Supreme Court Seeks Compromise in Securities Fraud Case

Faced with the real prospect of overturning a 26-year-old precedent permitting class-action cases based on investors' trust in market prices, several justices asked whether it might be better to require that investors prove that the fraud affected the price.

Four conservative justices previously had made clear their desire to modify or overturn the 1988 decision. That would take a huge burden off U.S. corporations but make class-action challenges more difficult to bring.

During oral arguments in the case of Halliburton v. Erica P. John Fund, however, both Justices Anthony Kennedy and John Roberts appeared to be searching for a middle ground. Even Justice Antonin Scalia, an opponent of the court's earlier decision in Basic v. Levinson, mused about the court adopting "Basic writ small."

Despite Congress' enactment of legislation in 1995 designed to limit frivolous lawsuits, about 200 securities class-action claims are filed each year, which have led to $73 billion in settlements. More than 40% of corporations on major stock exchanges have been targeted.

Companies such as Halliburton, a Houston-based energy giant, say the costs for insurance and payouts represent a significant burden on businesses. On the other side, trade groups representing institutional investors say reliance on market prices is essential, because most of them use market indexes and lack the time and expertise to parse corporate financial statements.

In past rulings that have scaled back on other types of class-action lawsuits, Kennedy, Scalia and Justices Samuel Alito and Clarence Thomas expressed doubts about the "fraud on the market" theory adopted in 1988.

Those doubts are based on the theory that market prices are not always accurate, up-to-date indicators of a stock's value. As the U.S. Chamber of Commerce contended in its court brief, many investors trade "precisely because they do not believe the market price accurately reflects the true value of the security."

Lawyers for the investors' fund and the Obama administration, which opposes overruling Basic, argued that very few traders buck the market under the assumption they know a fraudulent scheme is afoot. Even when they do, said deputy solicitor general Malcolm Stewart, the traders are trying to beat the system before the market figures it out proving their ultimate efficiency.

Markets "are massively more efficient today than they were in 1988," said David Boies, the lawyer for the fund. "Everybody who buys assumes that that market price is fraud-free."

The investors' fund contends that Halliburton misrepresented the firm's asbestos litigation liability, construction contract revenue and benefits from a merger between 1999-2001, a period that included part of former vice president Dick Cheney's chairmanship of the company.

Halliburton and a number of allies, including the U.S. Chamber of Commerce, say investors should not be allowed to bring class-action lawsuits based on an economic theory that markets are efficient. Rather, Halliburton attorney Aaron Streett said, "actual eyeball reliance" on fraudulent misrepresentations or omissions must be shown.

Several justices seemed reluctant to go that far, particularly after 26 years of adherence to the earlier decision by courts and Congress. They seized on a brief written by two law professors that instead recommended using "event studies" of the fraud and its impact on market prices.

"A class wishing to avail itself of the fraud on the market presumption of reliance should be required to show that a fraud on the market actually occurred," argued the professors, including Adam Pritchard of the University of Michigan and M. Todd Henderson of the University of Chicago.

Boies warned the court that event studies can be complicated and expensive. But compared to throwing out the entire fraud-on-the-market theory, Stewart said, the consequences for investors would not be "nearly so dramatic."

A decision on the case is expected by June.