The U.S. Supreme Court’s iffy economics are shortchanging investors. The top court assumes the prices of listed shares reflect all public information, including lies. That allows owners of widely traded stock to sue en masse but cuts out others. A case against Halliburton gives the justices an opportunity to rethink their rules and focus more on duped investors.
Shareholders of the oil services company claim they overpaid for its stock because it lied about asbestos liabilities and other matters. As in most securities fraud class actions, they haven’t had to prove that each relied on the alleged misrepresentations. If the statements really were factored into the share value, as the so-called efficient markets theory predicts, reliance can be presumed.
The theory, though, isn’t universally accepted. And it applies only in well-developed, high-volume markets. Many stocks don’t trade on such exchanges, so judges have to determine which ones do.
That’s a tall order for jurists lacking economic expertise. Even if they make the right call, defrauded shareholders who happen to own lightly traded stock can’t file class actions. And whatever the ruling, companies lack any way to show that a misrepresentation didn’t affect share value and cause losses.
Halliburton’s solution is to eliminate the presumption of reliance. A better approach would be to avoid the issue of market efficiency and focus instead on whether an alleged lie affected a stock’s price.
Investors could use so-called event studies, already common in courts, to show that a stock’s value dropped or rose when a misrepresentation occurred or was revealed. Companies could try to rebut the evidence. If they failed, the presumption of reliance would kick in, allowing shareholders to sue as a class.
Proof of stock movement typically isn’t required until a lawsuit’s later stages, giving investors time to develop evidence. Requiring such proof earlier shouldn’t be much of a burden, though, considering the alternatives: a status quo that precludes some fraud victims from suing – or a sharp drop in securities class actions.
The latter would please the likes of Halliburton but seriously harm investors. Such suits have proven effective at punishing financial wrongdoing. The Supreme Court has a chance not just to preserve them, but to improve them as well.