurred neither determines whether a class

action may be maintained in accordance with Rule 23 nor defines the class that may be certified.

Conceptually, there is a wide gap between (a) an individual’s claim that he has been denied a

promotion on discriminatory grounds, and his otherwise unsupported allegation that the company

has a policy of discrimination, and (b) the existence of a class of persons who have suffered the

same injury as that individual, such that the individual’s claim and the class claims will share

common questions of law or fact and that the individual’s claim will be typical of the class claims.

[footnote omitted] For respondent to bridge that gap, he must prove much more than the validity of

his own claim. Even though evidence that he was passed over for promotion when several less

deserving whites were advanced may support the conclusion that respondent was denied the

promotion because of his national origin, such evidence would not necessarily justify the additional

inferences (1) that this discriminatory treatment is typical of petitioner’s promotion practices, (2)

that petitioner’s promotion practices are motivated by a policy of ethnic discrimination that

pervades petitioner’s Irving division, or (3) that this policy of ethnic discrimination is reflected in

petitioner’s other employment practices, such as hiring, in the same way it is manifested in the

promotion practices. These additional inferences demonstrate the tenuous character of any

presumption that the class claims are “fairly encompassed” within respondent’s claim.

485 U.S. 224 (1988).

Id. at 242.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Cases, notably the Halliburton cases, have set out additional parameters for securities fraud class

certification. Discussed later in this report, they include proof of loss causation and proof of

materiality only at the merits stage, not at the class certification stage, and the right of a defendant

to rebut the Basic presumption of reliance at the class certification stage.

It should be noted that, in response to the belief that too many frivolous class action securities

cases were being brought, particularly in the 1980s, Congress in the 1990s enacted two statutes.

The stated reasons for bringing all of these lawsuits were varied—fraud, mismanagement,

nondisclosure of material information—but practically all of the lawsuits involved the loss of

money by shareholders of the corporation. Some of the lawsuits no doubt had merit, but others

were deemed frivolous and were brought as a matter of course when, for example, the share value

of the stock of a corporation went down for reasons having nothing to do with the culpability of

corporate managers.

In 1995, Congress enacted the Private Securities Litigation Reform Act (PSLRA).18 The PSLRA

limits shareholder lawsuits in federal courts by such actions as the following: (1) having the court

appoint a lead plaintiff determined to be the most capable of adequately representing the interests

of class members; (2) prohibiting a person from being a lead plaintiff in any more than five class

actions in a three-year period; (3) guaranteeing that plaintiffs receive full disclosure of settlement

terms; (4) eliminating coverage of securities fraud by the Racketeer Influenced and Corrupt

Organizations Act; (5) providing a safe harbor for forward-looking statements; (6) providing for

proportionate liability; and (7) providing for auditor disclosure of corporate fraud.

The Securities Litigation Uniform Standards Act of 1998 (SLUSA)19 was enacted in response to

the perceived failure of the PSLRA to curb alleged abuses of securities fraud class action

litigation. PSLRA had set out a framework for bringing securities fraud class action cases in

federal courts. However, in many instances, plaintiffs circumvented PSLRA by bringing cases in

state courts on the basis of common law fraud or other non-federal claims.

SLUSA attempted to make certain that plaintiffs not be able to avoid the PSLRA requirements by

requiring a securities fraud case to be brought only in a federal court and only under a uniform

standard if certain criteria are satisfied, among them the following: (1) The lawsuit is a covered

class action; (2) The claim concerns a covered security; (3) The plaintiff alleges a

misrepresentation or omission of a material fact; and (4) The misrepresentation or omission is

made in connection with the purchase or sale of a covered security.

There has been considerable controversy concerning securities fraud class action certification.

Passions run high among both supporters and opponents of class action certification over what

standards should be met. Some believe that many securities fraud class actions are frivolous and

that the only winners are the attorneys who bring the suits and who reap large legal fees. These

opponents of class actions argue that the lawsuits are often brought to pressure companies into

large settlements because companies are afraid of the expenses associated with defending class

action suits. People who support easing requirements for securities fraud class action suits believe

that the suits are necessary to hold companies accountable and that, otherwise, companies will be

more likely to engage in fraudulent behavior with the belief that plaintiffs will be reluctant to risk

the costs associated with certification and suing on the merits. Lawsuits have been brought,

settlements have been reached, and federal statutes have been enacted, but the issue of securities

P.L. 104-67, codified in a number of provisions of 15 U.S.C. §§78a et seq.

