US Supreme Court to hear argument on"fraud on the market"
Insurance eBulletin - 25 November 2013
The United States Supreme Court (Supreme Court) has recently agreed to hear arguments in a case that has the potential to overturn or modify the controversial "fraud on the market" presumption in class actions relating to securities litigation in the United States. The outcome of this case will have wide-ranging ramifications for the Directors' and Officers' (D&O) insurance markets both in the US and in Australia.
On Friday 15 November 2013, the Supreme Court agreed to hear an appeal in a long running class action against Halliburton1.
The Erica P. John Fund, Inc, as lead plaintiff, had been successful in a claim against Halliburton Co that certain directors and officers had misled shareholders by understating the company's asbestos liabilities and overstating the revenues in its engineering and construction divisions and the benefits of its merger with Dresser Industries.
At issue in the appeal will be whether a 1988 decision by the Supreme Court, in Basic Inc v Levinson (Basic), should be overruled or substantially modified to set aside the "fraud on the market" presumption that has underpinned securities class actions in the US for 25 years.
Since the decision in Basic, the "fraud on the market" presumption has relieved plaintiffs in securities class actions of the need to prove individual reliance by each member of a class on a misrepresentation made by a company.
Based on the "efficient market hypothesis", the "fraud on the market" theory has operated in the US as a rebuttable presumption that the price at which investors buy and sell stock reflects an efficient market which has taken into account all publicly available information, including misstatements by a company. The fact that a misstatement by a company is presumed to have been factored into the price of the security means shareholders do not need to show individual reliance on misleading information.
While it is not possible to foreshadow the Supreme Court's decision, comments by a number of the Supreme Court judges in the recent case of Amgen v Connecticut Retirement Plans and Trust Fund2 indicated their willingness to revisit the presumption established in Basic.
Should the presumption be overturned, it may be significantly harder for plaintiffs in US securities class actions to achieve class certification and the often generous settlements they have enjoyed since Basic. This will have a significant impact on the market for D&O insurance in the US.
Whichever way the decision goes, it will likely have a bearing on the considerations that might be taken into account should the High Court in Australia be required to consider similar issues, particularly in connection with the presumption of reliance. Participants in the D&O market in Australia should be aware of the potential changing landscape and pay close attention to the outcome of the case, which is likely be heard and decided before the end of the current term of the Supreme Court in June 2014.
1 Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317 (S.Ct.)
2 Amgen v. Connecticut Retirement Plans and Trust Fund, No. 11-1085 (S.Ct.)
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