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Halliburton: Do Plaintiffs Have A Fix In Affiliated Ute?
Law360, New York (February 13, 2014, 2:07 PM ET) -- Even the most experienced securities defense
attorneys regularly summarize Rule 10b-5(b) as creating a cause of action for “false or misleading
statements and omissions of material fact.” Courts — including the U.S. Supreme Court — routinely use
the same shorthand.
When I was a new securities litigation defense attorney, one of the first things that I learned was the
importance of adding the rest of the sentence: “false or misleading statements and omissions of
material fact necessary to make statements made not misleading.”
One of the most common misconceptions about federal securities laws is that Rule 10b-5(b) creates a
cause of action for omissions as well as for false or misleading statements. But by the express terms of
the rule, and Supreme Court precedent, omissions are only actionable if they cause an affirmative
statement to be false or misleading because of the information that was omitted.
In other words, when a claim is based upon an alleged omission, it is not enough for a plaintiff to
demonstrate that something was omitted, or even that the omitted fact was material. Rather, in order
to state a cause of action, the omitted information must have made an affirmative statement materially
misleading by creating “an impression of a state of affairs that differs in a material way from the one
that actually exists.” See Brody v. Transitional Hospitals Corp., 280 F.3d 997, 1006 (9th Cir. 2002).
It is understandable that plaintiffs’ attorneys would try to obscure this standard. If all they needed to
establish was that material information was omitted, it would be relatively easy to bring a successful
claim.
No matter how much is disclosed, you can always find something that was omitted, and the squishy
standard for materiality leaves plenty of room to make a case that the omission was material. But the
key to many successful motions to dismiss is to hold plaintiffs to the text of the rule: whether they are
alleging an affirmative lie, or a lie by omission, they must point to a statement that was false or
misleading.
In the building frenzy among securities attorneys over the possible consequences of the Supreme
Court’s upcoming ruling in Halliburton Co. v. Erica P. John Fund, this key distinction has been widely
forgotten. As attorneys contemplate the possible demise of the fraud-on-the-market presumption laid
down in Basic v. Levinson, there is wide speculation about how, in the face of such a ruling, securities
class actions might continue. (See Doug Greene’s discussion of the possible impact of Halliburton.)
One theory that has been repeatedly put forward by defense attorneys and legal commentators is that
plaintiffs’ attorneys could cast their claims as alleging only material omissions, rather than false or
misleading statements. The theory is that this approach would allow plaintiffs to sidestep the formidable
obstacle of proving classwide reliance in the absence of the fraud-on-the-market presumption, by taking
advantage of a Supreme Court ruling that indicated that proof of reliance was not necessary to support
a claim based on omissions. See Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972).
Wrote one securities litigation defense firm: if the Halliburton court rejects the fraud-on-the-market
presumption, “plaintiffs could turn to the Affiliated Ute presumption, in which a plaintiff can avoid
pleading actual reliance in a case framed as a material omission ... The Affiliated Ute presumption will
allow plaintiffs’ lawyers to recast their affirmative misrepresentation claims as pure omission claims,
which do not need to rely on the fraud-on-the-market presumption to proceed. ... Parties will vigorously
litigate whether the crux of a case concerns affirmative misstatements, pure omissions, or both.”
But Affiliated Ute does not offer a quick fix to the potential elimination of Basic’s fraud-on-the-market
presumption. Affiliated Ute did not involve public statements or the securities markets, much less a
securities class action under Rule 10b-5(b). Rather, it involved face-to-face transactions among a
relatively small group of individuals related to the allocation of Native American mineral rights.
The Affiliated Ute court found that the defendants had failed to disclose material information to Native
Americans as part of a fraudulent scheme to induce them to sell their mineral rights below market
value. The court found that this created liability under Rule 10b-5(a) and (c), the subsections of the rule
that create liability for a fraudulent “device, scheme or artifice” or “practice or course of business.” In
these circumstances, the court held that causation was established, and the plaintiffs did not need to
prove “reliance” on the material omissions.