P.L. 105-353, codified in a number of provisions of 15 U.S.C. §§78a et seq.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

fraud class action certification is far from being settled. The Halliburton cases will likely make

this clear.

Halliburton Cases

Federal District Court Decision—I

The Erica P. John Fund (Fund), which exists to support the Archdiocese of Milwaukee, originally

brought suit against Halliburton in 2002, with accusations that Halliburton had committed

securities fraud in violation of Section 10(b) of the Securities Exchange Act of 1934 and

Securities and Exchange Commission (SEC) Rule 10b-5 by understating its asbestos liabilities,

overstating its revenues by including billings whose collections were unlikely, and exaggerating

cost savings and efficiencies derived from a 1998 merger. Plaintiffs alleged that the

misrepresentations inflated the price of Halliburton stock and that, when the truth was later

revealed, the stock price dropped and they lost money.

In September 2007, the Fund moved to certify a class of persons who owned Halliburton stock

during the appropriate time period. In an unpublished opinion, the Federal District Court for the

Northern District of Texas declined to certify the class to bring the lawsuit on the basis that the

plaintiffs had not proved reliance (one of the necessary elements for proving a Section 10(b)

claim, as mentioned above) on material misstatements made by Halliburton.

Fifth Circuit Decision—I

The U.S. Court of Appeals for the Fifth Circuit (Fifth Circuit) affirmed.20 In its decision, the Fifth

Circuit began its analysis by stating that the case involved a private fraud-on-the-market

allegation. The fraud-on-the-market theory, as discussed earlier, was set out in the Supreme Court

case Basic, Inc. v. Levinson. It is based on the assumption that, in an efficient, well-developed

securities market, all material information about a company is available to the public and that this

information is reflected in the stock price. In order to use the fraud-on-the-market presumption of

reliance, according to the Fifth Circuit, a plaintiff must show that an alleged misstatement

“actually moved the market.”21 The court stated that it was necessary for the plaintiff to show loss

causation and to show it “at the class certification stage by a preponderance of all admissible

evidence.”22 In addition, the court required that the plaintiff show that the decline in the stock’s

price actually resulted from the disclosure of the truth concerning the earlier misstatements rather

than from the release of unrelated negative information. In response to the plaintiff’s claim that it

had identified specific misrepresentations by Halliburton and that it had linked those

misrepresentations, at least partially, to corrective disclosures, the Fifth Circuit stated that it was

unconvinced. After going through the plaintiff’s claims of Halliburton’s misrepresentations and

finding fault with all of the plaintiff’s arguments about their impact on the decline of the stock

price once Halliburton had issued corrective statements, the court concluded that the plaintiff had

failed to meet the Fifth Circuit’s requirements for proving loss causation at the class certification

stage.

The Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330 (5 th Cir. 2010).

Oscar Private Equity Investments v. Allegiance Telecom, Inc. 487 F.3d 261, 269 (5 th Cir. 2007).

Id.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Supreme Court Decision—I

The Supreme Court in 2011 reversed the Fifth Circuit’s decision. In Erica P. John Fund, Inc. v.

Halliburton Co.,23 the Court began its opinion by stating what is required to prevail on the merits

in a private securities fraud action:

To prevail on the merits in a private securities fraud action, investors must demonstrate

that the defendant’s deceptive conduct caused their claimed economic loss. This

requirement is commonly referred to as “loss causation.”

In contrast, the question presented to the Court in this case and in the lower court cases was

whether securities fraud plaintiffs had to prove loss causation for class certification. The merits of

the plaintiffs’ case were not at issue. What was at sole issue, according to the Court, was whether

the plaintiffs satisfied the class action certification predominance requirement of FRCP 23(b)(3).

