Saturday, February 15, 2014
Hello, everyone. Stefan put out a call for reasonable facsimiles of business law professors, and I figured I fit the bill. I’m a Visiting Assistant Professor at Duke Law, currently teaching Securities Litigation. I’ve arrived here directly from practice: For the past 11 years, I’ve worked as a plaintiff-side securities litigator.
(On my first day of class, I asked how many of my students had done securities litigation work, perhaps as summer associates. Almost every hand went up. Then I asked how many had worked plaintiff-side. The hands went down so quickly I swear I heard whooshing noises. To be fair, there was one student who’d done plaintiffs’ work – outside the US.)
Anyway, like anyone teaching securities litigation these days, there’s one thing on my mind: Halliburton, where the Supreme Court is being asked to overrule Basic Inc v. Levinson, the case where it endorsed the fraud on the market presumption of reliance for claims brought under Section 10(b) of the Securities Exchange Act.
There’s been a lot of chatter about the possibility that if Basic is overruled, plaintiffs may, in some instances, still be able to obtain a presumption of reliance under Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972) – many of the Halliburton parties and amici seem to assume this is the case, and it’s come up in the blogosphere.
Affiliated Ute holds that when a fraud consists of material omissions rather than affirmative misstatements, reliance may be presumed.
The problem that often seems to be overlooked, though, is that the Affiliated Ute presumption is rebuttable – and specifically, it’s rebuttable upon a showing that disclosure would not have made a difference, because the plaintiff never read the document in which the omission is contained. See Eckstein v. Balcor Film Investors, 58 F.3d 1162 (7th Cir. 1995); Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981).
Given that, I don’t see how much of a role it can play with respect to substituting for Basic. Defendants’ obvious ability to rebut the presumption with respect to wide swaths of the class should be enough to defeat class certification. This is not to say that defendants’ rebuttal arguments should be entertained at class certification; the point is that there will be so many individualized differences among class members regarding what they read or did not read that class certification would usually be inappropriate, just as in any other non-fraud-on-the-market case where a defense applies differently to a significant number of class members (though there is authority the other way, see In re Smith Barney Transfer Agent Litig., 290 F.R.D. 42 (S.D.N.Y. 2013)).
But then I have a long train of speculation as I imagine how this might play out….
[More after the break]
Of course, if we assume the Supreme Court has overruled Basic, we live in such a radically different world that it’s difficult to imagine how existing doctrine applies – I think the slate would almost be wiped clean, and we’d need to start again.
That said, and assuming we’re within the confines of existing law, I can’t help but wonder whether defendants have the right to rebut Affiliated Ute in situations where they would not or could not have disclosed the truth, such that the disclosure hypothetical is off the table. This could occur, for example, if the “truth” was that the defendants had engaged in antitrust violations, or other forms of illegal behavior.
Affiliated Ute arguments often fail because the court concludes the claim is based primarily on misstatements, rather than omissions. But there’s a separate line of caselaw holding that if the defendant conceals the fact that its success rests on illegal activity, mere reports of revenues and earnings are not misstatements. The only misstatements, if any exist, would come if the defendant falsely explicitly attributed its success to “legal” factors.
The plaintiffs would need to identify a duty to disclose such behavior, of course, but they could try Item 303 of Regulation S-K.
If those cases came up in a world where fraud on the market is off the table, would courts accept Affiliated Ute in situations where disclosure was not an option, because it would be too devastating to the company or its managers?
If this sounds a bit familiar, it should – it’s a twist on the mostly-rejected doctrine of “fraud created the market.” That doctrine, which is generally dead letter now, allowed for the possibility that in some situations, a security is so unmarketable that its mere existence is a fraud. If Basic disappears, plaintiffs will be searching for alternatives, and new takes on “fraud created the market” would be one option.
To be fair, there is some question whether Affiliated Ute – which is where this chain of reasoning began – is properly applied to open-market transactions (although many courts have tended to assume it does). The case itself involved a face-to-face fraud; silence under those circumstances is deceptive because the plaintiff expects that she has been given all material information that the defendant is under a duty to provide. The context is different in an open-market transaction, where the plaintiff would have to affirmatively seek out information, and may have chosen not to do so.
My own view of Affiliated Ute is actually a bit different. The hornbook interpretation is that plaintiffs should not bear the burden of proof in omissions cases, because it is infeasible to show that one “relied” on the absence of something. But that rationale appears nowhere in the opinion itself, and the facts of that case suggest that it’s not really about omissions at all – it’s about a situation where the concealed fact was so fundamental that few rational investors would have engaged in the transaction had the truth been known. There’s actually a reasonably robust line of precedent – both within the securities context and without it – holding that reliance can be presumed in all sorts of cases – even in misstatement cases, not just omissions cases – so long as the concealed fact is so important that the mere fact that the customer engaged in the transaction demonstrates reliance on its absence. See, e.g., Peterson v. H & R Block Tax Servs., 174 F.R.D. 78 (N.D. Ill. 1997).
None of this reasoning is in Affiliated Ute itself; the explicit holding was only that reliance may be presumed when defendants fail to disclose a material fact that they had a duty to disclose. But Affiliated Ute was also decided years before the Supreme Court set a uniform standard for materiality in securities transactions, and the omission in Affiliated Ute was quite dramatic: the defendants were purchasing securities from the plaintiffs, and then flipping them to their own customers at markups that might have been anywhere from 25% to 100% of the original purchase price. That’s more than just a material omission – that’s a material omission. It’s an omission so big that the Court may well have thought that the plaintiffs’ willingness to sell their securities proved they must have “relied” on the omissions, in the sense that they relied that on the assumption that no such secondary market existed – their behavior is pretty tough to explain otherwise.
If that’s true, then Affiliated Ute looks a lot like fraud created the market – the idea of fundamental flaws in the transaction that go to the heart of the plaintiffs’ understandings of the deal.
If nothing else, if Basic is overruled and we see an upsurge in Affiliated Ute arguments, courts will have to confront the question whether the relatively low standard for materiality that was later set by Basic fits comfortably within the Affiliated Ute framework.