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On June 23th, the Supreme Court handed down one of the most highly anticipated securities litigation opinions in recent memory. Halliburton II brought the fraud-on-the-market theory, the linchpin of securities class actions, squarely in front of the Court. For months, excerpts from various other Court opinions suggested the theory was ripe for review, leading many scholars to posit the Court would overrule the precedent set twenty-five years ago in Basic v. Levinson, if given the chance. The Court ultimately declined to completely overturn the presumption of reliance, instead opting for a middle approach that allows defendants to rebut the presumption at the class-certification stage, thereby avoiding costly settlements. This decision raises important questions for the future of securities class actions.
The fraud-on-the-market theory allows discrete plaintiffs with minimal damages to aggregate their claims as a class action, thus making lawsuits for misleading statements issued by publicly-traded corporations feasible. The theory relies on the efficient market hypothesis, the idea that the stock price incorporates all publicly-available information. In short, because the stock price incorporates all information, any investor who bought or sold the security after the misleading statement was made is presumed to have relied on it, even if a particular plaintiff did not trade on the basis of the information, or even know of its existence. While stopping short of overturning the presumption, the Supreme Court in Halliburton II erected a substantial barrier to certifying a class by giving defendants the ability to show, by means of event studies, that the price did not move in reaction to the misleading statement.
This opinion is especially intriguing given the current dynamic of the securities market, where high-frequency trading reigns supreme. High-frequency trading is a recent phenomenon wherein major brokerage houses assemble high-powered computers connected to securities exchanges via the fastest Internet connections available. This set-up allows these investors to gain access to information shortly before the rest of the market, which they then trade on before the market incorporates the information into the stock price. In addition, some traders participate in a strategy called “spoofing” where they post and cancel orders en masse to manipulate the flow of market activity by providing false signals to other investors. This practice was exposed by Michael Lewis in his recent book, Flash Boys, which subsequently created a large outcry for regulation by the investing public.
A string of recent jurisprudence and agency actions call into question the quality of information in the current market and whether the efficient market hypothesis is still sound logic. This may prove to be a major coup for defendants in securities class actions: if they can show that the market for their stock is inefficient due to a large volume of high-frequency trading, they perhaps can successfully defeat certification of the class. As a novel legal question, it will be interesting to watch this battle play out in courtrooms across America in the coming months.
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