A

fter serving as the cornerstone

for modern private securities lit-
igation for 25 years, the most
powerful engine of civil liability ever es-
tablished in American law is now under
re at the U.S. Supreme Court.
Known as the Basic presumption, the
fraud-on-the-market theory allows plain-
tiff lawyers to certify a securities class
action for fraudulent misrepresentations
under Rule 23 of the Federal Rules of
Civil Procedure without any proof that
class members actually relied on the false
information when purchasing or selling
a companys securities. See Basic Inc.
v. Levinson, 485 U.S. 224, 241-42, 250
(1988). Reliance is presumed according
to the efcient-market hypothesis: that
an efcient market will immediately in-
corporate all material, public representa-
tions about the company. Thus, a person
is presumed to have relied on a compa-
nys misrepresentations if he or she pur-
chases or sells securities at the market
price. Reliance ties into the predomi-
nance requirement for class certication
under FRCP 23(b).
But after years of growing scholarly
and empirical attack in light of real-world
market inefciencies, this hypothesis,
along with the Basic presumption itself,
is now on the chopping block for the rst
time since inception.
In making a second appearance before
the Supreme Court, the petitioners in Er-
ica P. John Fund Inc. v. Halliburton Co.,
13-317, are asking the justices to over-
rule or substantially modify the Basic
presumption, or at least allow defendants
the opportunity to rebut the presumption
to prevent class certication. Such re-
buttal would be price impact evidence
that alleged misrepresentations did not
actually distort the market price of the
stock in this instance. The defendant
petitioners assert the assumption that
an efcient market is always efcient is
nave and faulty. Markets are not rational.
Referring to the 1998 to 2001 technolo-
gy bubble and the most recent economic
crisis as examples, the petitioners stress
that real-world experience dictates that
only some markets are efcient some of
the time with respect to some informa-
tion a reality which shakes the Basic
majority held that proof was not required
given that its merits affected all class
members equally, not just individuals.
In his concurrence, Justice Samuel Ali-
to observed that more recent evidence
suggests that the presumption may rest
on a faulty premise .... [R]econsideration
of the Basic presumption may be appro-
priate. Likewise, Justice Antonin Scalia
echoed Whites sentiments in his dissent
by calling the holding a worsening of a
regrettable situation: Todays holding
does not merely accept what some con-
sider the regrettable consequences of the
four-Justice opinion in Basic; it expands
those consequences from the arguably
regrettable to the unquestionably disas-
trous.
Some may wonder why this should
matter given that the plaintiffs hold the
ultimate burden of proof on the merits.
The reality is that once the class is cer-
tied, the sheer aggregation of claims
exerts so much settlement pressure that
most cases are settled without regard to
the merits; they are settled because the
defendants simply cannot risk the conse-
quences of an adverse result, even if that
adverse result is wrong on the merits.
See Brief of DRI The Voice of the De-
fense Bar as Amicus Curiae in Support of
Petitioners at *3, Halliburton Co. v. Eri-
ca P. John Fund Inc., 2013 WL 5652548
(Oct. 11, 2013) (No. 13-317). Class cer-
tication literally crushes defendants
under the weight of possible liability.
Indeed, over 3,050 private securities
fraud class actions were led between
1997 and 2012, generating more than
$73.1 billion in settlements. See Brief
of Former SEC Commissioners and Of-
cials and Law Professors as Amici Cur-
iae in Support of Petitioners at *3-4, Hal-
liburton Co. v. Erica P. John Fund Inc.,
2013 WL 5652547 (Oct. 11, 2013) (No.
13-317). Included are six of the 10 largest
settlements in class action history. These
astounding gures are matched by the
tens of billions in fees for plaintiffs and
defense attorneys. Several former SEC
commissioners have commented that the
Basic presumption revolutionized pri-
vate securities litigation and made it the
massive multibillion-dollar industry that
it is today. For that reason, requiring this
additional proof before class certication
would be a game changer.
presumption to its core.
The Supreme Court adopted Basic
with only four justices, representing a
bare majority of a bare quorum. Rely-
ing on concepts of fairness, public pol-
icy, probability, judicial economy, and
common sense, the majority adopted the
presumption as a practical resolution
to the problem of balancing the substan-
tive requirement of reliance against the
procedural elements of class certication
under Rule 23. At the time, the hypothesis
enjoyed widespread support from recent
empirical studies. The court itself did not
assess the general validity of the hypoth-
esis. Rather, it presumed its validity and
simply focused on whether it was proper
to adopt a reliance presumption in securi-
ties cases as a matter of rst impression.
In his dissent, Justice Byron White ex-
pressed great concern with replacing bed-
rock securities and class action law with
such a newly minted economic hypothe-
sis: [T]he Court today ventures into this
area beyond its expertise, beyond by
its own admission the connes of our
previous fraud cases. Describing it as
a mere babe, White cautioned that the
court embraced the hypothesis with the
sweeping condence usually reserved
for more mature legal doctrines. He
feared it would lead to many adverse,
unintended consequences down the road.
Such questioning and criticism only
grew louder over time, with claims that
the economic hypothesis was out of step
with modernity and simply did not work
in practice. In fact, in a recent opinion,
some justices outright questioned the
need to revisit the Basic presumption. See
Amgen Inc. v. Connecticut Retirement
Plans and Trust Funds, 133 S. Ct. 1184,
1204-06 (2013). While addressing a sim-
ilar issue of whether plaintiffs must prove
the materiality of alleged misrepresenta-
tions by a company (a Basic presumption
prerequisite) before class certication, the
By Christina Lincoln
THURSDAY, DECEMBER 19, 2013
www.dailyjournal.com
LOS ANGELES
Day of reckoning for securities class actions
PERSPECTIVE
After years of growing scholar-
ly and empirical attack in light
of real-world market inefcien-
cies, this hypothesis, along with
the Basic presumption itself, is
now on the chopping block.
So what is the likely result from the
court? Some believe that Basic will
stand untouched given stare decisis and
the courts overall wariness to intro-
duce blanket changes to the law; oth-
ers mourn the impending doom of the
presumption, along with shareholder
rights. It will probably be somewhere
in between. Because the Basic pre-
sumptions laissez-faire approach to
Rule 23 sits awkwardly with recent
cases that heightened plaintiffs bur-
den of proof in the general class action
context, the court may continue down
its increasingly conservative path and
tighten the requirements of Basic due
to recent economic realities whether
adding to one of the existing require-
ments for the presumption or creating
a whole new requirement for price im-
pact. See AT&T Mobility LLC v. Con-
cepcion, 131 S. Ct. 1740, 1753 (2011)
(federal preemption regarding uncon-
scionability of class arbitration waiv-
ers); Wal-Mart Stores Inc. v. Dukes,
131 S. Ct. 2541, 2556-57 (2011) (fail-
ing commonality requirement by not
showing general policy for discrimina-
tion); Comcast Corp. v. Behrend, 133
S. Ct. 1426, 1434-35 (2013) (rejecting
regression model to calculate damages
to prove predominance).
Regardless, the Basic doctrine appears
to be deteriorating before our very eyes
and the court should address the legal
communitys growing concerns over the
validity of the underlying economic hy-
pothesis.
With arguments set for March 5, 2014:
let the battle begin.
Christina Lincoln is an associate with
Newmeyer & Dillion LLP in Newport
Beach.
Reprinted with permission from the Daily Journal. 2013 Daily Journal Corporation. All rights reserved. Reprinted by ReprintPros 949-702-5390.
CHRISTINA LINCOLN
Newmeyer & Dillion