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Class-Actions & Market Integrity

The ruling in Erica P. John Fund v. Halliburton got lost among the other opinions released at the end of the Supreme Court's term. The case had already been to the Supreme Court once on a separate issue. This iteration presented the Court with the opportunity to fundamentally rethink its own role in generating securities class actions. Instead, the Court made only peripheral changes that slightly limit the leverage that class action attorneys have against a corporation after a drop in its stock price.

Securities fraud class actions under section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 thereunder require the plaintiff, in buying or selling stock, to have relied on the alleged misstatement. Basic Inc. v. Levinson, 485 U. S. 224 (1988), created a rebuttable presumption of reliance grounded in the expectation that the price of a stock traded in an efficient market reflects all material public information. By doing so, it eliminated the need for individual showings of reliance and so made class actions possible.

Halliburton urged the Court to drop the Basic rebuttable presumption. The court left Basic in place. Instead, it took the much more modest step of allowing a defendant at the class certification stage to rebut the Basic presumption of reliance by presenting information to show that the alleged misstatements did not affect the stock price. A class could not be certified if there was no effect on the stock price.

The Court suggested that Halliburton redirect to Congress its complaints about the extortive nature of class actions built on the Basic presumption. Justice Clarence Thomas, in his concurring opinion in which he was joined by Justices Scalia and Alito, took the position that "Basic should be overruled." Reliance, in his view, is an inherently individual question that turns on actual facts rather than presumptions built on "armchair" theories about how markets and investors operate. He called the Court out for having created the private cause of action under section 10(b) and rule 10b-5 in the first place, which means that there is no statutory language to guide its subsequent application. Justice Thomas urged the Court not to wait for Congress to fix Basic: "when we err in areas of judge-made law, we ought to presume that Congress expects us to correct our own mistakes--not the other way around."

The Court's fresh look at Basic left matters largely unchanged. Congress should take its own fresh look at whether the class action system--which forces shareholder-funded settlements out of companies regardless of a clear link to actual fraud--is deterring fraud as intended or undermining the integrity of the capital markets upon which the Basic presumption is built.

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Rafael Mangual
Project Manager,
Legal Policy

Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.