Price Impact, Materiality, and Halliburton II

Allen Ferrell is Harvey Greenfield Professor of Securities Law at Harvard Law School and Andrew H. Roper is Lecturer in Law at Stanford Law School and Executive Vice President with Compass Lexecon. This post is based on a forthcoming article by Professors Ferrell and Roper. Related research from the Program on Corporate Governance includes Rethinking Basic by Lucian Bebchuk and Allen Ferrell (discussed on the Forum here).

In a recent article entitled Price Impact, Materiality, and Halliburton II, Drew Roper and I discuss various themes and issues that have arisen in the lower court rulings applying the Supreme Court’s ruling in Halliburton v. Erica John Fund, Inc., 134 S. Ct. 2398 (2014) (“Halliburton II”). The Supreme Court’s decision in this important case reaffirmed the availability of the fraud-on-the-market presumption of “reliance” for purposes of a Rule 10b-5 class certification. At the same time, the Court held that defendants could rebut the presumption if they could provide “direct evidence” that the alleged misrepresentations did not in fact impact the price of the security (i.e., a lack of price impact).

We first identify three general themes that emerge from these decisions. First, when addressing confirmatory misrepresentations—alleged misrepresentations by a defendant that falsely confirm existing market expectations—some courts have concluded that a lack of a change in the security’s price at the time of the misrepresentation does not rule out a potential price impact associated with the alleged misrepresentation. For instance, in McIntire v. China MediaExpress Holdings, Inc., 38 F. Supp. 3d 415, 433 (S.D.N.Y. 2014), defendants argued that there was no statistically significant price increase when the misrepresentations at issue were made. The court found that this evidence was insufficient to rebut the Basic Inc. presumption because a “material misstatement can impact a stock’s value … by improperly maintaining the existing stock price.” This ruling raises the question concerning the scope of a “maintenance” theory of price impact.

Second, lower courts have reasoned that the identification of non-fraud related news that could have caused stock price changes on the misrepresentation and corrective disclosure dates (the latter consisting of disclosures that reveal to the market the alleged misrepresentation) by itself is not sufficient for establishing a lack of price impact.

Third, courts have come to disparate conclusions about the benefit of looking at disclosures in addition to the alleged misrepresentation disclosures in a price impact analysis. While courts generally have considered price changes associated with alleged corrective disclosures and certain other disclosures in assessing the price impact of the alleged misrepresentations, some courts have nevertheless suggested they will not consider certain types of additional disclosures. In other words, some courts have determined that some disclosures and the market reaction to them constitute potentially relevant economic evidence on the issue of price impact while other disclosures cannot even be considered. For instance, some courts have refused to consider disclosures identified by defendants that arguably establish that the market already in fact knew the truth allegedly being misrepresented and thus the alleged misrepresentation (or corrective disclosure thereof) could not have resulted in a change in the total mix of information made available to the market and, hence, could not have affected the pricing of the security (assuming the market was indeed efficient).

Combined, the lower court cases applying Halliburton II to date suggest that courts have not adopted clear or even entirely consistent rules when assessing price impact analyses. On a related note, a number of interesting issues raised by the Halliburton II Court have not been fully answered in the existing case law.

For instance, what is the basis for the Halliburton II Court’s distinction between the materiality of a misrepresentation and whether the misrepresentation had a price impact? After all, information is deemed “material,” using the standard TSC Industries, Inc. v. Northway, Inc. definition, when there is a “substantial likelihood that the disclosure of the [information] would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” As is widely appreciated, in the context of a case in which plaintiffs have successfully invoked the Basic Inc. presumption by showing the market to be efficient, “the total mix of information made available” would encompass all publicly available information given that any prior disclosed information is already reflected in the market price in an efficient market. Therefore, only new information that would significantly alter what is already publicly available would be deemed “material” under TSC Industries, Inc. But this materiality definition raises the following question: assuming some new information does significantly alter what is already known from publicly available information, and hence would thereby be deemed “material,” would not that same new information also elicit a change in the market price once disclosed given that the market price reflects all publicly available information?

Or to take another issue raised by the Court’s opinion in Halliburton II: What role does the potential distinction between the price impact of an alleged misrepresentation and the price impact of the falsity of the alleged misrepresentation play in determining the existence of price impact? Event studies can only directly measure the price impact of statements, rather than the price impact of the aspect of the statement that is false.

We discuss these issues, among others, in our article by presenting a series of hypothetical fact patterns.

The full article is available for download here.

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