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

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

And so a case that experts said could have been a game-changer for the securities class-action landscape, had fraud-on-the-market been overturned, instead will likely have a much smaller impact on the 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 one of its executives, that misrepresentations by Halliburton between June 3, 1999 and Dec. 7, 2001 regarding potential liability in asbestos litigation caused the company's stock price to drop.

What was at stake

During the case, Halliburton had asked the court to overrule the fraud-on-the-market presumption established in the 1988 case, Basic Inc v. Levinson. Without this presumption, plaintiff attorneys would have faced significant barriers when bringing securities class actions, as they would have to demonstrate that each shareholder believed, and made investment decisions because of, fraudulent misrepresentations, as opposed to presuming class-wide reliance.

An April Kaufman Dolowich & Voluck/AXIS white paper on the case—authored by Ivan J. Dolowich, managing partner at Kaufman Dolowich & Voluck, LLP; and Frederick M. Zauderer, senior vice president, claims manager at AXIS Insurance—explains the obstacles plaintiff attorneys would face without the fraud-on-the-market presumption: “Given that most investors are not aware of statements made by the companies whose stock they purchased and because the existence of thousands or tens of thousands of class members, this process would be unduly burdensome.”

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

What the Supreme Court said

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

Halliburton proposed two alternatives to overruling Basic: requiring plaintiffs to prove that a defendant's misrepresentation affected stock price, and allowing defendants to rebut the Basic presumption by showing evidence of a lack of price impact at the class-certification stage, rather than only at the merits stage.

The court rejected the first alternative but agreed with the second.

Regarding the portion agreed to by the court, AXIS' Zauderer, speaking today to PC360, says, “There's been some back and forth cases 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 of the case, and whether or not the price moved as a result of misstatements would seem to be part of the merits. But the court held it's also part of what's necessary to make a determination under Rule 23, which governs class certification.”

In other words, he says, the court ruled price impact is an essential feature of making a ruling on class certification.

What it means for D&O and securities class actions

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

However, Kaufman Dolowich & Voluck's Dolowich tells PC360, “Given that the court did not reverse the Basic presumption of reliance, I think in that respect it is a bit of a plaintiff's victory. I'm sure some on the plaintiff's bar are breathing a sigh of relief.”

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

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

He indicates, though, that plaintiffs may try to plead cases differently. “The Basic presumption only applies to misrepresentation cases under rule 10b 5,” he says. “It does not apply to the so-called omission cases. In the omission cases, Plaintiffs rely on a different presumption — the Affiliated Ute presumption, which is arguably unaffected by the Supreme Court holding in this Halliburton case.

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

Zauderer wonders how many cases today's Supreme Court ruling will realistically impact. He notes Halliburton was trying to raise evidence that its stock price was not impacted by misstatements and the correction thereof. “I'm not sure that's prevalent in a lot of cases,” he says.

He explains that in classic cases, a company will make statements that all is well, and then all of a sudden change course and say, “We were wrong,” or note that financial reports issued previously cannot be relied upon and have to be restated. And then the stock price drops. “There's not much you can do to argue there'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&O marketplace.

Brenda Shelly, managing director, FINPRO at Marsh, generally agrees that the ruling will not transform the D&O market, at least in the immediate future: “While the ruling is likely to make bringing federal securities class action lawsuits against public companies more difficult and expensive for plaintiffs, it is not expected to have a material effect on directors and officers liability insurance rates or market capacity immediately,” she says.

But she adds that over the longer term, there may be some changes in D&O rates, as well as frequency and severity of cases: “More analysis is needed to determine the likely effect of potentially higher legal fees and expenses associated with time and effort spent in defeating the presumption. This, in turn, could affect not only D&O rates but also the frequency and severity for those cases that survive as class actions.“

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

Special Reports /

In Case That Could Have Changed D&O Landscape, Supreme Court Takes a Baby Step

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