In determining whether the FRCP 23(b)(3) requirement of common questions of law or fact has

been met, the element of reliance by a plaintiff must often be examined. The Court discussed

how, in Basic v. Levinson, it had recognized that requiring a plaintiff to demonstrate that he was

actually aware of a company’s statement and engaged in purchasing stock based upon that

statement would be too limiting and “would place an unnecessarily unrealistic evidentiary burden

on the Rule 10b-5 plaintiff who has traded on an impersonal market.”24 Thus, in Basic, as

discussed earlier, the Court allowed the plaintiffs to invoke a rebuttable presumption of reliance

based on the fraud-on-the-market theory.25

The Supreme Court concluded by stating that the Court of Appeals erred when it required the

Erica P. John Fund to prove loss causation at the certification stage. The Court refused to address

any other questions which Halliburton might have, such as the presumption of reliance under the

fraud-on-the-market theory or how and when the presumption might be rebutted. The Supreme

Court vacated the judgment of the Fifth Circuit and remanded it for further proceedings consistent

with the opinion.

Federal District Court Decision—II

On remand, Halliburton argued that the class should still not be certified because it had

discovered evidence that the alleged fraud did not affect the market price of the stock. Halliburton

contended that, by demonstrating the absence of any “price impact,”26 it had complied with the

guidance set out in Basic that a defendant must have the opportunity to rebut the presumption of

No. 09-1403, 563 U.S. ___ (2011).

Basic v. Levinson, 485 U.S. 224, 242 (1988).

At 245-248, the Court in Basic stated:

The presumption of reliance employed in this case is consistent with, and, by facilitating Rule 10b-5

litigation, supports the congressional policy embodied in the 1934 Act. In drafting that Act, Congress expressly

relied on the premise that securities markets are affected by information, and enacted legislation to facilitate an

investor’s reliance on the integrity of those markets....

The presumption is also supported by common sense and probability. Recent empirical studies have tended to

confirm Congress’ premise that the market price of shares traded on well-developed markets reflects all publicly

available information, and, hence, any material misrepresentations. [footnote omitted] It has been noted that “it is

hard to imagine that there ever is a buyer or seller who does not rely on market integrity. Who would knowingly

roll the dice in a crooked crap game.... ” [citation omitted]

Any showing that severs 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.

“Price impact” is the effect of a misrepresentation on a stock price.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

reliance allowed by the fraud-on-the-market theory. Without the benefit of the Basic presumption,

according to Halliburton, investors would have to prove reliance on an individual basis; thus,

individual issues would predominate over common ones, precluding class certification.

According to statements in the decision later issued by the Fifth Circuit, the district court on

remand declined to consider the evidence which Halliburton claimed to have discovered. The

district court found that the price impact evidence did not have a bearing on the important issue of

whether common issues predominated so as to satisfy FRCP 23(b)(3). Instead, believing that

common issues predominated and that the other requirements of Rule 23 were met, the district

court certified the class.

Fifth Circuit Decision—II

Halliburton appealed to the Fifth Circuit, and in April 2013 the Fifth Circuit in Erica P. John

Fund, Inc. v. Halliburton Co.27 affirmed the district court’s decision to certify the class. Only two

months before the Fifth Circuit’s decision, the Supreme Court decided another case, Amgen, Inc.

v. Connecticut Retirement Plans (Amgen),28 which the Fifth Circuit referenced in the Halliburton

decision.

In Amgen, the Supreme Court held that a plaintiff in a securities fraud Section 10(b) case is not

required to prove prior to certification of a class action that a defendant made a material

misstatement. The case resolved a significant split among the federal circuit courts on the issue of

whether proof of materiality (reliance upon a material29 misstatement or omission) is required for

class certification.30

718 F.3d 423 (5th Cir. 2013).

No. 11-1085, 568 U.S. ___ (2013).

Courts have sketched out a definition of material information as information that a reasonable investor would need to

make an informed investment decision. See, e.g., TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976) and Mills

v. Electric Auto-Lite Co., 396 U.S. 375 (1970).

Over the years, cases, notably Matrixx Initiatives, Inc. v. Siracusano (No. 09-1156, 563 U.S. ___ (2011), have

established the requirement that a plaintiff must prove in a securities fraud claim that there was reliance upon a material

misstatement or omission by the defendant. As stated above, in Basic the Supreme Court endorsed a fraud-on-themarket theory allowing a plaintiff in an efficient market to invoke a rebuttable presumption of reliance upon a public,

material misrepresentation. Connecticut Retirement in Amgen invoked the fraud-on-the-market theory in seeking class

action certification under FRCP 23(b)(3) against Amgen for alleged material misstatements. Amgen defended that

Connecticut Retirement had not proved the misstatements to be material and could not therefore be certified as an

appropriate class.

