To recover damages in a securities fraud class action under section 10(b) of the Securities Exchange Act of 19341 (1934 Act), investors must prove that they relied on the defendant’s misrepresentation in connection with the purchase or sale of a security. In Basic Inc. v. Levinson,2 the Supreme Court held that investors could satisfy the reliance requirement by invoking a rebuttable presumption of classwide reliance.3 This presumption, based on the “fraud-on-the-market theory,” has two related components: first, that the price of a security traded in an efficient market reflects all material public information and, second, that the buyer of a security may be presumed to have relied on the integrity of the market price.4 In order to invoke the presumption, a plaintiff seeking class certification must establish that the security traded in an efficient market, among other predicates.5
By dispensing with proof of individualized reliance, Basic fueled a multibillion dollar shareholder class action industry.6 Last Term, in Halliburton Co. v. Erica P. John Fund, Inc. (Halliburton II),7 the Supreme Court considered whether to “overrule or substantially modify” the Basic presumption8 — the linchpin of modern private securities litigation. The Court declined to overturn Basic, but held that defendants can defeat the presumption at the class certification stage by introducing evidence that the alleged misrepresentation did not affect the stock price.9 Although Halliburton II implicates substantive issues at the intersection of economic theory, financial markets, and securities regulation, the case was not decided on those terms. Instead, the outcome reflects adherence to stare decisis and reluctance to fundamentally alter securities class action practice.
In June 2002, the Erica P. John Fund (the Fund) filed a securities fraud class action in the Northern District of Texas against Halliburton Co. and its CEO David Lesar (together, “Halliburton”).10 The complaint alleged that, between June 3, 1999 and December 7, 2001, Halliburton made a series of misrepresentations — downplaying asbestos liabilities, overstating revenues from construction contracts, and overstating the benefits of a merger — in an attempt to inflate its stock price.11 The Fund further alleged that the stock price declined after Halliburton made corrective disclosures, resulting in financial loss.12 Five years later, the Fund invoked the Basic presumption and moved to certify a class pursuant to Federal Rule of Civil Procedure 23.13
In November 2008, the district court denied the class certification motion.14 The court found that the Fund had failed to establish “loss causation” — a causal connection between the defendant’s alleged representations and the plaintiffs’ economic losses15 — and therefore could not invoke Basic’s presumption of classwide reliance to satisfy the Rule 23(b)(3) requirement that “questions of law or fact common to class members predominate over any questions affecting only individual members.”16 The Fifth Circuit affirmed.17 The Supreme Court reversed, stating that requiring loss causation as a precondition for invoking the Basic presumption is “not justified by Basic or its logic.”18
On remand, Halliburton argued that class certification was inappropriate because the evidence introduced to disprove loss causation also revealed that the alleged misrepresentations did not impact the stock price. Absent any “price impact,” Halliburton contended, the proposed class could not invoke the Basic presumption, and investors would have to prove reliance on an individual basis.19 The district court declined to consider Halliburton’s argument, noting that price impact does not bear on the inquiry of common issue predominance under Rule 23(b)(3), and certified the class.20
The Fifth Circuit affirmed.21 Writing for a unanimous panel, Judge Davis22 found that Halliburton’s price impact evidence could be used to refute the presumption of reliance at trial, but not at class certification.23 The court relied on the recent Supreme Court decision in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds,24 which held that classes invoking the Basic presumption do not need to prove materiality to obtain class certification.25 Since failure of proof on the question of materiality “end[s] the case for one and for all,” materiality has no bearing on predominance.26 Applying similar logic, Judge Davis concluded that price impact — which “inherently applies to everyone in the class”27 — should not be addressed at class certification because the focus of Rule 23(b)(3) is “not whether the plaintiffs will fail or succeed, but whether they will fail or succeed together.”28
The Supreme Court reversed.29 Writing for the Court, Chief Justice Roberts30 first considered whether to overrule or modify Basic’s presumption of reliance. Overturning long-settled precedent requires “special justification.”31 According to the Court, Halliburton failed to “so discredit[] Basic” as to justify a departure from stare decisis.32
First, Halliburton’s argument that the Basic presumption is inconsistent with Congress’s intent in passing the 1934 Act33 — the same argument made by the dissenting Justices in Basic — was not persuasive in 1988, and the Court found “no new reason to endorse it now.”34
