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(Article from Securities Law Alert, August 2015)

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In Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (Halliburton II), the Supreme Court held that defendants are entitled to rebut the presumption of reliance set forth in Basic Inc. v. Levinson, 485 U.S. 224 (1988) at the class certification stage by presenting evidence that the alleged misrepresentation or corrective disclosure had no price impact.[1] The Halliburton II Court vacated the district court’s class certification order in a long-running securities fraud action against Halliburton Company, and remanded the action for further proceedings consistent with its opinion.

On July 25, 2015, the Northern District of Texas applied the Court’s guidance in Halliburton II to deny plaintiffs’ motion for class certification in the Halliburton action as to claims involving five of the six alleged corrective disclosures at issue. Erica P. John Fund, Inc. v. Halliburton Co., 2015 WL 4522863 (N.D. Tex. 2015) (Lynn, J.) (Halliburton III). The court found that Halliburton had successfully rebutted the Basic presumption by proving that these five alleged corrective disclosures had no impact on the company’s stock price. However, the court determined that Halliburton had failed to prove a lack of price impact as to one of the alleged corrective disclosures, and granted plaintiffs’ motion for class certification with respect to claims concerning that disclosure.

Background

The Northern District of Texas first considered plaintiffs’ motion for class certification in 2008. The court declined to certify the class on the ground that plaintiffs had not proved loss causation, as required under applicable Fifth Circuit precedent. Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 2008 WL 4791492 (N.D. Tex. Nov. 4, 2008). The Fifth Circuit affirmed. Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 597 F.3d 330 (5th Cir. 2010). The Supreme Court subsequently vacated the Fifth Circuit’s decision, holding that plaintiffs “need not” “prove loss causation in order to obtain class certification.” Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011) (Halliburton I).[2] The Court remanded the action for further proceedings consistent with its opinion.

On remand, Halliburton sought to overcome the Basic presumption by presenting evidence that the alleged misrepresentations had no price impact. The Northern District of Texas found that consideration of price-impact evidence was not appropriate at the class certification stage, and granted plaintiffs’ motion for class certification. Archdiocese of Milwaukee Supporting Fund, Inc. v. Halliburton Co., 2012 WL 565997 (N.D. Tex. Jan. 27, 2012). The Fifth Circuit affirmed. Erica P. John Fund, Inc. v. Halliburton Co., 718 F.3d 423 (5th Cir. 2013). Once again, the Supreme Court granted certiorari.

In Halliburton II, the Supreme Court held that “defendants must be afforded an opportunity before class certification to defeat the [Basic] presumption through evidence that an alleged misrepresentation did not actually affect the market price of the stock.” 134 S. Ct. 2398. The Court explained that under Basic, “‘[a]ny showing that severs the link between the alleged misrepresentation and . . . the price received (or paid) by the plaintiff . . . will be sufficient to rebut the presumption of reliance’ because ‘the basis for finding that the fraud had been transmitted through market price would be gone’” (quoting Basic, 485 U.S. 224). The Halliburton II Court found that “[p]rice impact is thus an essential precondition for any Rule 10b-5 class action.” The Court determined that, “[w]hile Basic allows plaintiffs to establish that precondition 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.”

The Supreme Court vacated the class certification order in the Halliburton case and remanded the action for further proceedings consistent with its opinion in Halliburton II. Plaintiffs subsequently moved for class certification as to claims in connection with six allegedly corrective disclosures. Prior to ruling on plaintiffs’ motion for class certification, the Northern District of Texas held an evidentiary hearing in which both parties presented expert testimony on whether the alleged corrective disclosures impacted Halliburton’s stock price.

Court Finds Defendants Have the Burden of Both Production and Persuasion on the Issue of Price Impact at the Class Certification Stage

As an initial matter, the Northern District of Texas noted that “[t]he Supreme Court did not state expressly in Halliburton II whether plaintiffs or defendants must carry the burden of persuasion to show price impact or lack thereof.” Halliburton III, 2015 WL 4522863. Based on its “analysis of . . . Halliburton II, and decisions by other district courts since Halliburton II,” the court determined that Halliburton bore “the burdens of production and persuasion to show lack of price impact.” The court held that it was up to Halliburton to “persuade the [c]ourt that its expert’s event studies [were] more probative of price impact than [plaintiffs’] expert’s event studies.” The court reasoned that if it required “plaintiffs to carry the burden of persuasion to show price impact at the class certification stage,” then it “would, in effect, be requiring [plaintiffs] to prove price impact directly, a proposition the Supreme Court [in Halliburton II] refused to adopt.”