In holding that proof of materiality is not required for certification of a securities fraud class action, the Court reasoned

that the plaintiffs’ assertion was sufficient for the purpose of class certification because at that particular stage of the

proceedings the issue was not whether there had actually been a material misstatement or omission by the defendant.

The Court believed that that determination could occur at a later time when the certified class presented its evidence of

material misstatements to a court. The Supreme Court was not persuaded by Amgen’s rebuttal argument that policy

considerations militated in favor of proof of materiality because class certification might place pressure on a defendant

to settle rather than to risk significant costs in defending its actions. The Court believed that the pivotal inquiry in the

case was whether proof of materiality was necessary to satisfy the requirement of Rule 23(b)(3) that questions of law or

fact common to the class would predominate over any individual questions of law or fact. The Court stated,

The District Court did not err, we agree with the Court of Appeals, by disregarding Amgen’s

rebuttal evidence in deciding whether Connecticut Retirement’s proposed class satisfied Rule

23(b)(3)’s predominance requirement. The Court of Appeals concluded, and Amgen does not

contest, that Amgen’s rebuttal evidence aimed to prove that the misrepresentations and omissions

alleged in Connecticut Retirement’s complaint were immaterial.... As explained above, however,

the potential immateriality of Amgen’s alleged misrepresentations and omissions is no barrier to

finding that common questions predominate.... If the alleged misrepresentations and omissions are

(continued...)

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

After discussing the Amgen case, the Fifth Circuit examined Halliburton’s claim that the question

before the court was whether price impact was an issue which a defendant might use at class

certification in order to rebut the fraud-on-the-market presumption that the stock price was

affected by a misstatement that was later corrected. Halliburton argued that, in spite of the proof

provided to support invoking the fraud-on-the-market presumption of reliance, its own evidence

showed that the misrepresentation did not actually have an impact on the price which the

purchaser paid for the stock. The Fifth Circuit agreed with Halliburton that, if there was no price

impact, then that evidence could be used at the trial on the merits to refute the fraud-on-themarket reliance of presumption. Although the Fifth Circuit believed that the Supreme Court in

Amgen did not discuss whether this evidence could be considered at class certification, the Fifth

Circuit stated that the Supreme Court did provide a framework for resolving the question. That

framework, according to the Fifth Circuit, was based simply on whether resolution of the matter

was necessary for determining whether questions of law or fact common to the class would

predominate over questions affecting only individual members.

The Fifth Circuit then examined whether price impact evidence was common to the class and

whether there was any risk that a later failure to prove the common question of price impact

would result in the predominance of individual questions. The Fifth Circuit disagreed with

Halliburton’s argument that in this particular case the plaintiff class could not show price impact

and should lose the class-wide presumption of reliance, leaving individuals, according to

Halliburton, with possibly still viable fraud claims which they could pursue on an individual

basis. According to the Fifth Circuit, if Halliburton could successfully rebut the fraud-on-themarket presumption by showing no price impact, not only could there be no class certification but

the individual plaintiffs would also have no claims because they could not establish loss

causation, an essential element of a Section 10(b) fraud action. Thus, the Fifth Circuit affirmed

the district court decision, concluding that price impact fraud-on-the-market rebuttal evidence

could not be addressed at class certification. The Court stated,

Proof of price impact is based upon common evidence, and later proof of no price impact

will not result in the possibility of individual claims continuing. Accordingly,

Halliburton’s price impact evidence does not bear on the question of common question

predominance, and is thus appropriately considered only on the merits after the class has

been certified.31

Supreme Court Decision—II

Halliburton filed a writ of certiorari with the Supreme Court. The Court granted the petition, and

on June 23, 2014, the Court issued its decision, Halliburton Co. v. Erica P. John Fund, Inc. The

Court in its decision could have invalidated the fraud-on-the-market theory and overruled Basic,

or it could have prevented the defendants from being allowed to rebut evidence at the class

certification stage. It did neither; instead, it chose a middle ground, giving, in a sense, something

(...continued)

ultimately found immaterial, the fraud-on-the-market presumption of classwide reliance will

collapse. But again, as earlier explained ... , individual reliance questions will not overwhelm

questions common to the class, for the class members’ claims will have failed on their merits, thus

bringing the litigation to a close. Therefore, just as a plaintiff class’s inability to prove materiality

creates no risk that individual questions will predominate, so even a definitive rebuttal on the issue

of materiality would not undermine the predominance of questions common to the class. No. 111085, 568 U.S. ___, slip op. at 11.

