Securities Class Action Future to be Decided by Supreme Court

Following the U.S. Supreme Court’s decision to take up the “fraud-on-the-market” theory underpinning most securities fraud class actions, the Wall Street Journal has examined whether these class actions are likely to become.  The case could reshape the “balance of power” between companies and the lawyers who sue them based on alleged corporate wrongdoing or omissions that may have impacted stock prices.

When investors sue a company under the “fraud on the market” theory, investors are allowed to join forces in a class action without having to prove a direct connection, or similarity, between each shareholder’s losses and the alleged fraud, the WSJ.com article explained.

Essentially, the fraud-on-the-market theory is premised on the theory that at any given moment, the market price of actively traded securities is reflective of all relevant publicly available information, on which potential investors rely.  As such, if a company makes public misrepresentations, those representations are presumed to defraud investors, regardless of whether a particular investor directly relied on the false or misleading statements, because those representations are assumed to have unfairly affected the market price for the securities.  If a market price has been artificially inflated by virtue of misrepresentations, then the courts have found the market price to have been “infected by fraud.”

The U.S. Supreme Court upheld the fraud-on-the-market theory in 1988 in the case of Basic Inc. v Levinson (485 U.S. 224).  Thus, the fraud-on-the-market theory allows a class action to proceed against a company on behalf of every investor who sells stock at a loss, regardless of the individual investor’s true reason for the stock sale.

Many have referred to the judicially-created fraud-on-the-market doctrine as creating a sort of loss-insurance plan for investors and have widely criticized it for causing excessive litigation.  However, as noted in the WSJ.com article, private securities class actions are arguably “instrumental in … promoting market confidence” and “do a better job of compensating duped investors than government regulat[ion].”

The Supreme Court will soon reconsider this theory in Halliburton v. Erica John Fund.  The Halliburton case involves investors who bought shares in Halliburton between 1999 and 2001 who accuse the oil-field services company of misleading investors about critical information about the company including the benefits of a 1998 merger with Dresser Industries and cost overrun accountings.  It is also alleged that the company concealed its exposure to asbestos liabilities. When this information was later disclosed, the stock price “took a dive.”

If the Supreme Court strikes down the fraud-on-the-market doctrine, plaintiffs’ securities lawyers say the ruling could devastate the future of securities class actions.  Given the high cost of litigation, if shareholders were unable to sue as a class under this theory, it may be “impractical for all but the largest institutional investors to pursue claims on their own,” the WSJ.com article noted.  If that occurs, then it would be up to the legislature to pass a new law mirroring the “fraud-on-the-market” doctrine.

If you believe you may have been the victim of securities fraud, contact the attorneys at Audet and Partners, LLP for a free consultation.  Call us at (800) 965-1461 or complete and submit our confidential inquiry form on the right side of this page.

* Source: Gershman, Jacob (2014, February 26), Wsj.com (http://online.wsj.com/news/articles/SB10001424052702304071004579407382791413024)