Academic journal article Harvard Law Review

Congress, the Supreme Court, and the Rise of Securities-Fraud Class Actions

Academic journal article Harvard Law Review

Congress, the Supreme Court, and the Rise of Securities-Fraud Class Actions

Article excerpt


The United States has a complex regime of securities-fraud enforcement in place to protect its securities markets. Functioning properly, securities markets help drive the American economy by providing investors with valuable information, facilitating business combinations, and raising capital. But these markets can malfunction in many ways--fraud can run rampant, or excessive litigation can lead executives to withhold useful information. The trick is having a regime that deters fraud while simultaneously encouraging information sharing. The problem is that our current regime is not up to the task, primarily because it allows for securities-fraud class actions.

These actions have become much more frequent over the last three decades, spurred on by the Supreme Court's decision in Basic Inc. v. Levinson. (1) Commonly filed against corporations that have suffered a significant stock price change, securities-fraud class actions usually allege that the corporation or its executives made a false statement that improperly increased or propped up the stock price prior to the change. (2) For example, in the classic securities-fraud case, a CEO might suggest in an interview that her company is on track to deliver its best quarterly returns ever, only to later admit that returns will actually be lower than expected, causing the stock price to drop. An individual investor who relied on the CEO's initial statement to purchase stock could sue the corporation before Basic; what Basic allowed is for suits--including class actions--to proceed even if the suing investors did not know about or directly rely upon the statement. (3)

The Court seems to have thought facilitating class actions in this way would advance the twin purposes of anti-securities-fraud laws: victim compensation and fraud deterrence. (4) However, class actions have been shown to be a poor means of accomplishing either purpose. They do not compensate effectively because the end result of most class actions is an arbitrary transfer of wealth between groups of innocent shareholders--many of whom are diversified investors who, in aggregate, likely net out from securities fraud. (5) Nor do class actions deter securities fraud efficiently; instead, by incentivizing private plaintiffs to file sometimes-frivolous suits against corporations in order to reach quick settlements, they generate substantial overdeterrence costs. (6)

So it was with great fanfare among advocates of securities-litigation reform that the Court took up Halliburton Co. v. Erica P. John Fund, Inc. (Halliburton II), (7) a case that appeared to have promise as a way to limit securities-fraud class actions and minimize some of their downsides. And the Court's decision, affording defendants an opportunity to defeat class certification by showing that a misstatement did not affect a security's price, (8) on the surface seemed to do just that. However, Halliburton II's apparent promise was doomed from the start because of the "price-maintenance theory"--a theory that had been around for years when Halliburton II was decided. By allowing plaintiffs to argue that defendants' misstatements fraudulently kept a security's price at artificially high levels, the price-maintenance theory makes it nearly impossible for defendants to show that a security's price was not affected by alleged fraud. As a result, defeating class certification is nearly impossible as well, and Halliburton II ultimately does almost nothing to restrain securities-fraud class actions.

Perhaps predicting that its decision would not successfully curb securities-fraud class actions, the Halliburton II Court suggested that if there was a more pervasive problem with this area of the law, it was Congress's to fix. In light of the failure of Halliburton II and other Supreme Court decisions to stem the tide of securities-fraud class actions, Congress should heed the Court's call, overturn Basic, and centralize authority for civil securities-fraud enforcement in the U. …

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