718 F.3d 423, 435 (5th Cir. 2013).

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

to everyone but everything to no one. The Court decided, with respect to the first question stated

at the beginning of this report, not to overrule the presumption of reliance provided by the fraudon-the-market theory but that, with respect to the second question, defendants in a class action

may attempt to rebut the presumption of reliance at the class certification stage by introducing

evidence that the alleged misrepresentations did not distort the market price of its stock. Chief

Justice Roberts wrote the opinion and was joined by Justices Kennedy, Ginsburg, Breyer,

Sotomayor, and Kagan.

The Court first examined Halliburton’s argument to overrule the presumption of reliance in Basic,

thereby requiring every securities fraud plaintiff to prove actual reliance on the defendant’s

misrepresentation when deciding whether to buy or sell a company’s stock. The Court stated that

before overturning a long-settled precedent, it must, according to Dickerson v. United States,32

find “special justification,” not simply an argument that the precedent was “wrongly decided.”

The Court then recapped its rationale and holding in Basic v. Levinson. According to the fraudon-the-market theory developed in Basic, when an investor buys or sells stock at the market price,

his reliance on any public material misrepresentations may be presumed for a securities fraud

action. Based on this theory, the Halliburton Court emphasized, a securities fraud plaintiff must

show: 1. that the alleged misrepresentations were publicly known; 2. that they were material; 3.

that the stock traded in an efficient market; and 4. that the plaintiff traded the stock between the

time that the misrepresentations were made and when the truth was disclosed. Basic also made

clear that the presumption of reliance was rebuttable and not conclusive.

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. 33

Halliburton argued before the Supreme Court that securities fraud plaintiffs should always be

required to prove direct reliance and that the Supreme Court in Basic mistakenly allowed

plaintiffs to invoke a presumption of reliance. Halliburton claimed that the Basic presumption is

opposed to Congress’s intent in the Securities Exchange Act and that subsequent developments in

economic theory have undermined the Basic presumption. The Court concluded that neither of

these arguments constituted “special justification” for overruling Basic.

With respect to the argument that the Basic presumption contravened congressional intent in the

Securities Exchange Act, Halliburton stated that the private right of action under Section 10(b) is

a judicial construct that Congress did not enact and that the Court must identify some provision

from the Securities Exchange Act which does provide for a private right of action and interpret

any private right of action allowed under Section 10(b) in an analogous way. The provision which

Halliburton identified as most similar was Section 18(a),34 which creates a private right of action

for investors to allow recovery of damages based on misrepresentations in regulatory filings. That

provision requires an investor to prove that he bought or sold stock by relying upon a defendant’s

misrepresentation. The defendant disputed Halliburton by arguing that Congress has actually

affirmed Basic’s construction of Section 10(b) and that, further, Section 9 of the Securities

Exchange Act,35 which does not require actual reliance, is the closest analogue to Section 10(b).

The Supreme Court stated that Halliburton’s argument had been made in Basic and that it was

unconvincing then and unconvincing now.

530 U.S. 428 (2000).

485 U.S. 224, 248 (1988).

15 U.S.C. §78r(a).

15 U.S.C. §78i.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Halliburton then argued that the economic premises upon which Basic rested—the “robust view

of market efficiency” and investor reliance upon the integrity of the marketplace—are no longer

tenable. The Court refuted these arguments by stating that the Basic decision did not rest upon a

binary view of market efficiency but, rather, that it recognized that market efficiency is a matter

of degree. Further, Basic did not state that all investors rely upon the integrity of the marketplace

but that, instead, it is reasonable to presume that most investors rely upon the security’s price as

an assessment of its value in light of all publicly available information.

The Court next discussed that the principle of stare decisis (the doctrine of precedent) has

“special force” in the interpretation of statutes because of the fact that at any time Congress may

undo a court decision by enacting legislation.36 The Court mentioned other decisions, such as

Central Bank of Denver, N.A. v. First Interstate Bank of Denver37 and Stoneridge Investment

Partners, LLC v. Scientific Atlanta, Inc.,38 which have dealt with the Section 10(b) cause of

action, and found no inconsistency between them and the presumption of reliance allowed in

Basic.

