U.S. Supreme Court justices sought a middle ground to preserve class-action shareholder lawsuits as they heard a case testing the legal rules that have fostered thousands of cases over the past quarter century.

Hearing arguments yesterday in Washington, the justices considered a bid by Halliburton Co. and business groups to overturn a 1988 decision that forms the legal basis for 80 percent of the group securities suits filed each year.

The one-hour session suggested that two potential swing votes, Chief Justice John Roberts and Justice Anthony Kennedy, weren’t willing to go that far. Kennedy repeatedly asked about a proposal by two law professors to give defendants more tools to stop shareholder lawsuits at an early stage, without abolishing class actions altogether.

“I call it the midway position,” Kennedy told Halliburton’s lawyer, adding that such an approach would provide a “substantial answer” to his arguments against the 1988 decision. The law professors’ brief suggests that judges conduct an “event study” early in each case to determine whether a company statement affected its stock price.

Securities-fraud litigation has thrived in recent years even as Congress has tried to rein it in. More than 4,000 class-action suits have been filed since 1996, producing almost $80 billion in settlements, according to NERA Economic Consulting, a unit of insurance broker Marsh & McClennan Cos.

Boies Involved

Accords involving Enron Corp. and WorldCom Inc. alone totaled more than $13 billion, and Bank of America Corp. last year agreed to pay $2.4 billion to settle investor claims over its Merrill Lynch & Co. acquisition. Pfizer Inc., Vivendi SA and Amgen Inc. are among the companies with pending lawsuits that could be affected by the high court case.

The shareholders, led by the Erica P. John Fund and represented by David Boies, contend that from 1999 to 2001 Halliburton falsified earnings reports, played down estimated asbestos liability and overstated the benefits of a merger. Boies told the justices that Halliburton stock dropped 42 percent on the day those statement were shown to be false.

Dick Cheney, later the U.S. vice president, served as chairman and chief executive officer of the Houston-based, oilfield-services provider during part of the disputed period.

The 1988 ruling, Basic v. Levinson, said judges considering misrepresentation claims should presume that investors will take any public misstatement into account before buying shares.

Overcoming Hurdles

That “fraud-on-the-market presumption” helps shareholders overcome two separate legal hurdles: the securities-law requirement that they show they relied on a company misstatement and the class-action requirement that the plaintiffs’ claims have enough similarities to warrant a group lawsuit.

Without the presumption, each shareholder would have to show individual reliance on an alleged misstatement. That requirement, in turn, would preclude class actions because it would require judges to conduct a case-by-base inquiry into the circumstances of each shareholder.

Justice Elena Kagan said the Basic ruling was woven deeply into the law. She pointed to two statutes passed by Congress in the 1990s that limited class actions, even while leaving the Basic presumption intact.

“Congress has had every opportunity and has declined every opportunity to change Basic itself,” she said.

Acknowledging Reality

Justice Antonin Scalia said those statutes weren’t necessarily a “ratification” of the Basic decision. “It’s just an acknowledgment of reality,” he said.

The idea behind the Basic ruling was that the securities markets operate efficiently. Halliburton’s lawyer, Aaron Streett, argued that experience and research have shown the market to be much less efficient than the court thought.

“It was wrong when it was decided, and it is even more clearly erroneous today,” he said.

Roberts questioned whether the court was equipped to make that determination.

“How am I supposed to review the economic literature and decide which of you is correct on that?” Roberts asked.

The law professors’ brief says judges should conduct the event study before letting a class action proceed. Judges now make that determination at a later stage in the case.

The brief, written by Washington lawyer John Elwood, was filed on behalf of Adam Pritchard of the University of Michigan Law School and M. Todd Henderson of the University of Chicago Law School.

Dramatic Impact

The Obama administration is backing the shareholders. A Justice Department lawyer, Malcolm Stewart, told the justices that overturning Basic would have “potentially dramatic” consequences.

Requiring event studies wouldn’t be “nearly so dramatic,” he said.

Tom Goldstein, a Washington lawyer who represents plaintiffs in securities cases, said in an e-mail that such an approach “would not radically change securities litigation, and it would not go nearly as far as defendants had hoped.”

In court, Boies said an event study requirement would be complicated in the Halliburton case because significant news was revealed on nine dates.

“For each day, you’ve got to look at what the confounding factors are and you have to try to separate them,” Boies said. “That’s very complicated. It takes a lot of time. It’s very expensive.”

Justice Sonia Sotomayor suggested she saw the event-study proposal as a major change that would force the plaintiffs to prove much of their case in order to get class action approval.

“I don’t see how this is a midpoint,” she said. “Why bother with Basic at all if we’re going to do what you’re suggesting?”

The court will rule by July in the case, Halliburton v. Erica P. John Fund, 13-317.

–Editors: Mark McQuillan, Justin Blum
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