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Supreme Court Upholds “Fraud on the Market” Theory in Securities Class Actions

In Halliburton v. Erica P. John Fund, the Supreme Court upheld its previous ruling that plaintiffs in class actions can rely on the “fraud-on-the-market” presumption.  In securities fraud actions under the SEC’s rule 10b-5, plaintiffs must prove that they relied on a defendant’s misrepresentations in making the decision to buy or sell a particular stock.  In an earlier case (Basic Inc. v. Levinson), the Supreme Court had held that requiring every plaintiff in a class action to prove reliance on the material misstatement would effectively prevent class actions under Rule 10b-5.  Therefore, the Court in Basic allowed plaintiffs to use the fraud-on-the-market theory, which states that “the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.”  As a result, the Basic Court found that reliance on material misrepresentations is presumed.  The Court in Halliburton declined to overrule that presumption, allowing plaintiffs to proceed with suits based on the fraud-on-the-market theory.  However, the Court in Halliburton agreed that defendants should be allowed to use evidence of a lack of price impact to rebut the presumption of reliance before class certification.  Defendants were already permitted to introduce evidence of no price impact at the merits stage, as well as at the certification stage to counter plaintiffs’ arguments showing market efficiency.