The Court also discussed recent decisions such as Wal-Mart Stores, Inc. v. Dukes, which have

governed class action certification and the requirement that plaintiffs prove that their class

satisfies FRCP 23. It found that the Basic presumption of reliance did not relieve plaintiffs from

meeting the class certification requirements and that Halliburton’s claims that the Basic

presumption leads to unnecessary lawsuits should be addressed by Congress. In fact, according to

the Court, Congress did address some of the securities class action frivolous lawsuit concerns in

the Private Securities Litigation Reform Act and the Securities Litigation Uniform Standards Act,

discussed earlier in the report.

Halliburton proposed two alternatives to overruling Basic. The first alternative would require that

a plaintiff actually prove that a defendant’s misrepresentation affected the stock price (“price

impact”) before invoking the Basic presumption of reliance. The Court found this alternative

unacceptable for the same reasons that it refused in general to overrule Basic’s presumption of

reliance. As stated before, according to Basic, if a plaintiff can show that the defendant’s

misrepresentation was publicly known and material, that the stock traded in an efficient market,

and that the plaintiff traded the stock between the time when the misrepresentations were made

and the truth was revealed, he is allowed to invoke the Basic presumption of reliance. If a

plaintiff were required to prove, as Halliburton urged, price impact directly, he would be

foreclosed from showing that the stock was trading in an efficient market, thus overruling an

important element set out by Basic in its presumption of reliance doctrine.

The Court stated 134 S. Ct. 2411:

The principle of stare decisis has “special force” in respect to statutory interpretation because

Congress remains free to alter what we have done. [citations and quotations omitted] So too with

Basic’s presumption of reliance. Although the presumption is a judicially created doctrine,

designed to implement a judicially created cause of action, we have described the presumption as

“a substantive doctrine of federal securities-fraud law.” Amgen, supra, at ___ (slip op., at 5). That is

because it provides a way of satisfying the reliance element of the Rule 10b-5 cause of action.

[citation omitted] As with any other element of that cause of action, Congress may overturn or

modify any aspect of our interpretations of the reliance requirement, including the Basic

presumption itself. Given that possibility, we see no reason to exempt the Basic presumption from

ordinary principles of stare decisis.

511 U.S. 164 (1994).

552 U.S. 148 (2008).

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Halliburton’s second proposed alternative would allow a defendant to rebut the Basic

presumption of reliance by showing a lack of price impact and to show the lack of price impact

not only at the merits stage but, more importantly according to Halliburton, before the class is

certified. If a defendant were able to show a lack of price impact at the time that the class is

arguing for certification, Halliburton claimed, it could prevent the class from being certified.

The Supreme Court was receptive to Halliburton’s second proposed alternative to overruling

Basic. According to the Court, it makes no sense to forbid defendants from using the same

evidence about price impact before class certification that they would be able to use at the merits

stage to rebut the presumption of reliance. The Court stated that this prohibition would actually be

inconsistent with its decision in Basic.39

The Court disagreed with the Fifth Circuit’s interpretation of Amgen as not allowing the

consideration of price impact fraud-on-the-market rebuttal evidence at class certification. Amgen,

according to the Supreme Court in Halliburton II, held that, although materiality is required for

invoking the Basic presumption of reliance, the question of whether material misrepresentation

actually occurred should be left to the merits stage of the case. However, the Amgen decision did

not forbid, for purposes of class certification, the presenting of evidence that an alleged

misrepresentation did not affect the price of the stock. In fact, according to the Court in

Halliburton II, in order to maintain the consistency of the presumption of reliance as set out in

Basic with the class certification requirements of FRCP 23, defendants must have the opportunity

before the class is certified to provide evidence that an alleged misrepresentation did not affect

the price of the stock.40

The Court vacated the Fifth Circuit’s judgment and remanded the case for further proceedings

consistent with the opinion.