Second, the Court explained that recent economic developments — specifically, empirical studies showing that capital markets are often inefficient — do not represent “the kind of fundamental shift in economic theory that could justify overruling a precedent.”35 Basic itself relied on a “fairly modest premise” and did not endorse any particular economic theory.36 Furthermore, while some investors may consider price integrity “marginal or irrelevant,”37 “most investors . . . rely on the security’s market price as an unbiased assessment of [its] value.”38
Third, the Court rejected the notion that the Basic presumption conflicts with its recent decisions construing the Rule 10b-5 action and the Rule 23 class certification analysis.39 Previously, the Court has refused to extend Rule 10b-5 liability by eviscerating the reliance requirement,40 acknowledging it must “give ‘narrow dimensions . . . to a right of action Congress did not authorize.’”41 The Court has also refused to lessen the pleading standard for Rule 23 class certification, requiring actual proof of predominance.42 But Basic neither eliminates the reliance element nor alters the burden of proof; instead, as the Court noted, it provides “an alternative means of satisfying [them].”43
Finally, the Court stated that concerns about the “serious and harmful consequences” of the Basic presumption — including the volume of meritless claims, the costs to shareholders, and the strain on judicial resources — are “more appropriately addressed to Congress.”44
Having decided not to overrule the Basic presumption, the Court also declined to modify the prerequisites for invoking it. To rely on Basic, a plaintiff must prove that “(1) the alleged misrepresentations were publicly known, (2) they were material, (3) the stock traded in an efficient market, and (4) the plaintiff traded the stock between when the misrepresentations were made and when the truth was revealed.”45 The first three prerequisites are proxies for price impact — “whether the alleged misrepresentations affected the market price in the first place.”46 According to Halliburton, these indirect proxies are imperfect; plaintiffs should instead be required to prove price impact directly by showing that a defendant’s misrepresentation actually affected the stock price.47 However, the Court refused to “radically alter the required showing for the reliance element of the Rule 10b-5 cause of action” for the same reasons it declined to overturn Basic.48
Finally, the Court considered whether a defendant may introduce price-impact evidence at the class certification stage to rebut the fraud-on-the-market presumption. Defendants already rely on such evidence at the merits stage to rebut the presumption, as well as at the class certification stage to counter a plaintiff’s showing of general market efficiency.49 In the Court’s view, preventing defendants from relying on the same evidence prior to class certification to rebut the presumption altogether “makes no sense” and is inconsistent with Basic.50 The Court distinguished Amgen — which held that materiality, a prerequisite for invoking Basic, should be left to the merits stage because it has no bearing on the predominance requirement of Rule 23(b)(3) — on the grounds that “[p]rice impact is different”51: “The fact that a misrepresentation . . . had price impact . . . is ‘Basic’s fundamental premise.’”52
Justice Thomas concurred in the judgment.53 In his view, “Basic’s reimagined reliance requirement was a mistake.”54 First, the Basic presumption is based on “a questionable understanding of disputed economic theory and flawed intuitions about investor behavior.”55 The first assumption underlying the presumption — that public information is reflected in the market price — is on “shaky footing,”56 and the second assumption — that investors transact in reliance on the integrity of the market price — is “simply wrong.”57 Second, Basic is inconsistent with recent cases clarifying that Rule 23 requires “proof” of predominance since it allows plaintiffs to bypass the evidentiary requirement.58 Third, Basic’s rebuttable presumption is irrebutable in practice. Precertification rebuttal is ineffectual as long as one class representative can prove reliance, and postcertification rebuttal is infrequent due to settlement pressures.59 Finally, stare decisis does not compel adherence to “muddled logic and armchair economics,”60 particularly in an area of judge-made law, and inferences from congressional inaction are speculative and contrary to established principles of statutory interpretation.61
The outcome in Halliburton II cannot be explained in terms of support for a particular economic theory or agreement with a prior statutory interpretation. The majority did not seriously engage with the merits arguments challenging Basic, voicing concern about adjudicating an economic debate outside the Court’s institutional competence62 and emphasizing that the “wrongly decided” inquiry is not part of the stare decisis calculus.63 Instead, reaffirmation of Basic can be understood in terms of congressional acquiescence, reliance, and broader policy concerns. The Court’s strict adherence to precedent indicates a preference for maintaining the status quo in securities class actions, consistent with its price-impact holding.
