May 23 For two months last summer, Stanford Law
School professor Joseph Grundfest locked himself away in his
home office in California's Portola Valley. Grundfest's house
overlooks the Santa Cruz Mountains, but his attention was fixed
on the piles of paper - mostly U.S. Supreme Court opinions and
Congressional reports from the 1930s - stacked on his desk and
the surrounding floor. Grundfest researched and wrote for weeks
with monastic obsessiveness, speaking to hardly anyone but his
research assistants and his wife, who made sure he was eating.
When he emerged in August, Grundfest - an influential former
Commissioner at the U.S. Securities and Exchange Commission who
now sits on the board of the private equity firm KKR & Co - had
in hand a 78-page paper larded with more than 400 footnotes. His
aim was nothing less than to destroy securities fraud class
action lawsuits by shareholders, which have been the bane of
many businesses in the U.S. since the Supreme Court endorsed the
cases 26 years ago.
Grundfest sent the draft around to several other law
professors, including the University of Michigan's Adam
Pritchard, another favorite of pro-business groups. Pritchard
read Grundfest's paper with a sense of familiarity: Five years
earlier, in a study for the Cato Institute, he had pinpointed
the same obscure provision of a 1934 securities law as the means
to curtail big settlements in securities fraud class actions. He
sent Grundfest an email: "I see you've put a new twist on
The intellectual jousting match between Grundfest and
Pritchard is no longer just academic. Any day now, in the case
Halliburton Co v. Erica P. John Fund, the Supreme Court will
decide the future of securities fraud class actions, litigation
that has generated more than $80 billion in settlements and
untold billions more in legal fees. Grundfest and Pritchard
filed competing friend-of-the court briefs, both supporting
Halliburton but advocating different rationales for curtailing
The court may, of course, decide to make no change, but if
the justices do rein in securities fraud litigation, it's widely
expected that they will lean on arguments advanced by Pritchard
But which one?
BEGINNING WITH "BASIC"
The foundation of securities fraud class actions is a 1988
Supreme Court decision in the case Basic v. Levinson. It applied
to fraud litigation a then-voguish economic theory, the
efficient capital markets hypothesis, which posits that share
prices reflect all publicly available information. The court
said that when a broadly-traded corporation publicly
misrepresents the truth, it perpetrates a "fraud on the market"
- so individual shareholders need not show that they relied on
The Basic ruling led to an explosion of shareholder class
actions. The number of filings tripled between 1988 and 1991,
according to Georgetown University law professor Donald
Langevoort, prompting such an outcry from corporate defendants
that Congress rewrote the rules for shareholder class actions
twice in the 1990s. Even after those reforms, the boom in
securities fraud suits continued, resulting in six of the 10
biggest settlements in class action history.
Proponents of the cases argue that they return money to
deceived shareholders and provide a necessary private complement
to the SEC's regulatory enforcement. Detractors claim the suits
don't actually benefit shareholders, just their lawyers. For
decades, pro-business groups such as the U.S. Chamber of
Commerce have railed against shareholder class actions, both in
Congress and in briefs at the Supreme Court. But in 25 years of
litigation challenges, corporate defendants managed only to
restrain securities fraud class actions, not to eliminate them.
Basic v. Levinson seemed to be irreversible - until Justice
Antonin Scalia suggested otherwise at oral arguments in November
2012 in Amgen v. Connecticut Retirement Plans. "Maybe we
shouldn't have this fraud-on-the-market theory," Scalia said.
"Maybe we should overrule Basic."
TWO LINES OF ATTACK
Scalia's comment was apparently prompted by a
friend-of-the-court brief submitted by Pritchard and two other
law professors - the only brief in the Amgen case explicitly to
call on the justices to reverse Basic.
Pritchard has been critiquing the Basic decision since he
was a student editor at the Virginia Law Review in 1991. In his
Cato paper, Pritchard pioneered a theory based on Justice Byron
White's dissent in the Basic case. He focused on the one
provision of the Securities Exchange Act of 1934 (the law
governing securities fraud) that specifically addresses private
shareholder suits. That provision, Section 18, requires
investors to prove they relied on corporate misrepresentations.
Pritchard argued that Section 18 severely restricts the damages
shareholders can collect in fraud class actions.
Along with other law professors, Pritchard also questioned
the economic underpinnings of "fraud on the market" doctrine,
arguing that it's based on an overly simplistic view of share
prices. Pritchard, Yale Law School professor Jonathan Macey and
University of Chicago professor Todd Henderson first pitched
that argument to the Supreme Court in a 2011 friend-of-the-court
brief. They proposed that investors should be required to show
that corporate misrepresentations distorted share prices by
offering evidence of a market correction when the truth was
revealed. Such "price impact" studies usually are submitted in
the late stage of a case, when investors show how much they were
damaged, but the professors said trial judges should require
them before allowing investors to sue as a class.
The following year, Pritchard and Henderson filed a similar
brief in the Amgen case, another challenge to a shareholder
class action. When the Supreme Court came out with its Amgen
opinion in February 2013, four justices bought in. "Recent
evidence suggests that [the Basic decision] may rest on a faulty
economic premise," wrote Justice Samuel Alito. "In light of this
development, reconsideration of the Basic presumption may be
A SHOT AT HISTORY
Those were the words that sent Grundfest into seclusion last
summer, to put on paper an idea he'd been mulling for several
years. The Supreme Court's invitation to revisit Basic was a
chance to make business history - even if curtailing the cases
would cost him the fees he occasionally earns as an expert for
Grundfest's thesis went even further than Pritchard's. In
broad terms, his paper argued that Basic can't override the
language of Section 18. Investors, he said, can't recover money
damages at all without showing they relied on corporate
In its details, Grundfest's approach offered features to win
over the Supreme Court's conservatives. It was grounded in the
text of the 1934 law, which is the preferred approach of
Justices Scalia and Clarence Thomas. It would allow the court to
avoid an economic debate on the efficient capital markets
hypothesis. And its most subtle advantage was that the Supreme
Court wouldn't have to overturn Basic altogether, which would
make it more palatable for a court traditionalist like Chief
Justice John Roberts to support.
