“Fraud on the market” and securities class actions

Our team has been monitoring some key developments that could soon impact US and Canadian companies that list shares on US exchanges. One of 2014’s most important legal developments is likely to flow from the US Supreme Court’s ruling on “fraud on the market” theory, to be rendered in Halliburton Co. v. Erica P. John Fund Inc. (“Haliburton”). Oral argument in Halliburton took place on March 5, 2014.

In Halliburton, the US Supreme Court has been asked whether “it should overrule or substantially modify the holding in Basic v. Levinson, 485 U.S. 224 (1988) … to the extent that it recognizes a presumption of class-wide reliance derived from the fraud on the market theory.”  The decision in Halliburton is expected to be of importance given that in Amgen Inc. v. Connecticut Retirement Plans, a case decided in early 2013, members of the Supreme Court expressed concern with respect to the fraud on the market theory. 

In Basic v. Levinson, the US Supreme Court had previously stated that the reliance requirement under section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, placed “an unnecessarily unrealistic evidentiary burden” on plaintiffs who traded on an impersonal market.  To address this concern, the Court accepted the “fraud on the market” theory, by which plaintiffs benefit from a rebuttable presumption of reliance on material misrepresentations made to the public.  The fraud on the market presumption is based on the assumption that, in an efficient market, the price of shares reflects all publicly available information. Thus, under the theory, any material information is expected to result quickly in a decrease in the price of a share. A key assumption under the theory is that fraud was what kept the share price high before proper disclosure, and as such reliance is imputed.

The Court’s approval of the fraud on the market theory expanded securities class actions in the US from 1988 to date, and the theory has found its way into securities litigation in neighboring jurisdictions, most notably in Canada. Currently, in Canada, it remains unclear as to whether there exists a fraud on the market presumption of reliance at common law (although provincial statutory liability in Canada exempts plaintiffs from the need to prove reliance where there has been secondary market misrepresentation, but with express conditions and liability ceilings).

Canadian domiciled companies are now watching the Halliburton case with interest. Canadian issuers are increasingly facing the fraud on the market presumption as the increasing trend toward parallel US/Canada filings continues.  A recent report indicates that as of December 2013, there were 54 Canadian securities class actions pending, representing more than $19 billion in claims.  In 2013 alone, there were 10 new securities class actions filed in Canada; 8 of those actions involved securities listed on the Toronto Stock Exchange (TSX), with six issuers also being cross-listed on the US exchanges and each of these companies faces parallel securities class actions filed in the US.

The upcoming decision in Halliburton will be very important for both US and foreign companies that are exposed to Rule 10(b)-5 liability in the US. Going forward, the decision is also expected to play a role in shaping Canadian common and civil law with respect to the principle of reliance in securities class actions.