The court also rejected Halliburton’s attempt to rely on Rule 301 of the Federal Rules of Evidence to claim “that it should bear only the burden of production” on the issue of price impact. Rule 301 provides that “unless a federal statute or [the Federal Rules of Evidence] provide otherwise, the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption.” Rule 301 further provides that it “does not shift the burden of persuasion, which remains on the party who had it originally.” The court found that “the fraud-on-the-market presumption is atypical, and as a result, does not neatly fit into the Rule 301 framework.” Halliburton III, 2015 WL 4522863. The court explained that “a literal application of Rule 301 to the fraud-on-the-market presumption in a class certification hearing would allow defendants to preclude class certification by merely putting on a reputable expert . . . [who could] opine with 95% confidence that a corrective disclosure had no effect on price.” Pursuant to “Halliburton’s position on Rule 301,” plaintiffs “would then be forced to move forward and prove reliance without the aid of the presumption, which would doom the class on predominance grounds.” The court determined that “the Supreme Court would not have modified the fraud-on-the-market presumption so substantially without explicitly saying so.”

Court Finds Class Certification Is Not the Proper Stage at Which to Determine Whether Disclosures Are Corrective

The court declined to address Halliburton’s contention that “each of the alleged corrective disclosures were not, in fact[,] corrective.” The court found that the Supreme Court’s decisions in Halliburton I, Halliburton II, and Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 133 S. Ct. 1184 (2013)[3] “strongly suggest that the issue of whether disclosures are corrective is not a proper inquiry at the certification stage.” The court explained that “Basic presupposes that a misrepresentation is reflected in the market price at the time of the transaction.” For purposes of class certification, the court therefore “conclude[d] that the asserted misrepresentations were, in fact, misrepresentations, and assume[d] that the asserted corrective disclosures were corrective of the alleged misrepresentations.” The court reasoned that “hold[ing] otherwise would require the [c]ourt to pass judgment on the merits of the allegations after the dismissal stage and before summary judgment — in effect, giving a third bite at the apple to Halliburton.”

The court further found that “Halliburton’s arguments regarding whether the disclosures were corrective [were], in effect, a veiled attempt to assert the ‘truth on the market’ defense, which pertain[ed] to materiality and [was] not properly before the [c]ourt” at the class certification stage. The court explained that, if it determined that a particular disclosure was not corrective, such a finding would not “cause[ ] individual questions of law and fact to predominate over common questions.” Rather, “it would end [the] controversy altogether.”

Court Holds Five of the Six Alleged Corrective Disclosures Had No Price Impact

The court then turned to whether Halliburton had proved that the alleged corrective disclosures had no price impact. The court explained that in order “[t]o show that a corrective disclosure had a negative impact on a company’s share price, courts generally require a party’s expert to testify based on an event study that meets the 95% confidence standard, which means ‘one can reject with 95% confidence the null hypothesis that the corrective disclosure had no impact on price.’” The court further noted that “[a]n event study is generally comprised of two parts: (1) a calculation of the market-adjusted price change in the issuer’s share price at the time the corrective disclosure became public . . . ; and (2) a determination of whether the corrective disclosure is among the [company-related] news that affected the price on the date the disclosure became public.”

In the case before it, Halliburton’s expert determined that there were 35 separate dates on which plaintiffs alleged either a misrepresentation or a corrective disclosure. Halliburton’s expert found that none of the alleged misrepresentations or corrective disclosures had any price impact except for Halliburton’s December 7, 2001 disclosure of an adverse asbestos-related verdict against the company. As to that particular disclosure, Halliburton’s expert opined that “there was no price reaction as to the alleged misrepresentation, which the [c]ourt interpret[ed] to mean that the price reaction was caused by [other] factors.” Plaintiffs’ expert conducted an event study only with respect to the six alleged corrective disclosures at issue, and found that “the market responded significantly to each of these six events.” 

