This article was first published in Law360 on July 25, 2014.
In its recent, highly anticipated decision in Halliburton Co. v. Erica P. John Fund,[1] the U.S. Supreme Court declined an invitation to overturn the so-called “fraud on the market” presumption applicable to securities class action certification.[2] Had the court accepted that invitation, Halliburton might well have been a game changer that markedly altered the securities class action landscape — and the directors and officers liability insurance market.
Without the presumption, it would be far more difficult for Rule 10b-5 plaintiffs to obtain class certification — and therefore much more difficult for the plaintiffs bar to use the specter of massive class damages to extract from companies and their D&O insurers the types of enormous settlements that are a current feature and reality of securities class action litigation.[3]
Nevertheless, while clearly not the game changer that publicly traded companies and their D&O insurance carriers may have hoped for, Halliburton offers securities class action defendants a significant new arrow in their litigation quiver: companies may now attempt to rebut the presumption at the class certification stage by demonstrating that their alleged misrepresentations had no impact on stock price, rather than wait for a trial on the merits. In addition to having the clear potential to change the way that securities claims are litigated, companies are well-advised to consider the potential insurance implications. Below is a brief overview of the decision and a discussion of the potential insurance implications.
The Halliburton Decision
By way of brief background, in Halliburton a group of investors brought a putative class action against Halliburton and one of its executives asserting misrepresentations in violation of § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.[4] For years, the parties have been fighting as to whether a class should be certified.
On remand from the Supreme Court’s initial decision on class certification, which held that plaintiffs need not prove loss causation at the class certification stage in order to invoke the fraud on the market presumption, Halliburton argued that class certification was inappropriate because the evidence it had earlier introduced to disprove loss causation also showed that none of its alleged misrepresentations had actually affected its stock price and, therefore, it had rebutted the presumption. The district court rejected this argument, applied the presumption and certified the class.
The Fifth Circuit affirmed. While acknowledging that “‘Halliburton’s price impact evidence could be used at the trial on the merits to refute the presumption of reliance,” the Fifth Circuit held that Halliburton “could not use such evidence for that purpose at the class certification stage.”[5]
In an opinion authored by Chief Justice John Roberts, and joined by Justices Anthony Kennedy, Ruth Bader Ginsburg, Stephen Breyer, Sonia Sotomayor and Elena Kagan, the court declined to overturn the fraud-on-the-market presumption, which was first adopted by the court over 25 years ago in Basic Inc. v. Levinson,[6] noting that “[b]efore overturning a long-settled precedent” the court would “require ‘special justification,’ not just an argument that the precedent was wrongly decided.”[7] The court ultimately found that special justification lacking.
Nevertheless, while declining to overturn the Basic presumption, the court held that securities class action defendants “must be afforded an opportunity before class certification to defeat the presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.”[8] Indeed, the court emphasized the “bizarre results” that may ensue if defendant companies were not afforded the opportunity to demonstrate that alleged misstatements had no ”price impact” on share value.
The court noted in this regard that plaintiffs and defendants both submit price impact evidence prior to class certification for purposes of demonstrating (and rebutting) general market efficiency and that this evidence may show “an efficient market, on which the alleged misrepresentation had no price impact.”[9] The court found that, if certification were granted in that circumstance, “[s]uch a result is inconsistent with Basic’s own logic.”[10] The court clarified that “[w]hile Basic allows plaintiffs to establish [price impact] indirectly, it does not require courts to ignore a defendant’s direct, more salient evidence showing that the alleged misrepresentation did not actually affect the stock’s market price and, consequently, that the Basic presumption does not apply.”[11] Because the courts below denied Halliburton the opportunity to defeat the presumption, the court vacated the judgment and remanded the case.
Impact and Insurance Takeaways
From a defense perspective, Halliburton is not the game changer that it might have been. However, although the full impact of the decision will be realized over time, the decision clearly has the potential to change the way that Rule 10b-5 securities claims are litigated, and may be of significant benefit to companies and their D&O insurers.
For starters, although it remains to be seen whether the case will result in fewer cases filed, or a significant number of cases recast as omission cases (as opposed to affirmative misrepresentation cases),[12] it certainly will result in the denial of class certifications in cases in which certification previously would have been granted.[13] To the extent certification is avoided, plaintiffs lawyers are obviously curtailed in their ability to extract enormous settlements based on the specter of massive classwide damages — which clearly is of benefit to companies and their D&O insurers.
From an insurance perspective, Halliburton also, not surprisingly, does not have the type of wide-ranging impact on the D&O insurance market that it may have had if the court had overturned the Basic presumption.[14] Nevertheless, companies are well-advised to keep in mind that the decision is likely to increase -— and may significantly increase -— defense costs at and prior to the class certification stage in view of the need for expert witness testimony and discovery regarding price impact, and anticipated discovery battles surrounding the types of, and quantum of, price impact evidence that companies may rely upon to rebut the Basic “fraud on the market” presumption. One insurer has noted that “[p]resenting this evidence, in the form of event studies prepared by expert economists, may lead to significant costs for plaintiffs and defendants early in the litigation process.”[15]
In this regard, companies may wish to carefully consider their D&O program and confirm that their policies would respond to cover expert witnesses and “event study” expenses. Importantly, D&O policies can and do differ substantially from carrier to carrier — even from policy to policy underwritten by the same carrier.
