Post-Halliburton II Update: Eighth Circuit Denies Class Certification Based on Lack of Price Impact
In its 2014 landmark ruling in Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), the U.S. Supreme Court unanimously held that securities fraud defendants may rebut the fraud-on-the-market presumption of reliance before class certification by showing that the alleged misrepresentations did not impact the price of the underlying security.
Last week, in IBEW Local 98 Pension Fund, et al. v. Best Buy Co., Inc. (“Best Buy”), the Eighth Circuit became the first appellate court since Halliburton II to hold that defendants had successfully rebutted the fraud-on-the-market presumption to defeat class certification.
Background: The Fraud-On-The-Market Doctrine
In order to bring a securities fraud claim under Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and SEC Rule 10b-5, a plaintiff is required to prove, among other things, that he or she relied upon the alleged misrepresentation when making a decision to buy or sell the security.
To address this issue, in Basic v. Levinson, the Supreme Court held that securities fraud plaintiffs may invoke a rebuttable presumption of class-wide reliance based on the “fraud-on-the-market” doctrine.
In order to invoke the Basic presumption, plaintiffs must prove four elements: “(1) that the alleged misrepresentations were publicly known, (2) that they were material, (3) that the stock traded in an efficient market, and (4) that the plaintiff traded the stock between the time the representations were made and when the truth was revealed.”
The Best Buy Decision
Plaintiff IBEW Local 98 Pension Fund, on behalf of itself and other shareholders of Best Buy Co., Inc. (“Best Buy”), filed suit against Best Buy and three of its executives alleging violations of Section 10(b) of the Exchange Act and SEC Rule 10b-5. Specifically, plaintiffs claimed that, on September 14, 2010, defendants made three fraudulent or recklessly misleading statements—one in a press release and two in a subsequent conference call—that artificially inflated and maintained Best Buy’s stock price until its third-quarter earnings were disclosed in December 2010.
The press release, issued at 8:00 am on September 14, informed investors that Best Buy was increasing its full-year earnings per share (EPS) guidance by ten cents to $3.55 – $3.70. After this announcement, Best Buy’s stock price rose to $37.25 when the market opened at 9:30 am that morning—an increase of 7.5% over the previous day’s closing price.
On December 14, 2010, Best Buy announced that third quarter sales were “lower than expected” and reduced its 2011 EPS guidance to $3.20 – $3.40. After this announcement, Best Buy’s stock—which had increased since September 14—closed at $35.52 or 14.8% lower than its previous closing price.
The United States District Court for the District of Minnesota dismissed plaintiffs’ claims, with prejudice, finding the alleged misrepresentations made in the September 14 press release and on the conference call were forward-looking statements protected by the safe harbor provision of the Private Securities Litigation Report Act (“PSLRA”). After granting plaintiffs’ leave to file an amended complaint, the district again dismissed plaintiffs’ claims relating to the press release, but permitted claims relating to the conference call to proceed.
Plaintiffs moved to certify the class, and relied upon Basic’s fraud-on-the-market presumption to prove the reliance element of their 10b-5 claims and satisfy Rule 23’s predominance requirement.
The district court, which stayed its decision on class certification until the resolution of Halliburton II, granted plaintiff’s motion for class certification finding that defendants failed to adequately rebut the presumption of reliance. The court explained that, “[e]ven though the stock price may have been inflated prior to the earnings phone conference . . . the alleged misrepresentations could have further inflated the price, prolonged the inflation of the price, or slowed the rate of fall.” The court further held that “price impact can be shown by a decrease in price following a revelation of the fraud” and defendants did not offer “evidence to show that Best Buy’s stock price did not decrease when the truth was revealed” on December 14.
Eighth Circuit Decision
The Eighth Circuit reversed the decision of the district court, finding that defendants sufficiently rebutted the Basic presumption and, since plaintiffs presented no contrary evidence, plaintiffs failed to satisfy the predominance requirement of Rule 23(b)(3).
In a 2-1 decision, Judge James B. Loken, writing for the majority, found that the district court ignored “strong evidence” demonstrating a lack of price impact—the opinion of plaintiffs’ own expert.
In reaching its decision, the Court rejected two alternative theories offered by plaintiffs: (i) the conference call statements effected a “gradual increase” in the stock price between September and December of 2011, and (ii) Best Buy’s stock decline, after the alleged corrective disclosure on December 14, was evidence that the conference call statements “maintain[ed] an inflated stock price.” As to the first theory, the Court found that such a “gradual increase” was contrary to the very premise upon which the Basic presumption is founded, i.e., that an efficient market will “rapidly reflect” all publicly available information. As to plaintiffs’ second theory, the Eighth Circuit found that it “provided no evidence that refuted defendants’ overwhelming evidence of no price impact.”
The Best Buy Dissent
In her dissent, Judge Diane E. Murphy argued that the majority misapplied Halliburton II’s price impact analysis, and class certification should have been affirmed under plaintiffs’ “price maintenance theory.”
The Best Buy decision demonstrates that, in practice, the Halliburton II decision provides defendants with a meaningful avenue to defeat the fraud-on-the-market presumption. To date, the Eighth Circuit is the only federal appellate court to hold that the Basic presumption was adequately rebutted to defeat class certification. As a result, Best Buy will be an important authority, both within the Eighth Circuit and in other jurisdictions, as issues of reliance continue to be a battleground at the class certification stage.
Moreover, within the Eighth Circuit, the Best Buy decision may effectively limit plaintiffs’ ability to pursue securities fraud claims based on a “price maintenance” theory. Although such theories have been recognized by certain courts in other jurisdictions, after Best Buy, strong evidence demonstrating lack of an immediate, “front-end” price impact may be enough to rebut the Basic presumption in the Eighth Circuit. The Best Buy decision also suggests that the presumption cannot be grounded on mere speculation about the effects of the alleged misstatements—i.e., arguments that the misstatements “could have” further inflated the price, prolonged inflation or slowed the rate of price decline will likely be insufficient absent strong correlating evidence. It is, however, important to emphasize that the Eighth Circuit’s decision ultimately turned on plaintiffs’ expert’s agreement with defendant’s expert that there was a lack of price impact from the conference call.