Supreme Court, don’t tread on small investors

For more than a quarter of a century, investors have been able to bring class-action lawsuits against companies that have fraudulently inflated their stock prices without having to prove that each buyer of the stock had been individually duped. Now, industrial giant Halliburton Co. is trying to persuade the Supreme Court to make such lawsuits significantly harder, if not impossible, to bring. That would be a fantastic result for publicly traded companies, but a terrible one for the average investor.

While securities fraud can be devastating to small investors, their losses rarely are large enough to make it worthwhile for them to sue as individuals. That’s why class-action suits that combine the claims of all the defrauded investors are vital to protecting the little guy on Wall Street. The Supreme Court gave such suits a boost in 1988, ruling that federal law did not require each member of a class to show that he or she had seen and relied on a company’s fraudulent statements before buying a stock. Instead, the court said, it made sense to presume that most publicly available information is rapidly incorporated into a stock’s price, so that misleading statements given to some investors could cause a fraud on the entire market for that stock.

The new case started in 2002, when a group of Halliburton investors sought to recover losses they blamed on allegedly misleading representations the company made about its asbestos liabilities, construction revenue and merger efficiencies. After a series of rulings that allowed the case to proceed as a class action, Halliburton appealed to the Supreme Court, arguing that the 1988 ruling’s “fraud on the market” approach was no longer appropriate.

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According to Halliburton, many of today’s investors don’t care whether a company’s stock price accurately reflects its value because it’s immaterial to their investing strategy. That may be true, but as a group of securities-law experts advised the court, it doesn’t change the fact that stock prices respond when significant information about a company is disclosed, or that typical investors rely on the integrity of those prices. It’s fair to presume that if a deceptive statement affected the value of a company, the losses later suffered by the entire class of investors can be tied to that fraud.

At the oral argument Wednesday, Justice Anthony M. Kennedy suggested a compromise path: Before a court could allow a securities fraud case to become a class action, investors would have to show that the alleged fraud raised the price they had to pay for the stock. But that’s the sort of factual dispute that trials are designed to resolve, after both sides have gained access to all the available evidence. More important, Congress has clearly signaled its satisfaction with the court’s 1988 interpretation of securities law, leaving the fraud-on-the-market approach intact even as it put new limits on securities class actions. That’s all the more reason for the court to leave this precedent alone.