The U.S. Supreme Court, in a decision watched closely by D&Oprofessionals, did not go so far as to throw out the“fraud-on-the-market” presumption, used by securities plaintiffs toobtain class certification.

But the opinion of the court in Halliburton Co. v. Erica P.John Fund, Inc., written by Chief Justice John Roberts, didclarify that defendants should be allowed to show—prior toclass-certification—that alleged fraud did not have an impact onstock price.

And so a case that experts said could have been a game-changerfor the securities class-action landscape, had fraud-on-the-marketbeen overturned, instead will likely have a much smaller impact onthe D&O marketplace.

The underlying case involved a contention by Erica P. John Fund,as the lead plaintiff in a class action against Halliburton and oneof its executives, that misrepresentations by Halliburton betweenJune 3, 1999 and Dec. 7, 2001 regarding potential liability inasbestos litigation caused the company's stock price to drop.

What was at stake

During the case, Halliburton had asked the court to overrule thefraud-on-the-market presumption established in the 1988case, Basic Inc v. Levinson. Without thispresumption, plaintiff attorneys would have faced significantbarriers when bringing securities class actions, as they would haveto demonstrate that each shareholder believed, and made investmentdecisions because of, fraudulent misrepresentations, as opposed topresuming class-wide reliance.

An April Kaufman Dolowich & Voluck/AXIS white paper on the case—authored by Ivan J. Dolowich, managingpartner at Kaufman Dolowich & Voluck, LLP; and Frederick M.Zauderer, senior vice president, claims manager at AXISInsurance—explains the obstacles plaintiff attorneys would facewithout the fraud-on-the-market presumption: “Given that mostinvestors are not aware of statements made by the companies whosestock they purchased and because the existence of thousands or tensof thousands of class members, this process would be undulyburdensome.”

In an April 28 PC360 story, Ann Longmore, then of Willis but who will bejoining Marsh's FINPRO practice in July, outlined the importance ofthe case to the D&O market: “If [the Supreme Court justices]give thumbs down to the defense argument, then D&O claimscontinue unabated; D&O securities class actions continueunabated. If they take the opposite view and toss outfraud-on-the-market—if they go to that extreme—then we could seefederal securities class actions, at least initially, become thedinosaur.”

What the Supreme Court said

The court, though, declined to go to that extreme. In hisopinion, Chief Justice Roberts says that to overturn a“long-settled precedent,” the court requires “'SpecialJustification,” and he states, “Halliburton has failed to make thatshowing.”

Halliburton proposed two alternatives to overrulingBasic: requiring plaintiffs to prove that a defendant'smisrepresentation affected stock price, and allowing defendants torebut the Basic presumption by showing evidence of a lackof price impact at the class-certification stage, rather than onlyat the merits stage.

The court rejected the first alternative but agreed with thesecond.

Regarding the portion agreed to by the court, AXIS' Zauderer,speaking today to PC360, says, “There's been some back and forthcases over a few years as to what you can show at the early stages[at class certification]. You're not supposed to get into merits ofthe case, and whether or not the price moved as a result ofmisstatements would seem to be part of the merits. But the courtheld it's also part of what's necessary to make a determinationunder Rule 23, which governs class certification.”

In other words, he says, the court ruled price impact is anessential feature of making a ruling on classcertification.

What it means for D&O and securities classactions

But the impact this will have on the D&O marketplace and onsecurities class actions in general appears to be relatively mild.Some news accounts of the case portray the decision as a win forbusinesses since bringing class actions will likely be moreexpensive now that plaintiffs will have to do more work to getclasses certified.

However, Kaufman Dolowich & Voluck's Dolowich tellsPC360, “Given that the court did not reverse the Basicpresumption of reliance, I think in that respect it is a bit of aplaintiff's victory. I'm sure some on the plaintiff's bar arebreathing a sigh of relief.”

He adds, “There's no doubt that class certification will nowbecome more expensive, and maybe some of the weaker cases willfail, but that's about it.”

Dolowich also says he does not expect the frequency of suchcases to decline, stating that while defendants can challenge theprice-impact theory at class certification, second- and third-tierplaintiff firms will still likely take a chance and bring “iffier”cases.

He indicates, though, that plaintiffs may try to plead casesdifferently. “The Basic presumption only applies tomisrepresentation cases under rule 10b 5,” he says. “It does notapply to the so-called omission cases. In the omission cases,Plaintiffs rely on a different presumption — the AffiliatedUte presumption, which is arguably unaffected by the SupremeCourt holding in this Halliburton case.

As a result, he says plaintiffs may try to bring class actionsas omissions cases rather than misrepresentation cases.

Zauderer wonders how many cases today's Supreme Court rulingwill realistically impact. He notes Halliburton was trying to raiseevidence that its stock price was not impacted by misstatements andthe correction thereof. “I'm not sure that's prevalent in a lot ofcases,” he says.

He explains that in classic cases, a company will makestatements that all is well, and then all of a sudden change courseand say, “We were wrong,” or note that financial reports issuedpreviously cannot be relied upon and have to be restated. And thenthe stock price drops. “There's not much you can do to arguethere's not a price impact,” Zauderer says.

Ultimately, says, Dolowich, the ruling “is not a game-changer.”He adds he does not see any major changes in the D&Omarketplace.

Brenda Shelly, managing director, FINPRO at Marsh, generallyagrees that the ruling will not transform the D&O market, atleast in the immediate future: “While the ruling is likely to makebringing federal securities class action lawsuits against publiccompanies more difficult and expensive for plaintiffs, it is notexpected to have a material effect on directors and officersliability insurance rates or market capacity immediately,” shesays.

But she adds that over the longer term, there may be somechanges in D&O rates, as well as frequency and severity ofcases: “More analysis is needed to determine the likely effectof potentially higher legal fees and expenses associated with timeand effort spent in defeating the presumption. This, in turn, couldaffect not only D&O rates but also the frequency and severityfor those cases that survive as class actions.“

Zauderer notes the ruling would have been a game-changer hadfraud-on-the-market been overruled, but he says the court'soverriding concern was for smaller investors who, the court felt,would have been without remedy had such a change been made.