Justice Ginsburg, joined by Justices Breyer and Sotomayor, wrote a brief concurring opinion,

stating that “it is incumbent upon the defendant to show the absence of price impact,” thereby

imposing “no heavy toll on securities fraud plaintiffs with tenable claims.”41

The Court stated at 134 S. Ct. 2414-15:

There is no dispute that defendants may introduce such evidence at the merits stage to rebut the

Basic presumption. Basic itself “made clear that the presumption was just that, and could be

rebutted by appropriate evidence,” including evidence that the asserted misrepresentation (or its

correction) did not affect the market price of the defendant’s stock. [citation omitted]

Nor is there any dispute that defendants may introduce price impact evidence at the class

certification stage, so long as it is for the purpose of countering a plaintiff’s showing of market

efficiency, rather than directly rebutting the presumption. As EPJ Fund acknowledges, “[o]f course

... defendants can introduce evidence at class certification of lack of price impact as some evidence

that the market is not efficient.” [citations omitted]

After all, plaintiffs themselves can and do introduce evidence of the existence of price impact

in connection with “event studies”—regression analyses that seek to show that the market price of

the defendant’s stock tends to respond to pertinent publicly reported events. [citation omitted]

The Court stated 134 S. Ct. 2416:

Price impact is different [from materiality]. The fact that a misrepresentation “was reflected in

the market price at the time of [the] transaction”—that it had price impact—is “Basic’s

fundamental premise.” [citation omitted] It thus has everything to do with the issue of

predominance at the class certification stage. That is why, if reliance is to be shown through the

Basic presumption, the publicity and market efficiency prerequisites must be proved before class

certification. Without proof of those prerequisites, the fraud-on-the-market theory underlying the

presumption completely collapses, rendering class certification inappropriate.

Id., Ginsburg, R., concurring, at 134 S. Ct. 2417.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Justice Thomas, joined by Justices Scalia and Alito, filed an opinion concurring in the judgment

but calling for overruling Basic.42

Federal District Court Decision—III

On remand, the U.S. District Court for the Northern District of Texas fleshed out the Supreme

Court’s ruling that the defendant Halliburton must have an opportunity before class certification

to show that an alleged misrepresentation did not affect the price of its stock.43 In this case, the

Erica P. John Fund once again moved for class certification, this time basing its argument on

numerous alleged corrective disclosures in which Halliburton misstatements caused a drop in its

share price. On July 25, 2015, the district court denied the plaintiffs’ request for certification on

all except one of the alleged corrective disclosures.

The district court first examined whether plaintiffs or defendants had to carry the burden of

persuasion to show whether the alleged misstatements had an impact on the company’s stock

share price. The district court found nothing explicit in the Supreme Court’s Halliburton II

decision to answer the question. However, based on its analysis of the Supreme Court’s

Halliburton II decision, which, according to the district court, clarified that securities fraud

defendants may rebut the Basic presumption44 at the class certification stage, the district court

found that the burdens of production and persuasion to show lack of price impact were on

Halliburton, the defendants.

The district court next determined that so-called event studies45 submitted by both parties were

acceptable in judging whether alleged misrepresentations could have had an impact on share

price. After reducing numerous alleged corrective disclosures made by the EPJ Fund to six

relevant events, the district court in a lengthy and technical manner seemed to determine that, in

all but one of the six alleged corrective disclosures, Halliburton’s share price decline could be

attributed to factors other than alleged misstatements or that the event causing the decline was

already public information.

The one event for which the district court granted plaintiffs’ request for certification occurred on

December 7, 2001, when Halliburton announced that a Baltimore jury had found one of its

subsidiaries liable for $30 million in an asbestos lawsuit. This announcement caused

Halliburton’s shares to drop by 40%. The district court found that this price impact “likely

reflected the market’s view of Halliburton’s prior representations regarding its asbestos liability

and increased uncertainty in the asbestos environment,”46 arguably casting doubt on some of

At 134 S. Ct. 2427 in his concurring opinion, Justice Thomas stated,

Basic took an implied cause of action and grafted on a policy-driven presumption of reliance based

on nascent economic theory and personal intuitions about investment behavior. The result was an

unrecognizably broad cause of action ready made for class certification. Time and experience have

pointed up the error of that decision, making it all too clear that the Court’s attempt to revise

securities law to fit the alleged “new realities of financial markets” should have been left to

Congress. [citation omitted]

Erica P. John Fund, Inc. v. Halliburton Co., No. 3:02-CV-1152-M, 2015 U.S. Dist. LEXIS 97464 (N.D. Tex. July 25,

2015).

I.e., as discussed earlier, that in an efficient, well-developed securities market, all material information about a

company is available to the public and that this information is reflected in the stock price.