Coverage for expert witness fees and costs generally would be found within the definition of “defense costs” — a definition that typically is made part of the broader definition of a covered “loss” under D&O insurance contracts, which generally cover “loss” on account of any “claim” for a “wrongful act.” Policyholders will typically argue that the definition of “defense costs” includes expert witness fees and “event study” expenses. On the other hand, some insurers facing increased defense costs after Halliburton, may contend that policies that do not expressly reference “experts’ fees” do not provide coverage for such fees and expenses.
Corporate policyholders should also be aware that, anticipating the Halliburton decision, at least one insurer has issued a new endorsement, which provides, for no additional premium, first-dollar ($0 retention) coverage for class certification event study expenses. In particular, the specimen endorsement adds “class certification event study expenses” to the policy definition of “loss” and states that “no retention shall apply to loss incurred as class certification event study expenses.”[16] “Class certification event study expenses” is defined to include the fees and expenses of an expert witness to conduct an admissible price impact study. Specifically, class certification event study expenses is defined to include the following:
The reasonable and necessary fees, costs and expenses of an expert witness consented to by the Insurer, which consent shall not be unreasonably withheld, incurred by an Insured to conduct an admissible event study regarding any issues of fact relevant to the court’s decision as to whether to grant class certification in a Securities Claim.[17]
The insurer has stated that it created the endorsement to provide funds to obtain the event studies “early in the litigation process, potentially to head off class certification.”[18]
The assistance of knowledgeable insurance coverage counsel at D&O insurance placement and renewal can help to make sure that companies understand the changing litigation landscape and have policy language that adequately responds to that changing landscape.
Notes:
[1] 2014 WL 2807181, --- U.S. ---- (U.S. June 23, 2014).
[2] Under the “fraud on the market” presumption, Rule 10b-5 plaintiffs seeking class certification under Federal Rule of Civil Procedure 23 need not demonstrate that each individual plaintiff relied upon alleged misrepresentations. Instead, plaintiffs are entitled to a rebuttable presumption that, in well-developed markets, a company’s share price reflects all publicly available information about the company, including any material misrepresentations, and that the plaintiffs relied upon the share price and, therefore, presumably also relied upon the misrepresentations in deciding to buy or sell a company’s stock. As a result, whenever an investor buys or sells stock at the market price, his “reliance on any public material misrepresentations... may be presumed for purposes of a Rule 10b–5 action.” Halliburton 2014 WL 2807181, at *7 (quoting Basic Inc. v. Levinson, 485 U.S. 224, 247 (1988)).
[3] As the Supreme Court in Basic Inc. v. Levinson noted, “[r]equiring proof of individualized reliance from each member of the proposed plaintiff class effectively would have prevented respondents from proceeding with a class action, since individual issues then would have overwhelmed the common ones.” 485 U.S. 224, 242 (1988).
[4] Halliburton 2014 WL 2807181, at *4.
[5] Id. at *5 (quoting Erica P. John Fund Inc. v. Halliburton Co., 718 F.3d 423 (2013)).
[6] 485 U.S. 224 (1988).
[7] Halliburton 2014 WL 2807181, at *6.
[8] Id. at *17.
[9] Id. at *15.
[10]Id. at *16.
[11] Id.
[12] The Supreme Court has held that in circumstances “involving primarily a failure to disclose, positive proof of reliance is not a prerequisite to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of this decision.” Affiliated Ute Citizens of Utah v. U. S., 406 U.S. 128, 153-54 (1972). Plaintiffs also may recast claims as claims alleging violations of Sections 11 and 12 of the Securities Exchange Act of 1933.
[13] On the other hand, it is likely that the majority of meritorious 10b-5 claims involving securities traded in efficient markets will continue to be certified. In a concurring opinion, Justice Ginsburg, joined by Justices Breyer and Sotomayor, stated that “[t]he court's judgment ... should impose no heavy toll on securities fraud plaintiffs with tenable claims.” Halliburton 2014 WL 2807181, at *18.
[14] For an excellent discussion concerning how Halliburton may have impacted the D&O insurance market, see Kevin LaCroix, Top Ten D&O Stories of 2013 (Jan. 7, 2014), / (“Among the many consequences that would result if the Basic presumption were set aside, it seems likely that the way many public companies purchase D&O insurance would change. As Joe Monteleone noted on his D&O E&O Monitor blog, the end result could be that ‘there will be less of a need to buy large towers of D&O insurance, a likely reduction in rates and perhaps an overall shrinking of the D&O marketplace with fewer players and less revenue in both the insurer and brokerage communities.’ Of course, if securities litigation were to mutate into something smaller but more complex, the impact on D&O purchasing patterns and rates could take a different turn.”).
[15] “Introducing the Event Study Endorsement”
[16] AIG Class Certification Event Study Expenses endorsement, Specimen Form 117960 (6/14).
[17] Id.
[18] See AIG D&O Endorsement Responds to Change from Supreme Court ‘Fraud on the Market’ Decision, Business Wire (June 22, 2014).
