(Reuters) - Two highly influential securities law professors, Adam Pritchard of the University of Michigan and Todd Henderson of the University of Chicago, filed an amicus brief Monday at the U.S. Supreme Court, backing a petition for review (2017 WL 5127301) by the Brazilian oil and gas company Petrobras and its underwriters. Petrobras wants the justices to overturn a decision from last July in which the 2nd U.S. Circuit Court of Appeals affirmed certification of a class of investors suing the company for securities fraud. Pritchard and Henderson join an array of Petrobras amici, including the Securities Industry and Financial Markets Association and nearly two dozen other law and economics professors urging the Supreme Court to grant review of the 2nd Circuit decision.
They have an uphill fight.
There’s a lot of talk in the Petrobras petition and the amicus briefs about uncertainty in the lower courts on what evidence investors must offer in order to invoke the presumption of reliance on alleged corporate misstatements. As you surely recall, the Supreme Court established that presumption – and provided the foundation for securities fraud class actions – in 1988’s Basic v. Levinson (108 S.Ct. 978). In its 2014 reconsideration of Basic, Halliburton v. Erica P. John Fund (134 S.Ct. 2398), the court left the presumption intact but said defendants have a right to rebut it before the shareholder class is certified by showing the market for their shares does not meet the Supreme Court’s definition of efficiency. Petrobras and its amici argue that trial judges, in particular, need more help from the Supreme Court to understand the evidentiary standard for disproving market efficiency.
But as Petrobras shareholders pointed out in their brief opposing Supreme Court review, there is no conflict among the federal circuits on the particular issue Petrobras has raised, whether class certification requires investors to present empirical evidence that a company’s share price fell in response to the exposure of previous misrepresentations. Even Petrobras admitted there’s not much of a circuit split, though the company and its underwriters said that’s because circuit court rulings interpreting the Supreme Court’s precedent in Basic and Halliburton are rare.
So Petrobras and its amici are relying on the argument that the 2nd Circuit has gone rogue, disregarding Supreme Court precedent and, as the SIFMA brief put it, “substantially lowering the bar” for securities class action plaintiffs. The Petrobras investors can’t credibly deny that: Their law firm of record, Pomerantz, put out a statement after the 2nd Circuit elaborated on its Petrobras standard in a subsequent decision in a securities class action against Barclays that said the 2nd Circuit had provided “a far easier … path for securities class action plaintiffs going forward.” (Pomerantz was also counsel to the Barclays investors.)
That Barclays decision (875 F.3d 79), issued last month, features prominently in arguments by Petrobras and its amici that the 2nd Circuit has essentially made it impossible for large, publicly traded companies to defeat class certification in shareholder fraud cases.
Typically, as the new brief by Pritchard and Henderson explains quite lucidly, shareholders rely on empirical “event studies” – complex regression analyses – to isolate the impact of any particular event on a company’s share price. If shareholders dump stock after a corporation discloses misrepresentations, an event study should be able to show the share price fell in response to the disclosure and not to market forces unrelated to fraud. Event studies, the law profs wrote, are the gold standard for establishing the alleged fraud’s price impact.
Event studies often come into play at the class certification stage of shareholder fraud litigation if defendants attempt to rebut the Basic v. Levinson fraud-on-the-market presumption. The presumption is grounded in the idea that an efficient market reacts rationally to information like a corrective disclosure. Corporations whose shares are widely traded on U.S. exchanges can only contest market efficiency by arguing that investors did not react to new information. Plaintiffs’ lawyers typically use event studies to prove shareholders bought or sold in response to particular news events.
In the Petrobras case, the defendants contested shareholder event studies as proof of market efficiency because, they said, the investors’ economic analyses did not establish a direct connection between bad news and a drop in Petrobras’s share price. (They showed the market responded to news, but not necessarily in expected ways.) The 2nd Circuit said indirect evidence can also prove market efficiency. “Event studies offer the seductive promise of hard numbers and dispassionate truth, but methodological constraints limit their utility in the context of single-firm analyses,” the appeals court said.
The 2nd Circuit pushed that interpretation to its logical limit in the Barclays case, in which the appeals court said not only that shareholders don’t even have to provide an event study in order to invoke the Basic v. Levinson presumption but also that defendants bear the heavy burden of proving by a preponderance of the evidence that the market for their shares is not efficient. Barclays, as I’ve reported, claimed in a motion for rehearing that the 2nd Circuit opinion skews the balance of power in securities litigation so unfairly that it undermines the very integrity of U.S. capital markets.
Petrobras and its amici don’t go that far. But they do say the Barclays decision shows the 2nd Circuit is entrenched in its shareholder-friendly standard for establishing market efficiency. Put another way, the appeals court has made it very, very tough for defendants to rebut the Basic presumption that allows shareholders to win class certification.
“Prior to the (Petrobras) decision and the court’s subsequent decision in Waggoner v. Barclays, courts throughout the nation held that to draw an inference of reliance, plaintiffs in securities fraud cases must prove — at a bare minimum — that the price of a security reacted favorably to good news (and unfavorably to bad news),” the Petrobras reply brief said. “Now, fundamentally misinterpreting Halliburton II, the 2nd Circuit has held that plaintiffs are entitled to an inference of reliance on a misrepresentation — and can shift the burden to defendants to disprove reliance — based solely on proof that the defendant has characteristics shared by all large companies: high trading volume, coverage by many analysts, multiple market makers, and eligibility to file simplified registration statements.”
The Supreme Court is scheduled to conference on the Petrobras petition on Jan. 5. Petrobras is represented by Cleary Gottlieb Steen & Hamilton. Skadden Arps Slate Meagher & Flom represents the underwriters.