An event study is “[a]n empirical study that has experienced a significant catalyst occurrence, and has subsequently

changed dramatically in value as a result of that catalyst. The event can have either a positive or negative effect on the

value of the security.” http://www.investopedia.com/terms/e/eventstudy.asp.

2015 U.S. Dist. LEXIS 97464, at *95.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Halliburton’s earlier representations about its asbestos liability. The district court, therefore,

granted plaintiffs’ motion for class certification only with respect to the alleged corrective

disclosure on December 7, 2001, and denied the class certification for the other five corrective

disclosures on which the plaintiffs relied.

On November 5, 2015, the Fifth Circuit granted Halliburton’s appeal of the district court’s

decision granting class certification concerning the alleged corrective disclosure.47

Conclusion

It appears that over the past thirty years the Supreme Court has struck something of a middle

ground in setting out the parameters for securities fraud class action certification, finding for

neither plaintiffs nor defendants in all challenges. The Court has held that there must be

predominance of common issues of fact or law (General Telephone Company of the Southwest v.

Falcon, as affirmed by Basic v. Levinson), a burden which plaintiffs must meet. Presuming

reliance on material misstatements is allowed under certain circumstances (Basic v. Levinson), a

development opposed by defendants, who have argued for direct reliance. Limiting or eliminating

proof of materiality at the class certification stage (Amgen, Inc. v. Connecticut Retirement Plans)

is another development which defendants opposed. Not having to prove loss causation at the class

certification stage (Supreme Court’s first Halliburton decision) was another favorable decision

for class action plaintiffs. Requiring proof of market efficiency (Basic v. Levinson) is a burden

which the plaintiffs may find difficult at times to meet. Allowing defendants at the class

certification stage to rebut the presumption of reliance (Basic v. Levinson) is a decision which

plaintiffs may oppose.

In the same way, the Supreme Court struck a kind of middle ground in its decision of Halliburton

II. The Court did not overrule Basic v. Levinson and its fraud-on-the-market theory which allows

a presumption of reliance, rather than required direct reliance, under certain circumstances, but

the Court did allow defendants to rebut this presumption of reliance at the class certification stage

by introducing evidence that the alleged misrepresentations did not distort the stock’s market

price. Basic had stated that the defendants could rebut the presumption of reliance, and in

Halliburton II the Court recognized that one way to rebut the presumption of reliance is to show

an absence of price impact caused by defendant’s alleged misstatements.

Despite the Court’s not jettisoning the fraud-on-the-market reliance presumption of reliance set

out in Basic, some commenters believe that defendants achieved a significant victory in

Halliburton II. An attorney who represented Halliburton stated that “[T]he defense has argued for

the ability to rebut the presumption with price impact evidence since the case went up to the court

the first time in 2010.”48 When she stated that the defendant has the burden of showing the

absence of price impact, Justice Ginsburg in her brief concurring opinion may have anticipated

that many will believe that the Halliburton II decision will make class action certification more

difficult.

The Halliburton II decision has already begun to have an impact on class certification. In a case

decided not long after Halliburton II, the U.S. Court of Appeals for the Eleventh Circuit on

August 6 vacated the certification of a plaintiff class in a lawsuit brought against Regions

Erica P. John Fund, Inc. v. Halliburton Co. No. 15-90038 (5th Cir., appeal granted November 5, 2015).

http://www.bna.com/halliburton-lawyer-case-n17179893183.

Congressional Research Service

Securities Fraud Class Action Certification: Halliburton Co. v. Erica P. John Fund, Inc.

Financial Corporation so that the lower court could consider Regions’ evidence of lack of price

impact caused by allegedly fraudulent statements about real estate investments.49

Halliburton II was clearly not the end of the Erica P. John Fund v. Halliburton saga. The federal

district court decision has fleshed out some of the particulars of the Supreme Court’s Halliburton

II decision. It approved the use of event studies by both parties to attempt to determine whether

alleged misstatements cause a drop in share price. However, this case is not the end of the class

certif. tion challenges, as the fifth Circuit has granted Halliburton leave to appeal. If the class is

finally certified, the courts may then face the merits of the case.

Author Contact Information

(name redacted)

Legislative Attorney

[redacted]@crs.loc.gov , 7-....

Local 703, I.B. of T. Grocery & Food Employees Welfare Fund v. Regions Financial Corporation, 762 F.3d 1248

(11th Cir. 2014).

Congressional Research Service

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