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Thoughts while waiting (and waiting) for Halliburton
- 1. Stephen M. Bainbridge National Business Law Scholars Conference June 20, 2014 Thoughts While Waiting (and Waiting) for Halliburton
- 2. Part I The Illegitimacy of Basic
- 3. Basically Bad Statutory Construction • Bare majority of a bare quorum Birth by judicial fiat Ignored the basic question Overlooked the obvious analogy
- 4. Basically Bad Statutory Construction • Bare majority of a bare quorum Birth by judicial fiat • The “awkward task” of inferring what Congress would have done Ignored the basic question Overlooked the obvious analogy
- 5. Basically Bad Statutory Construction • Bare majority of a bare quorum Birth by judicial fiat • The “awkward task” of inferring what Congress would have done Ignored the basic question • i.e., Section 18(a) of the Securities Exchange Act Overlooked the obvious analogy
- 6. Part I The Irrelevance of Economic Analysis to Fraud on the Market
- 7. Financial Economics Common Sense The irrelevance of financial economics Fraud Price-setting investors react Price changes Ordinary Investors Affected No FotM = No Class Action
- 8. The Henderson/Pritchard Proposal Problems The continuing irrelevance of financial economics Invoke fraud on the market if “the challenged disclosure artificially inflated ([or] deflated) the market price of the particular security.” “The event study Is the best available tool to examine market distortion and show reliance” “A direct analysis of the market impact of a specific alleged misstatement, rather than examination of general market efficiency, is a more straightforward and reliable test for whether the fraud on the market theory should be invoked” Serious problems: • Define the event correctly • Setting horizons • Sample selection Assumes validity of CAPM Perpetuates the battle of financial experts • De facto mini-trial Fisch critique: • Event studies ineffective re statements are in line with market expectations • Securities fraud more often arises from an effort to cover up an unexpected problem than from making false statements about positive development 8
- 9. Part III Why the Supreme Court Routinely Gets it Wrong
- 10. Supreme Court Securities law Decisions Widely Criticized Why? Bainbridge & Gulati, How do Judges Maximize? (The Same Way Everybody Else Does— Boundedly): Rules of Thumb in Securities Fraud Opinions, 51 Emory Law Journal 83 (2002) Typically lack a broad, consistent understanding of the relevant public policy considerations. Frequently lack such basics as doctrinal coherence and fidelity to prior opinions. Lack of expertise among Justices • What incentive do they have to deal with “dog” cases? Lack of expertise among clerks
- 11. What not to do What to do Implication for Reading SCOTUS Opinions in Securities Law Courts and commentators read SCOUS opinions as though: • Those decisions were statutes to be interpreted from strict textualist perspective • One could ascribe intentionality to the justice’s utterances Do not ascribe intentionality to the court Interpret Supreme Court decisions in this area narrowly, as reaching only the specific issues before the court • Dictum should be largely ignored 11
Editor's Notes
- The fraud on the market theory came about not by an act of Congress. The fraud-on- the-market presumption was, instead, the work of a bare majority of a bare quorum of this Court. A judicially created rule, tacked on to a judicially created right of action, the fraud-on-the-market presumption did not derive from the text, structure, or history of the federal securities laws. It rested on a policy preference of Justice Blackmun that “[r]equiring proof of individualized reliance” should be dispensed with, so that Section 10(b) plaintiffs could be free to “proceed[] with a class action.”
- As it never enacted a “private cause of action under § 10(b), Congress had no occasion to address how to ... compute ... liability arising from it.” Determining the elements that a private plaintiff must establish to recover damages under Section 10(b) thus requires a kind of “historical reconstruction.” In so doing, the Court has found it “‘anomalous to impute to Congress an intention to expand ... a judicially implied cause of action beyond the bounds it delineated for comparable express causes of action.’ The Court must “face[] the awkward task of answering a hypothetical question—of “attempt[ing] to infer ‘how the 1934 Congress would have addressed the issue had the 10b–5 action been included as an express provision in the 1934 Act.’” And “[f]or that inquiry,” the Court must “use the express causes of action in the securities Acts as the primary model for the § 10(b) action”—“in particular, ... those portions of the 1934 Act most analogous to the private 10b–5 right of action that is of judicial creation,”
- Section 18(a) “impose[s] liability upon defendants who stand in a position most similar to 10b–5 defendants.” In fact, Section 18(a) is the only express private right of action in the 1933 and 1934 Acts that provides an aftermarket damages remedy analogous to that recognized under Section 10(b). Accordingly, the Court must use that express right “as the primary model for the § 10(b) action.” Section 18(a) expressly allows recovery only by persons who buy or sell “in reliance upon” the allegedly false or misleading statement that affects the market price. 15 U.S.C. § 78r(a). Given this unambiguous text, courts have consistently held that “Section 18 requires that a plaintiff establish know- ledge of and reliance upon the alleged misstatements contained in any document filed with the SEC”7—in other words, “‘eyeball’ reliance,” that the plaintiff “actually read and relied on the filed document.” It follows, then, that Section 18’s requirement of actual reliance must also be a prerequisite for the recovery of damages under Section 10(b).
