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U.S. Supreme Court Reins in Shareholder Litigation, to a Degree

Jun 23, 2014

The U.S. Supreme issued a highly anticipated ruling today in Halliburton v. Erica P. John Fund, giving companies an early opportunity to challenge class-action securities lawsuits but declining to reverse a quarter-century-old ruling that encouraged investors to sue companies based on the "fraud of the market presumption." (See opinion, SCOTUSblog case entry.)

At issue was the 1988 Basic Inc. v. Levinson case, in which the court ruled that investors who lost money in the market because of distorted information did not have to prove that they actually relied on the misrepresentation, a decision that invites hugely expensive and meritless class-action suits. In a friend of the court brief, Business Roundtable, the U.S. Chamber, National Association of Maufacturers and PhRMA had argued that the Basic decision should be reversed: Under securities law, actual reliance is an “essential element” for a fraud claim; and under the Basic ruling, securities fraud plaintiffs get a near free-pass to being certified as a class. From the brief:

In sum, this Court should reaffirm the importance of the element of actual reliance in private securities fraud cases by eliminating or substantially modifying the Basic presumption. Doing so will not cause securities fraud to go undeterred or leave investors who are harmed by fraud without effective means to recover their losses.

Writing for majority, Chief Justice John Roberts found that Halliburton had not proved the "kind of fundamental shift in economic theory" that would justify overturning the Bright precedent. However, courts should give companies a right to challenge shareholder lawsuits at an early stage by showing that an alleged misstatement didn’t affect a company’s stock price.  (From Bloomberg, "Shareholder Class-Action Suits Curbed by U.S. High Court.")

Several of the reports on the opinion called it a "middle of the road" decision.

The New York Times explained why, from a business standpoint, this case was considered one of the most important of the Supreme Court's term. From "Supreme Court Erects Obstacle to Class Actions for Securities Fraud":

The decision will cut back on suits that can involve enormous sums. Settlements between companies and investors over the last decade have totaled about $62 billion, with about $10.5 billion of that amount going to plaintiffs’ lawyers, according to a report from NERA, an economic consulting firm.

Companies facing potential class actions prefer to address as many issues as they can before judges decide whether to certify a class. Once a class is certified, they say, the damages sought are often so enormous that the only rational calculation is to settle even if the chances of losing at trial are small.

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