SCOTUS challenges fraud-on-the-market theory

Author: Zoe Thomas | Published: 2 Jul 2014
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Its ruling in Halliburton is a double-edged sword for defendants
A US Supreme Court ruling last Monday gives defendants in securities litigation a new tool to challenge class certification. But failure to prevent that certification could lead to a stronger case against them.

The double-edge sword was handed down in Halliburton v Erica P John Fund. The bench unanimously agreed the fraud-on-the-market theory – the presumption that all public information about a company is reflected in its share price – should remain. But they also agreed that defendants could contend class certification by arguing against the theory and the idea of price impact for all plaintiffs.

The decision could help limit the number of class certifications, leading to smaller defendant payouts and possibly fewer suits. 

"The Supreme Court has invited defendants to attack the underlying premise of efficient market theory – that all public information in efficiently embedded in a share’s trading price," said William McGuinness, partner at Fried Frank Harris, Shriver & Jacobson. "The decision is a bit of a mixed bag. It certainly gave defendants an important tool to use in the right cases, but because there is price attached you need to be careful when thinking about when you want to use it."

If a class is certified, settlements are likely to be higher. The prospect of preventing this could not only keep payouts down, but also lead to more rulings in favour of defendants.

The flip side of the coin is that if a judge grants certification after a challenge, the defence effectively lines up the case against itself since market manipulation has already been proven. In that situation, the defence is also likely looking at much higher costs, having both a class certification and a clear case for the plaintiffs.


  • The US Supreme Court has ruled that defendants in securities litigation can challenge class certification;
  • The challenge will allow defendants to argue against the long standing principle of fraud on the market;
  • But losing this challenge could increase the likelihood of losing the case entirely.

The Basic presumption

This case was being closed watched to see if the fraud-on-the-market theory and the so-called Basic presumption would be over turned.

The Basic presumption stems from the Supreme Court’s 1988 ruling in Basic Inc v Levinson that the class could be formed based of the presumption that efficient markets take into account all public information. Plaintiffs could therefore form a class on the presumptions that they all had the same information, as it would be based on the price. Any manipulation to that information would have affected all of them.

Forming a class meant little more than proving there was an efficient and liquid market in those shares. Halliburton challenged the Basic presumption, asserting that if all public information was taken into account in the price, the value of stock would change little and few people would invest.

Justices Antonin Scalia, John Roberts and Samuel Alito have all stated that they are willing to reconsider the role of the Basic presumption and the fraud-on-the-market theory. But in the end, the court stressed the importance of stare decisis and precedent (unless there is an incredibly strong reason to overturn it).

"The case was being closely watched to see if the Basic presumption would survive, but I thought it was interesting that while the court may have been sceptical about the economic theory underpinning Basic, it went out of its way to affirm on stare decisis – prior precedent," said McGuinness.

"The Court said we don’t overturn our prior statutory interpretations lightly, even when we suspect they might be wrong. There is a judicial and social value to saying once a statutory interpretation is made, that is it. bsent special circumstances it is for Congress to correct."

Further reading

S&P ruling: are CRA concerns justified?

The ISDAFix scandal: injured investors

Auditors deserve comfort letter protections