- At oral argument, CJ Roberts commented that the briefs debated precisely how efficient markets really are thought to be by modern economists. He asked: “How am I supposed to review the economic literature and decide which of you is correct?” Justice Ginsburg observed that if the Basic opinion had relied on “common sense,” then changes in economic theory wouldn’t undermine it. I agree. Basic purports to rely on an acceptance of what were then “[r]ecent empirical studies” supporting the efficient capital markets hypothesis, the theory “that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.” But this attempt to appear current on the state of financial economics was unnecessary. Corporate statements are often technical. Ordinary investors do not read them, and would not understand them if they tried. Were they required to show that they relied on the statements to sue, they would lose. Nonetheless, sophisticated stock analysts do read such statements, and do trade on the basis of the information they acquire through them. Because they control large financial resources, they help set the price of the stock through their trades, and unsophisticated investors buy and sell in the market these sophisticated investors have created. Although the unsophisticated investors do not directly rely on the corporate statements, in other words, they buy and sell stock at prices determined in part by people who do read and rely on them. Under the traditional approach, unsophisticated investors would never be able to show reliance, and thus would never recover under Rule 10b-5. They have, however, been damaged just as certainly as if they had read and relied on the statements. The FOM theory is but a fancy justification for the courts’ response—to eliminate the reliance requirement by presuming it. If defendants want to avoid liability, they must now show that their misrepresentation did not affect the market price.
- A amicus brief by Adam Pritchard and Todd Henderson argued that the Justices should avoid addressing the thorny question whether markets are perfectly efficient, and instead focus on whether there has been actual fraudulent distortion of market price — a determination they argue can be made through the use of “event studies.” Jill Fisch. In her article, The Trouble with Basic: Price Distortion after Halliburton, Fisch argues that event studies are of limited use, in part because they are not capable of measuring the effect that inaccurate statements confirming market expectations have on stock prices. For example, although event studies work well when measuring the effect of a fraudulent statement at odds with market expectations (for example, “the third quarter was surprisingly profitable”), they are less effective at measuring statements that are in line with market expectations (for example, “our third quarter profits were just as expected”). Securities fraud more often arises from an effort to cover up an unexpected problem than from making false statements about positive developments, and so Fisch asserts that they are not good tools with which to measure the effect on stock price in most of these cases.
- When deciding securities cases, the Court is faced with hard, dry, and highly technical issues. Supreme Court justices and their clerks arrive on the court with little expertise in securities law. One reasonably assumes that neither the justices nor their clerks have much interest developing substantial institutional expertise in this area after they arrive. (Former Justice Powell being the exception that proves these rules.) Accordingly, it would be surprising if the Court’s securities opinions exhibited anything remotely resembling expert craftsmanship. Under such conditions, we would expect the justices to take securities cases rarely, typically when there is a serious circuit split, which is in fact what we observe. When obliged to take a securities issue, the Court will seek to minimize the amount of effort required to render a decision. This observation is not intended pejoratively. To the contrary, the justices are acting rationally. Supreme Court justices (and their clerks) have a limited ability to master legal information, including the myriad complexities of doctrine and policy in the host of areas annually presented to the court. Specialization is a rational response to bounded rationality—the expert in a field makes the most of his limited capacity to absorb and master information by limiting the amount of information that must be processed by limiting the breadth of the field in which he develops expertise. Supreme Court justices will therefore need to specialize, just as experts in other fields must do. Specializing in securities law would not be rational. The psychic rewards of being a justice—present day celebrity and historical fame—are associated with decisions on great constitutional issues, not the minutiae of securities regulation.
- Courts and commentators at times seem to be read Supreme Court decisions as though those decisions were statutes to be interpreted from strict textualist perspective and one could ascribe intentionality to the justice’s utterances. Implicit in this approach to interpreting Supreme Court decisions is the notion that the Court is sufficiently aware of the import of the words it chooses to ascribe meaning thereto. A theory of Supreme Court decision making founded on bounded rationality, by contrast, argues for declining to ascribe intentionality to the court. Supreme Court decisions in this area should be interpreted narrowly, as reaching only the specific issues before the court, while dictum should be largely ignored. All of which suggests Halliburton will not decide very much.