Beyond Basic: Shareholder Litigation Without Fraud-On-The-Market

Will shareholder litigation survive the abandonment of the fraud-on-the-market presumption of reliance?  After the Supreme Court’s announcement that it will be considering the presumption in Halliburton Co. v. Erica P. John Fund,  No. 13-317, there is much discussion of whether a rejection of fraud-on-the-market could mean the end of securities litigation.  The fraud-on-the-market doctrine, set forth in Basic Inc. v. Levinson, 485 U.S. 224, 243-50 (1988), allows a plaintiff seeking class certification to use a rebuttable presumption to establish reliance.  The presumption is that public information is reflected in the price of a stock traded on a well-developed market, and that investors rely on the integrity of the market price when deciding whether to buy or sell a security.  Under the doctrine, investors do not need to show they actually relied on a misstatement in order to satisfy the “reliance” element of their claim for class certification.  Though overturning the presumption would have a significant impact on shareholder class actions under Section 10(b) of the Securities Exchange Act of 1934, it would not spell the end of shareholder litigation.


  • First, plaintiffs will adjust to a landscape without fraud-on-the-market and will frame their claims in other ways.  Much shareholder litigation does not require plaintiffs to prove reliance. For example, actions would still proceed under Section 11 of the Securities Act of 1933, which imposes strict liability for material misrepresentations and does not require reliance.  Plaintiffs may also turn to derivative litigation tools to litigate similar facts without proving reliance.
  • Second, uncoordinated non-class cases will replace class actions.  Companies experiencing large stock drops will likely be forced to tackle a larger number of cases brought by individual institutional investor plaintiffs or smaller groups of plaintiffs with joined claims.  Plaintiffs’ lawyers will benefit from non-class treatment by courts and follow-on suits would be likely.  Coordinating the potential mass of smaller cases would be difficult, if not impossible, for defendants.  Defending against such uncoordinated litigation would bring a new set of challenges.
  • Third, more cases will proceed to trial.  Settling non-class and non-coordinated cases will be more difficult given that there will be multiple plaintiffs’ firms on the other side of the table, rather than a single class counsel. The damages exposure in any single non-class case brought by a single or small group of investors will be much lower than in class actions.  However, given the coordination issues noted above, defendants may face multiple separate trials on the same or similar facts.
  • Fourth, plaintiffs will likely begin testing alternative theories for pleading reliance on a class-wide basis.  For example, plaintiffs could turn to the Affiliated Ute presumption, in which a plaintiff can avoid pleading actual reliance in a case framed as a material omission.  The Affiliated Ute presumption was used extensively (and litigated fairly extensively) during the mutual fund market timing litigation, which involved mutual fund securities that in many cases were not priced directly on the open market and for which the fraud-on-the-market presumption was unavailable.  The Affiliated Ute presumption will allow plaintiffs’ lawyers to recast their affirmative misrepresentation claims as pure omission claims, which do not need to rely on the fraud-on-the-market presumption to proceed.  See Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 152-153 (1972).  Parties will vigorously litigate whether the crux of a case concerns affirmative misstatements, pure omissions, or both.
  •  Fifth, because the fraud-on-the-market presumption is irrelevant with regard to regulatory actions, those actions would continue undisturbed.  In fact, regulatory actions may even increase in quantity due to pressure from investors on the SEC to fill the gap that would be left by Section 10(b) class actions.
  • Finally, the government could react with legislation to account for the changed landscape of securities litigation in a post-Basic world.  The end of fraud-on-the-market would mean that smaller shareholders are left without ready access to recourse for their losses and may result in less regulated securities markets overall.  Congress could enact legislation to enable securities fraud class actions or other vehicles for these smaller shareholders to take action.