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Update: Halliburton Co. vs. Erica P. John Fund, Inc.

Supreme Court Update – Court hears oral arguments in Halliburton Co. vs. Erica P. John Fund, Inc.

Last week the Supreme Court heard oral arguments in Halliburton Co. vs. Erica P. John Fund, Inc., a case which threatens the modern underpinnings of class certification in securities class action litigations. In 1988, in Basic Inc. vs. Levinson, the Supreme Court endorsed the “fraud on the market theory”, a rebuttable presumption that securities prices in an open and developed market reflect material public information and that investors rely on the integrity of the market price. This presumption relieved investors from having to demonstrate, prior to the class certification stage, individual reliance on (or even awareness of) any alleged misstatements in order to claim damages resulting from the alleged fraud. With respect to reliance for purposes of class certification, plaintiffs are only required to show that the stock traded in a semi-strong efficient market during the class period. In Halliburton, however, the Court has agreed to reconsider two questions: (i) whether it should overrule its holding in Basic, that a plaintiff in a private action under Section 10(B) of the Securities Exchange Act of 1934, and Rule 10B-5, may invoke a rebuttable presumption of reliance based on the “fraud on the market” theory; and (ii) whether such a plaintiff must prove that the alleged misrepresentation distorted the market price of the security in order for the suit to be maintained as a class action, and whether the lower court must allow the defendant at class certification to present evidence of no such price impact.

In our view, the holdings in Basic and the “fraud on the market” theory have afforded smaller investors efficient and streamlined access to damage recoveries in securities class action settlements. Such smaller investors (the oft-heard about “moms and pops” or “widows and orphans”) are less likely to have the time, knowledge or the resources to launch and fund individual private litigations against issuers who have made material misstatements in the marketplace or otherwise engaged in fraud. Further, the costs of litigation in the individual instance would most likely dwarf the damages they could hope to recover. The class action structure is a practical solution to this problem, permitting individual investors to group together and share litigation costs to recover damages due to fraud. In addition, the involvement of damage recovery specialists, like Battea, has vastly improved and streamlined the recovery process, ensuring fair and maximum distributions to all investors in accordance with the Plans of Allocation, regardless of their relative size or market power.

Furthermore, the way class action litigation attorneys are currently compensated has been highly criticized. Attorneys earn their fee as a percentage of a settlement which must be approved by the court. Plaintiff’s counsel are often dubbed “ambulance chasers”, portrayed as preying upon corporate America for their piece of the proverbial settlement pie. An alternative view is that the current payment structure actually enables investors to seek recourse for corporate wrongdoing without having to front capital for legal fees. If plaintiffs were required to finance the litigation costs up-front, there would likely be significantly less class action lawsuits as institutional investors such as pension funds would be forced to justify allocating capital to a lawsuit, the outcome of which is highly speculative. The current structure enables institutions to pursue remuneration on behalf of damaged investors with no financial risk. This payment structure also incentivizes attorneys to pursue cases with merit as they are taking a financial risk by litigating as they cover all the litigation expenses until (and only if) a case is settled or wins a jury verdict.

Of course, partisans have lined up on either side of the public debate. On the one hand, those supporting Halliburton’s efforts to overrule the legal precedent established in Basic include a commercial association, the U.S. Chamber Institute for Legal Reform, who published a position paper and filed an amicus curiae brief with the Court asserting that new “academic consensus” and “new evidence” justify overruling the Court’s previous holding. In our opinion, their assertions are based on misguided assumptions and facts with questionable sources. On the other side, legal scholars, former SEC Chairmen, the AARP, leading economists, pension funds and employee benefit funds, and a group of states, have all separately filed their own supporting briefs with the Court, emphasizing the benefits of upholding the substance of the Court’s decision in Basic. These briefs emphasize, among other things, that private enforcement of securities laws is an essential supplement to governmental criminal prosecutions and civil enforcement actions, and protect the integrity of the markets. The Court, in oral arguments, made reference to an amicus curiae brief filed by two law professors, and seemed to be looking for a middle ground approach, where the existing securities class action system would be largely maintained, but a broader opportunity given to defendant issuers to have claims dismissed before the class certification stage.

The Court’s re-consideration of these issues, which has obtained extensive news coverage in the days leading up to the oral arguments, will continue to be a “hot topic” and of particular interest until the opinion of the Court is released, which is anticipated by the end of June. We think if the Court were to overrule its previous holdings in Basic, the existing class action securities landscape would be radically transformed, and the costs associated with long term, passive index investing would increase, to the detriment of the average investor, who would face insuperable hurdles in obtaining recompense in connection with wrongdoing or fraud by public issuers.

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