Grundfest was itching to test the theory in a live case. He
asked one of the lawyers to whom he'd sent a draft, George
Conway of Wachtell, Lipton, Rosen & Katz, whether Wachtell had
any candidates. Conway, a corporate defense lawyer who has
dabbled in conservative politics, said he'd be on the lookout.
Less than a month later, the perfect opportunity appeared:
Halliburton petitioned the Supreme Court to review an appeals
court's decision allowing shareholders to proceed with a class
action over decade-old claims that the oil-services giant
underestimated its asbestos liability. Grundfest and Conway, who
volunteered his time, honed the professor's 78-page paper into a
brief urging the Supreme Court to take Halliburton's case.
Grundfest, also working without pay on this project, jumped on
the phone and the computer to rally support for his filing.
"It was a labor of love," said Conway in an email. Added
Grundfest: "Totally pro bono, not a nickel from anywhere."
Grundfest ultimately recruited a dozen other professors and
former SEC officials to sign the brief, which described the 1988
precedent as "the most powerful engine of civil liability ever
established in American law."
One of the few professors who declined Grundfest's
invitation was Pritchard. He had his own ideas.
Last November, the court voted to hear Halliburton's appeal.
The justices do not announce their votes or reasoning, so it's
impossible to know whether the Grundfest brief influenced their
decision. But it influenced Halliburton. After the justices
agreed to take the case, Halliburton's lawyers at Baker Botts
adopted the Section 18 argument and cited Grundfest's paper in
the company's brief.
Grundfest made a new round of calls to law professors and
former SEC officials to garner support for a brief reiterating
support for Halliburton. In addition, he and Conway urged a
friend, a former lawyer for the Senate Banking Committee, to
organize a brief arguing that Congress didn't mean to endorse
Basic when it failed to overturn the ruling in reforming
Pritchard, meanwhile, revised the brief from the Amgen case
to add his own Section 18 argument, then looked around for
co-signers. Chicago's Henderson said he'd join, even though he'd
also signed Grundfest's filing. No one else agreed to join the
On the other side, a group of 18 law professors banded
together in a friend-of-the-court brief arguing for the status
quo. One of them was Georgetown's Langevoort, who said the Basic
decision simply gives "the person who has been hurt the right to
sue." He was unmoved by the briefs from Grundfest and Pritchard.
"Nothing in defendants' arguments denies that there is
substantial harm from companies' lies," he said.
A GAME OF BINGO
Grundfest and his wife flew to Washington, D.C., for the
March 5 oral arguments in the Halliburton case. The night before
the hearing, they had dinner with Conway and a couple of other
friends and speculated about the questions the court would ask.
"We should make Bingo cards!" Grundfest said. Later that
night, he did. On plain white paper labeled "Halliburton Bingo,"
the squares included "Section 18(a)," "Justice White," and
"Lerach," a reference to the former plaintiffs lawyer Bill
Lerach, who was convicted of criminal conspiracy for his role in
a kickback scheme, and whose tactics prompted Congress to reform
private securities litigation. Grundfest also included himself
and Pritchard - in separate squares. The next morning, he handed
the Bingo cards out to friends.
Pritchard skipped the arguments and took his kids to Disney
Halliburton lawyer Aaron Streett led off the company's
argument with an oblique reference to Section 18. But then,
several minutes into his presentation, the argument took a turn.
Justice Anthony Kennedy asked, "Would you address briefly the
position taken by the law professors, I call it the midway
position, that says there should be an event study?"
Justice Kennedy and other justices kept coming back to "the
law professors' position," meaning Pritchard and Henderson, not
Grundfest. The price impact argument had stolen the court's
David Boies, who represented the shareholders suing
Halliburton, emphasized that price impact studies are complex,
expensive and time-consuming. But a lawyer for the government,
which argued in support of the shareholders, conceded that the
consequence of requiring such studies would not be dramatic.
The buzz outside of the courtroom after oral argument was
all about the brief that had inspired so much interest from the
justices. A cluster of shareholder lawyers standing in the
Supreme Court lobby expressed relief that the justices seemed
inclined to compromise instead of erasing their business. None
would talk on the record, but one plaintiffs lawyer said that if
the Halliburton decision ended up requiring shareholders to show
market impact, "We can live with that."
After the argument, Grundfest called Pritchard. "He said,
'good for you,'" Pritchard said.
Weeks later, as he waited for the Supreme Court's opinion,
Pritchard declined to hazard a guess about the outcome,
predicting only that Chief Justice Roberts will be the swing
vote. Grundfest, meanwhile, was still hoping his ideas will
influence the court. He said he could envision a three-way split
in which the three most liberal justices ruled to leave Basic
untouched, the three most conservative voted to overturn it and
the three in the middle opted to leave Basic intact and add a
price-impact test. That would mean a victory for Pritchard and
corporate defendants-even if it's not all that Grundfest,
Halliburton and the broader business lobby had hoped for.
"It's 50-50-50," Grundfest said.
(Reporting By Alison Frankel; Editing by Amy Stevens, Martin