Q&A: Grundfest on the Supreme Court and Class Actions
The U.S. Supreme Court’s seeming campaign to curtail class actions reached a new level on Nov. 15 with its decision to revisit a 25-year-old precedent that launched thousands of securities class actions and generated billions of dollars in settlements and legal fees.
But by granting review in Halliburton v. Erica John Fund, the court did not necessarily set securities class actions on the path to extinction, says Stanford Law School professor Joseph Grundfest, a leading scholar and chronicler of this category of litigation.
In an interview Sunday, Grundfest said that even if the Halliburton case results in restrictions on litigation under Section 10(b) of the Securities Act, class actions could proceed under different sections of the law, and a “scrum of individual actions” under 10(b) could be brought by large investors. He also said the high court might leave it to Congress to fix perceived problems with securities class actions.
The Halliburton petition asks the court to overturn or “substantially modify” the 1988 decision in Basic Inc. v. Levinson, which established the “fraud on the market” theory in 10(b) securities litigation. Under that theory, courts could presume that investors relied on misrepresentations by stock issuers, and investors could sue without having to show they actually did rely on those statements.
A brief filed in support of Halliburton by former Securities and Exchange Commission members—including Grundfest, a commissioner from 1985 to 1990—called the presumption “the most powerful engine of civil liability ever established in American law.”
As litigation under the presumption has increased, criticism has grown stronger. Economists and others assert that such class actions in effect transfer money from current investors in the targeted company to aggrieved former investors, with a significant percentage also going to lawyers on both sides of the litigation.
Granting the Halliburton case “will allow the Court to take a second look at the presumption. The Court will analyze whether economic learning over the past 25 years has undermined Basic’s foundation based on economic theory,” Mayer Brown partners Andrew Pincus and Archis Parasharami wrote on Nov. 15 on the Class Defense blog.
But securities plantiffs lawyer Daniel Sommers of Cohen Milstein Sellers & Toll said that “a reversal of Basic v. Levinson would represent the most radical change in the private enforcement of the federal securities law in a generation, and would be severe blow to investors’ rights.”
Without the reliance presumption, Sommers said, “reliance would become an individualized issue, making it virtually impossible for investors to utilize the class action mechanism.” Even large investors would be deterred from suing, he added.
“Without use of the fraud on the market presumption, investors would face a potentially insurmountable hurdle in gaining class action status for their cases and, as a result, may be left without any remedy under the anti-fraud provisions of the federal securities laws,” Sommers said.
Excerpts from the interview with Grundfest follow.
Tony Mauro: What has been the impact of Basic v. Levinson on the economy and specifically on the volume and dollar amounts of settlements?
Joseph Grundfest: More than 3,050 securities class actions were filed between 1997 and 2012, generating settlements in excess of $73.1 billion, including six of the ten largest class action settlements in American legal history. But to be entirely accurate, it is necessary to back out the settlements that would be attributable to Section 11 claims, which are not affected by Basic. However, because most Section 11 claims are coupled with Section 10(b) claims, I would view these data as suggesting upper bounds on the aggregate effects of class action securities fraud litigation.
Mauro: Why should Basic be overturned?
Grundfest: Simply put, Basic presents the court with a profound conundrum. Basic’s reasoning is entirely inconsistent with the textualist thrust of most Supreme Court decisions in the area, and its conclusion runs directly counter to the relevant legislative history. Further, while Basic and Amgen [v. Connecticut Retirement Plans] assert that the presumption is supposed to be rebuttable, the reality is that once the presumption attaches, with efficiency and materiality having been established, it is de facto irrebuttable … The idea of a truly rebuttable presumption has been demonstrated by 25 years of experience to be an utter fiction. To be sure, as a policy matter, there might be very powerful reasons to avoid this result and to have some mechanism that allows for class action Section 10(b) litigation, but this court could well conclude that a policy question of that significance and complexity should be resolved by Congress, and not by the court.
Mauro: Plaintiffs' advocates say that overturning Basic would make it almost impossible to certify a class, because proving reliance would become an individual matter, and individual litigation would not make financial sense. Do you agree with that analysis?
Grundfest: If the court applies an actual reliance standard, either by overturning Basic or by adding actual reliance as a precondition to the recovery of monetary damages, then Section 11 litigation will continue and cases currently prosecuted under Section 10(b) will morph into a scrum of individual actions brought by larger shareholders in the larger cases. This scrum will resemble the “opt out” cases that currently arise in the larger litigations.
Mauro: Would a victory for Halliburton make it easier for companies to circumvent the securities laws?
Grundfest: That's not an easy question to answer. We would have to know how the SEC will respond. Also, some critics of the current regime complain that many cases are meritless or weak. If that is correct, then any calculus would have to weigh the benefits of deterring weak or meritless litigation against the costs of also deterring meritorious litigation.