“Thus, (securities) cases certified as class actions—and 77% of decided motions for class certifications are granted, according to a 2014 study by consulting firm NERA—threaten defendants with financial ruin. They subject defendants to relentless pressure to settle, even in cases with weak merits.”, Andrew N. Vollmer, former Deputy General Counsel, the Securities and Exchange Commission

“I joined a brief urging the court to accept the case for review. In Halliburton, the Supreme Court should abandon the deeply flawed fraud-on-the-market theory for an actual reliance requirement.”, Andrew N. Vollmer, March 3, 2014

“Both private securities class action cases against me could not have moved forward with class certification without the “flawed fraud-on-the-market theory”. By way of example, the “Tripp” case involved two elderly individual shareholders who were “straw-men” plaintiffs. Mr. Tripp had to drop out during litigation, because was diagnosed with Alzheimers and the other 88-year-old plaintiff never read or relied on a single IndyMac securities filing (before purchasing his stock…by the way, he purchase more “after the truth had supposedly been revealed”!!!) nor did he read or comment on a single document filed on his behalf by his lawyers; they provided him a copy after filing!!! (He testified to these facts under oath. See blog Statement #147.) The plaintiffs’ lawyers controlled the entire case in violation of the PSLRA and yet the judge still certified him in a ruling that makes no sense and contradicts itself (see Statement #147). Also, in the “Tripp” matter the plaintiffs’ attorneys cited anonymous former employees (as their main witnesses of the alleged securities fraud). Once these individuals were disclosed (whose disclosure the plaintiffs’ attorney fought “tooth and nail”), it was apparent that these relatively junior employees never had any contact with me or others at IndyMac responsible for securities disclosures. (They also worked in an immaterial start-up unit…not even 1% of loan volume…that was closed because it couldn’t make a profit.) The bottom line is that these cases against me were 100% without merit…a fraud…yet these plaintiff’s attorneys were able to legally “extort” multi-million dollar settlements out of the very limited D&O insurance funds available, because they mislead the court and obtained class certification.”, Mike Perry, former Chairman and CEO, IndyMac Bank

OPINION

A Chance to Rein in Securities Class Actions

Time to restore the idea that investors actually relied on bad information provided by companies.

By

ANDREW N. VOLLMER
March 3, 2014 6:55 p.m. ET
On Wednesday, the Supreme Court will hear oral arguments in Halliburton v. Erica P. John Fund, a case that could dramatically decrease the number and size of class-action lawsuits that claim fraud by publicly traded companies. Such class actions are seen as either essential to compensating injured investors and deterring corporate misconduct—or mostly meritless distractions that drive securities offerings overseas and fail to compensate the injured or deter the misconduct.In Halliburton, the court has an opportunity to satisfy both views by trimming securities class actions while still preserving the core benefits of private securities cases.

Halliburton deals with one part of a securities-fraud claim called the reliance issue. In short, what information did an investor rely on when purchasing or selling the security? Historically, when a person sued for injury from a false statement about a security, courts required proof that the plaintiff heard or read the defendant’s misstatement and relied on it when buying or selling.

The Supreme Court removed that requirement in 1988 when it adopted the “fraud-on-the-market” theory of reliance in Basic v. Levinson . According to the new theory, the price of shares traded on efficient secondary markets reflects all publicly available information, including any misrepresentations. Because the market sends information to the investor through a market price, the courts assumed that an investor relied on the integrity of the market price—and therefore on misinformation. Specific proof of actual reliance was no longer necessary.

The theory became the bedrock of securities class actions brought against companies that allegedly made a false statement to public markets. All investors who traded in the public market at issue could join a class action without proof that each investor actually heard or read the misstatement.

The need to show actual reliance had been an important requirement of traditional common-law fraud cases. It defined a person who had been directly wronged by the defendant, even though others could suffer indirect loss from a false representation. Eliminating the need for this proof broke from the tradition as well as securities-law precedent. It was also inconsistent with the court’s decision to narrow the reliance element in the 2008 caseStoneridge v. Scientific-Atlanta, and the court’s decision to toughen class-certification standards in Wal-Mart v. Dukes in 2011 and again in 2013 with Comcast v. Behrend.

The foundation for the fraud-on-the-market theory was the efficient-capital-markets hypothesis championed by economist Eugene Fama. The hypothesis holds that share prices fully reflect information available at the time. But modern economic research, primarily in the field of behavioral finance, has cast doubt on the theory. Economists now recognize that the connections among public information, trading decisions and market prices require more than simple analysis. Information can affect market prices quickly or slowly depending on many factors.

Furthermore, fraud-on-the-market cases greatly expand the size of the plaintiff class. Class actions based on this theory have included hundreds or thousands of investors, such as the Royal Ahold case, which had more than 198,000 claimants. Thus, cases certified as class actions—and 77% of decided motions for class certifications are granted, according to a 2014 study by consulting firm NERA—threaten defendants with financial ruin. They subject defendants to relentless pressure to settle, even in cases with weak merits.

Rejecting the fraud-on-the-market theory would not end private enforcement. Traditional, cohesive class actions and individual securities cases would both remain and serve as a deterrent against securities misconduct.

Securities class actions would continue because many sophisticated investors actually hear, read and rely on the public disclosures from companies to make investment decisions. They attend investor conferences and hear management speakers; they receive the same earnings reports by blast emails; and they listen as a group to earnings calls and other important corporate announcements. Harmed investors could prove reliance and still cohere as a class under these circumstances.

In addition, institutional investors are increasingly bringing their own lawsuits when they believe a company’s disclosures were false and harmful, reducing the need for class actions to act as a deterrent. A 2013 study by Cornerstone Research of investors opting out of class-action settlements to bring their own cases showed that 53% of settlements valued at more than $500 million had an opt-out. Class actions were only 15%-20% of the total number of federal securities and commodities cases brought in 2012.

I joined a brief urging the court to accept the case for review. In Halliburton, the Supreme Court should abandon the deeply flawed fraud-on-the-market theory for an actual reliance requirement.

Mr. Vollmer, a professor and director of the law and business program at the University of Virginia School of Law, is a former deputy general counsel of the Securities and Exchange Commission. 

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Posted on March 13, 2014, in Postings. Bookmark the permalink. Leave a comment.

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