The Affiliated Ute ruling is thus based on the existence of a material omission as part of a fraudulent
scheme. But as the Supreme Court pointed out in Basic, and recently reaffirmed in Matrixx: “Silence,
absent a duty to disclose, is not misleading under Rule 10b-5.” Basic Inc. v. Levinson, 485 U.S. 224, 239
n.17 (1988); Matrixx Initiatives Inc. v. Siracusano, 131 S. Ct. 1309, 1322 (2011).
No matter how material it might be, an omission is not actionable unless there is a duty to disclose. See,
e.g., In re Time Warner Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir. 1993) (“[A] corporation is not required to
disclose a fact merely because a reasonable investor would very much like to know that fact.”).
There are specific circumstances under which such a duty to disclose might arise — for example, when
there is a fiduciary relationship between the parties, if an insider is trading stock, or under Items 303 or
503 of Regulation S-K relating to public offerings.
But Rule 10b-5(b), the traditional territory of securities class actions, imposes no such requirement. For
this reason, as several courts have pointed out, the “presumption” of reliance on material omissions
that developed from Affiliated Ute does not implicate core securities fraud claims. See, e.g., Regents of
the University of California v.Credit Suisse First Boston, 482 F. 3d 372, (5th Cir. 2007) (clarifying that
Affiliated Ute does not apply to actions for misrepresentations under Rule 10b-5(b)).
Thus, plaintiffs cannot simply recast their securities fraud allegations as “omissions,” as many
commentators have suggested, and cause the parties to have to “litigate whether the crux of a case
concerns affirmative misstatements, pure omissions, or both.” Plaintiffs may only state a claim under
10b-5(b) based on an affirmative misstatement — whether that affirmative statement was misleading
because of what it said, or because of what it did not say.
Under Affiliated Ute itself, the presumption of reliance on omissions is only invoked under Rule 10b-5 if
there is proof of a fraudulent “course of business” or a “device, scheme or artifice that operated as a
fraud” — under the rule’s little-used subsections (a) and (c).
Do these subsections — which are not necessarily dependent upon affirmative misstatements — create
a route for plaintiffs to find a way around the potential rejection of the fraud-on-the-market
presumption? Maybe in some cases, where plaintiffs are able to allege additional facts necessary to
show some form of “scheme” liability under these subsections. See Credit Suisse, 482 F.3d at 384
(“Merely pleading that defendants failed to fulfill [a duty to disclose] by means of a scheme or act,
rather than by a misleading statement, does not entitled plaintiffs to employ the Affiliated Ute
presumption.”).
But that potential “solution” raises more questions than it answers, since the law surrounding these
subsections is far less developed that the law of Rule 10b-5(b), and incorporates a number of additional
complexities.[1]
One thing is clear. Affiliated Ute does not offer a straightforward solution for plaintiffs’ lawyers if the
Halliburton court takes away the fraud-on-the-market presumption. Whether they phrase their
allegations as claims of affirmatively false statements or statements made false by omission, they are
still claims based on statements, not omissions, and current law requires that plaintiffs find a way to
show classwide reliance.
—By Claire Loebs Davis, Lane Powell PC
Claire Loebs Davis is a shareholder in Lane Powell's Seattle office.
This article first appeared in Lane Powell's blog, D&O Discourse.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its
clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general
information purposes and is not intended to be and should not be taken as legal advice.
[1] For example, the courts have established that Rule 10b-5 imposes a duty to disclose material
nonpublic information on a defendant who sells stock. But this “omission” claim is difficult for plaintiffs’
lawyers to bring, because a plaintiff must be a contemporaneous buyer to have standing — which
generally means the plaintiff must have purchased stock in the few days surrounding when the
defendant sold. The standing requirement also restricts damages for such a claim to a class of
contemporaneous purchasers — a much smaller group than the typical class in a securities class action
arising out of a false or misleading statement, which can include purchasers of stock over a period of
several years.
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