Spring 2014 Business Law Bulletin

On March 5, 2014, the U.S. Supreme Court heard oral argument in a securities class action that certain commentators predicted could be one of the most important business law cases of the past decade. Class actions are divided into two parts: the first is the certification stage where the court decides if the case can proceed as a class action, and the second is the merits stage during which the court (and ultimately the jury) determines whether the defendant is liable and, if so, the plaintiffs’ damages.

In many class actions, but particularly those in the securities context, the first stage—class certification—dictates the outcome of the case as many defendants decide that the risks and costs of defending a class action after the class is certified are greater than the cost of what would otherwise seem an exorbitant settlement amount.

Securities class actions are a multi-billion dollar industry for plaintiffs’ firms. USA Today recently reported that approximately 200 securities class action cases are filed each year, that securities class actions have led to $73 billion in settlements, and that more than 40% of the corporations on major stock exchanges have been targeted. It has reached the point where a corporation should expect such a class action suit if its stock appreciably drops, for any reason.

At issue in the recent case before the U.S. Supreme Court is whether securities class action plaintiffs can continue to use the “fraud-on-the-market” presumption to attain class certification. This presumption allows a securities action based on corporate misstatements to be certified as a class action with no proof that an individual investor was aware of the misstatements.

To invoke the presumption, the plaintiff need only prove that the stock in question was traded on an “efficient market” and the misstatements were public. Without the presumption, the court would have to examine each individual investor’s reliance on the alleged misrepresentation, making class certification impossible.

The fraud-on-the-market presumption has evolved into providing the basis for many federal district courts to simply grant class certification in any case involving public representations about stock traded on the New York Stock Exchange. When four justices in a decision last year questioned whether the presumption should even be continued, followed by the U.S. Supreme Court accepting certiorari in the Fall of 2013 in the Halliburton petition asking whether the Court should overrule or substantially modify the presumption, the effect on the corporate community was only slightly short of jubilation.

Not so fast. During oral argument, Justice Scalia aside, the Court asked few questions indicating that it is seriously considering scuttling the presumption. Instead, the focus was on a possible “middle ground” option of retaining the presumption, but requiring plaintiffs to also prove that the misstatements actually distorted the stock price, known as “price impact.” Plaintiffs already have to prove price impact, but have to do so post-class certification during the merits stage.

Price impact is important: simply because a stock price dramatically falls on the day that a prior corporate misstatement is corrected (such as through a restatement of earnings) does not mean the misstatement caused a shareholder to pay more for its stock than it otherwise would have paid. The price drop could be because of a freefall market, as in the 2008 financial crisis, or other bad news released the same day by the company or its industry, amongst other possible reasons.

Even if the presumption is not overruled, any change the U.S. Supreme Court can make in placing a higher burden on plaintiffs to invoke the presumption, or in allowing corporate defendants greater opportunities to rebut the presumption at the class certification stage (which one of the U.S. Supreme Court briefs described as being “as rare as hens’ teeth”), will be an improvement for the corporate community.

Following the oral argument, the U.S. Supreme Court may, but is not expected to, completely overturn the presumption. The corporate community, however, can be cautiously optimistic that securities class action plaintiffs will no longer be able to file a complaint, and in the words of Halliburton’s counsel at oral argument, “collect $200 and pass go and get right to class certification.” Something additional may be required, such as a court requiring plaintiffs to prove the misstatement actually impacted the stock price, or at the very least, allowing defendants to oppose class certification by introducing their own evidence of no price impact.

It is expected that the U.S. Supreme Court will release its decision by June.

Lorrie Hargrove and Tom Butler are Shareholders in the firm’s Class Action Litigation and Insurance & Financial Services Litigation practices. Lorrie can be reached at 205-254-1054 or lhargrove@maynardcooper.com. Tom can be reached at 205-254-1063 or tbutler@maynardcooper.com.