The US Supreme Court considers the “fraud on the market” theory but does not overturn 1988 precedent

published Sep 02, 2014
Recently, the US Supreme Court rejected an attempt to overturn a 1988 precedent in which the US Supreme Court recognised the "fraud on the market" theory, a rebuttable presumption of shareholder reliance on a listed company’s material public misrepresentations, recognised by US courts since 1988. Had the decision been decided differently, this may have been influential on courts in Australia.

As many of you will be aware, in Australia, the courts have not determined the test for causation in securities class actions. While this issue has been the subject of two reserved judgments by courts in Australia, there is presently no authoritative statement of the test to be applied.

Since 1988, courts in the United States have recognised a rebuttable presumption of shareholder reliance on a listed company’s material public misrepresentations.  This is known as the “fraud on the market” theory.  This presumption is based on the “efficient market hypothesis” and that the market price of a security reflects the company’s true value. If the presumption is applied, class members do not have to prove individual reliance on the alleged misrepresentations.

Recently, in a shareholder class action in the United States against Halliburton Co, the US Supreme Court was asked to reconsider the “fraud on the market” theory and to require that every class member prove actual reliance on the company’s misrepresentations.

By a 6:3 majority, Halliburton failed to persuade the court that the 1988 precedent should be overturned.  This means that the “market-based causation” argument advanced by claimants in Australia is unaffected.  Had the US Supreme Court overturned the 1988 precedent, this may have been influential on courts in Australia and could have affected acceptance by courts in Australia of a “market-based causation” argument as the correct test for causation in securities class actions.