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E-MailLucian Bebchuk is William J. Friedman and Alicia Townsend Friedman Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance, Harvard Law School. Allen Ferrell is Greenfield Professor of Securities Law, Harvard Law School. They are co-authors of Rethinking Basic, a Harvard Law School Discussion Paper forthcoming in the May 2014 issue of The Business Lawyer, that is available here. This post is the third in a three-part series in which they remark on the oral argument at the Halliburton case; the first two posts are available here and here.
As we discussed in our first two posts, the Halliburton oral argument (transcript available here), provided encouraging signs that a number of the Justices might choose to avoid making a judgment on the state of efficient market theory and to focus on the presence of fraudulent distortion (sometimes also referred to as price impact). In this post, we respond to arguments that the adoption of such an approach would be inconsistent with or at least in tension with the Court’s earlier rulings that merit issues should not be resolved at the class certification case.
In Rethinking Basic, we explain that class-wide reliance should depend not on the “efficiency” of the market for the company’s security but on the existence of fraudulent distortion of the market price, and that focusing on fraudulent distortion would provide a coherent and implementable framework for identifying class-wide reliance in appropriate circumstances. We also go on to explain that, in contrast to some claims to the contrary, determining fraudulent distortion would not usurp the merits issues of materiality and loss causation.
In responses to our paper (see, e.g., Kevin LaCroix of D&O blog’s thoughtful post here http://www.dandodiary.com/2014/01/articles/securities-litigation/dump-fraud-on-the-market-yet-preserve-securities-plaintiffs-ability-to-establish-reliance/) and in reactions to the oral argument in Halliburton, commentators raised the possibility that adopting a fraudulent distortion approach would create tension with some recent Supreme Court rulings.
In particular, questions were raised as to (1) whether a finding of fraudulent distortion would necessarily imply a finding of materiality, an issue that the Court held in Amgen to be a merits issue?, and (2) whether such a finding would necessarily imply a finding of loss causation, an issue that the Court in the earlier Halliburton case held also to be a merits issue?
As we explain below, based on our analysis in Rethinking Basic, the answer to both questions is no. We first address the question of materiality and then turn to loss causation.
Materiality
In our view, under a fraudulent distortion approach, a finding of fraudulent distortion would not entail that materiality necessarily exists and thus would not make consideration of the subject of materiality unnecessary at the merits stage (i.e. at summary judgment and trial). Consider the following hypothetical:
Under the fraudulent distortion approach we support, there would be class-wide reliance in the mining hypothetical. However, at the merits stage there would still be the issue of whether the statement was materially misleading. One factual issue would be what exactly was told to the CEO by the company’s geologists. How favorable or unfavorable was this information concerning the gold mine? And did this information render materially misleading the CEO’s statement that “I have talked with my geologists and I feel great about the gold mine.” (There is also the materiality issue of puffery, whether the statement is immaterial as a matter of law given that it arguably constitutes normal corporate optimism, an issue that would presumably be dealt with at the motion to dismiss stage). A finding that the statement had an impact on the stock price would thus not resolve, and would leave to the merits stage, the fact intensive issue of materiality, i.e., whether the statement involved a materially misleading statement, raised by the hypothetical.
Loss Causation
On a similar note, a finding of fraudulent distortion would not entail that loss causation exists and thus would not make consideration of the subject of loss causation unnecessary at the merits stage (i.e. at summary judgment and trial). Consider the following hypothetical:
In our hypothetical, plaintiffs have, by assumption, established class-wide reliance under our approach. However, the issue of loss causation would still be very much left unresolved. There has been no showing in our hypothetical that the fraudulent distortion resulted in any economic losses to plaintiffs. In Dura Pharmaceuticals, the Court explained: “in cases such as this one (i.e. fraud-on-the-market cases), an inflated purchase price will not itself constitute or proximately cause the relevant economic loss [for loss causation purposes] . . . [I]f, say, the purchaser sells the shares quickly before the relevant truth begins to leak out, the misrepresentation will not have led to any loss.”
Thus, merely purchasing at a fraudulent distorted price simply does not establish that the economic losses that one is seeking damages for were caused by the alleged fraud. Therefore, under the fraudulent distortion approach we support and hope the Supreme Court would adopt, the important merits issues of materiality and loss causation would not be usurped by a finding of fraudulent distortion at the class certification stage.
