Four former SEC Commissioners asked the Supreme Court to end the fraud-on-the-market presumption reliance in securities fraud actions that the Court in endorsed in its 1988 decision in Basic, Inc. v. Levinson 485 U.S. 224. In an amicus brief, the former Commissioners said that the Basic opinion effectively dispensed with the element of reliance in defiance of the text of the Securities Exchange Act and its legislative history and in contravention of the consistent holdings of the Court that reliance is required under Section 10(b). They argued that the reliance presumption is a judicially-created presumption tacked on to a judicially-created private right of action with no foundation in the statute’s text and unsupported by legislative history. Yet, in their view, the presumption has become the most powerful engine of civil liability ever established in American law, serving as the foundation of a massive, multibillion-dollar litigation industry.
This outcome has occurred even though the text and structure of the Exchange Act, along with its legislative history, make clear that private plaintiffs in securities fraud actions under Section 10(b) should be required to demonstrate actual reliance. That policy judgment, made explicitly by Congress, should control here, contended the former Commissioners.
Former SEC Commissioners Paul Atkins, Joseph Grundfest, Steven Wallman and Edward Fleischman signed the brief, along with former SEC General Counsel Brian Cartwright. The vehicle for the Court’s review of fraud-on-the-market is Halliburton v. Erica P. John Fund, Dkt. No. 13-317, which is set for oral argument on March 5.
Although the reliance presumption was ostensibly intended to be rebuttable, noted amici, the experience of the past twenty-five years teaches that it is, as a practical matter, irrebuttable, particularly in class actions. The promise that Basic intended the presumption to be rebuttable has failed, said the former SEC officials, and thus Basic has effectively dispensed with the requirement of reliance in Rule 10b-5 actions. A nonrebuttable presumption of reliance has effectively converted Rule 10b–5 into a scheme of investor’s insurance, said amici, a result for which there is no support in the Securities Exchange Act.
The former Commissioners reasoned that the fact that the theoretically rebuttable presumption of reliance is de facto irrebuttable comes from an internal contradiction central to Basic. The majority there admittedly created the presumption in order to facilitate class actions. But rebuttal is an individualized inquiry, noted amici, and, if successful, only bars an individual representative plaintiff from proceeding without proof of reliance. If a proposed class representative happens to be one of the few individual class members as to whom a defendant may be able to defeat the showing of causation, then all that plaintiff’s counsel need do is find a new one. And there will virtually always be another class member as to whom the presumption cannot be rebutted, said the brief, which is why rebuttal is futile in the vast number of cases, and a successful rebuttal will be exceedingly rare.