Court Finds a Multiple-Comparison Adjustment Was Warranted to Correct for the Possibility of False Positives

Halliburton’s expert contended that a multiple-comparison adjustment was warranted where, as here, “a large number of price reactions are tested for statistical significance, because the more price reactions tested, the greater the odds are of finding statistical significance simply due to chance.” While the court recognized that “multiple comparison adjustments are rarely utilized in event studies for securities litigation,” the court found that “the use of a multiple comparison adjustment [was] proper in this case because of the substantial number of comparisons, thirty-five comparisons, being tested for statistical significance in [Halliburton’s expert’s] analysis.” However, the court determined that the particular multiple-comparison adjustment that Halliburton’s expert applied (the “Bonferroni adjustment”) “generate[d] a relatively high incidence of . . . false negatives.” The court therefore applied a different adjustment (the “Holm-Bonferroni adjustment”), which, in the court’s view, “addresse[d] the multiple comparison problem [of false positives]. . . while also guarding against the prospect of unacceptably high levels of [false negatives].”

Court Finds Plaintiffs’ Expert’s Peer Index Should Be Used to Evaluate Price Impact

As to the relevant indices against which to measure Halliburton’s stock price movement, Halliburton’s expert “selected an index for each of Halliburton’s two main lines of business -- (1) energy services, and (2) engineering and construction (E&C).” Halliburton’s expert used the S&P 500 Energy Index and a Fortune E&C index. Plaintiffs’ expert, on the other hand, “constructed a peer index composed of companies identified by analysts as being Halliburton’s peers (‘Analyst Index’).” The court determined that this Analyst Index “increase[d] the explanatory power of [Halliburton’s expert’s model],” and found that “it should be utilized in measuring the statistical significance of the price reaction on the six dates in question.” 

Court Holds a Two-Day Window Cannot Be Used to Measure Price Impact in an Efficient Market

The court also considered whether the question of price impact should be analyzed over a one- or two-day window following the alleged corrective disclosure. Significantly, the court held that, “in this case, the use of a two-day window [was] inappropriate to measure price impact in an efficient market.” As a result, the court reasoned that “[a]n efficient market is said to digest or impound news into the stock price in a matter of minutes.” The court determined that “an alleged corrective disclosure released to the market at the start of Day 1, . . . followed by a price impact on Day 2, will not show price impact as to the alleged corrective disclosure.”

Court Finds Halliburton Successfully Rebutted the Basic Presumption of Reliance with Respect to Five of the Six Alleged Corrective Disclosures  

The court next assessed the evidence of price impact as to each of the six corrective disclosures alleged. The court found that Halliburton had succeeded in rebutting the Basic presumption of reliance by proving a lack of price impact as to five of these corrective disclosures.

With respect to Halliburton’s December 21, 2000 announcement of a $120 million after-tax charge in connection with restructuring and charges on the company’s fixed-price engineering and construction contracts, the court found plaintiffs’ expert’s “use of a two-day window [was] inconsistent with an efficient market, especially where the relevant disclosure was made before the market opened on Day 1.” As to Halliburton’s August 9, 2001 announcement concerning an “upward trend” in new asbestos claims and an increase in the company’s gross asbestos liability, the court found that this information “both [was] already disclosed and caused no statistically significant price reaction.” The court similarly found that Halliburton’s October 30, 2001 disclosure of an adverse asbestos-related jury verdict had no price impact because “[p]ublic announcements [of the jury verdict] preceded Halliburton’s press release” and there was no statistically significant price reaction to those announcements. The court likewise found that Halliburton had proved a lack of price impact as to asbestos-related disclosures on June 28, 2001 and December 4, 2001.

However, the court found that Halliburton had failed to prove a lack of price impact with respect to its December 7, 2001 announcement of an adverse asbestos-related jury verdict finding Dresser, a Halliburton subsidiary, liable for $30 million in damages. On the date of the announcement, Halliburton’s stock price dropped by 40%. Halliburton contended that the announcement had no price impact by pointing to a stock price rebound on December 10th, the second day of trading following the announcement. The court held that Halliburton could not rely on this Day 2 price rebound to show an absence of price impact “because to do so would be inconsistent with an efficient market, which is said to digest or impound news into the stock price in a matter of minutes.”

While the court found that “at least some of Halliburton’s stock price decline . . . [was] likely attributable to uncertainty in the asbestos environment that also impacted other companies with asbestos exposure,” the court held that Halliburton had failed to prove that this “uncertainty caused the entirety of Halliburton’s substantial price decline” on December 7, 2001. The court determined that “the price impact on December 7 likely reflected the market’s view of Halliburton’s prior representations regarding its asbestos liability and increased uncertainty in the asbestos environment.”

The court therefore granted plaintiffs’ motion for class certification “only with respect to the alleged corrective disclosure of December 7, 2001.”