At first glance, Basic seems an unlikely candidate for stare decisis deference. First, the case was decided by a “bare (four-to-two) majority of a bare quorum of the Court,” with three conservative members not participating.64 Second, it relied on “nascent economic theory and personal intuitions.”65 The Court has previously overruled decisions that are “unworkable” or “badly reasoned”;66 that have questionable theoretical underpinnings;67 or that are “irreconcilable” with intervening legal and policy developments.68 According to Justice Thomas, “Basic checks all the[se] boxes.”69 The majority did not seriously challenge this assessment. Third, Basic used a judge-made evidentiary presumption to expand a judge-made cause of action70 — both “creations of federal common law.”71 The latter point is particularly important, as the Court generally applies a more flexible stare decisis standard to common law and constitutional precedents than to statutory precedents.72 Justice Thomas advocated such an approach, noting that the Court has “not afforded stare decisis ‘special force’ outside the context of statutory interpretation,” and “Basic, of course, has nothing to do with statutory interpretation.”73
And yet, the Court ultimately declined to overrule the fraud-on-the-market presumption. First, although it did not make the argument explicitly, the Court was acutely aware that Congress has repeatedly enacted legislation to govern Rule 10b-5 litigation, and has repeatedly declined to disturb the Basic presumption.74 Congress enacted the Private Securities Litigation Reform Act of 199575 (PSLRA) to combat perceived abuses in securities litigation in federal court.76 Several years later, Congress passed the Securities Litigation Uniform Standards Act of 199877 (SLUSA) to prevent plaintiffs from circumventing the PSLRA by filing securities class actions in state court.78 These statutes do not represent explicit endorsement of Basic;79 however, they suggest acquiescence in the securities class action regime that it created.80 In this context, the “natural conservative judicial move is to defer.”81
Second, the Court found it significant that Congress not only rejected efforts to overturn Basic, but also made important substantive and procedural reforms.82 These reforms rely for their intended operation on the continued existence of Rule 10b-5 class actions.83 For example, the PSLRA can be understood as “a political compromise that preserves the foundation of the fraud-on-the-market class action while making it harder for plaintiffs to bring, plead[,] and prove a successful claim.”84 Thus, reliance concerns counsel against overturning Basic — the sort of far-reaching judicial intervention that could disturb the careful balance that Congress has struck.
Third, the Court may have been concerned about the policy implications of overruling Basic. Private securities class actions are part of a broader corporate governance regime that recognizes the role of private enforcement as an “essential supplement” to criminal and civil enforcement actions brought by the Department of Justice and the SEC.85 Without the fraud-on-the-market presumption, plaintiffs could not prove classwide reliance on misstatements;86 without proof of reliance, plaintiffs could not satisfy the predominance requirement for class certification;87 and without class certification, individual plaintiffs would face a huge cost barrier to bringing claims.88 Faced with this counterfactual, the Court opted to preserve the existing enforcement structure.
Having determined that the limits of private securities liability were frozen twenty years ago,89 the Court was reluctant to overrule a “substantive doctrine” of federal securities law90 — despite the fact that this doctrine, and the underlying cause of action, are “judicial construct[s],”91 and that interpretive errors in judge-made law are often corrected by the Court, not left to Congress.92 It is true that the Court “retains discretion over the contours of Basic,” and can revise its “proper interpretation”93 — but only within certain bounds. And the Halliburton II majority defined those bounds narrowly, embracing “ordinary principles of stare decisis”94 in order to justify its desired result: the preservation of the status quo for securities class actions.95
This status quo bias, informed by similar concerns as the stare decisis analysis, is apparent in the Court’s price-impact holding. Although the availability of price-impact rebuttal represents an additional tool in the corporate defendant’s toolkit, it is unlikely to significantly change class certification results.96 Certification motions unrelated to settlement are not filed in approximately seventy-five percent of securities class actions due to high dismissal and settlement rates; where such motions are filed and result in a final ruling, cases are equally likely to be granted or denied certification.97 And in the small number of cases currently granted certification — less than fifteen percent of the total98 — it is not clear that the opportunity to rebut the Basic presumption by showing lack of price impact will make much of a difference: in most cases, there is some price impact.99
To many, securities class actions conjure up images of Dickens’s Bleak House: interminable, inconclusive, and wasteful.100 By granting certiorari in Halliburton II, the Court had an opportunity to dismantle the modern securities fraud class action system by overturning Basic. But it seems that Basic, and the litigation machine it created, are here to stay because of stare decisis — at least for now. The message from the Court is clear: for meaningful securities law reform, corporate defendants, practitioners, and scholars must look to Congress.