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Court weighs securities fraud class-action cases

The Supreme Court is considering whether to abandon a quarter-century of precedent and make it tougher for investors to band together to sue corporations for securities fraud.

The justices hear arguments Wednesday in an appeal by Halliburton that seeks to block a class-action lawsuit claiming the energy services company inflated its stock price.

A group of investors says it lost money when Halliburton's stock price dropped after revelations the company misrepresented revenues, understated its liability in asbestos litigation and overstated the benefits of a merger.

(Read more: Supreme Court agrees to hear Omnicare securities case)

Justices threw out the company's first attempt to block the lawsuit in 2011. But Halliburton is now urging the court to overturn a 25-year-old decision that sparked a tidal wave of securities-related, class-action lawsuits against publicly traded companies and has led to billions in settlements.

A U.S. Supreme Court police officer paces along the steps to the court as snow falls on Tuesday, Jan. 21, 2014.
Bill Clark | CQ Roll Call | Getty Images
A U.S. Supreme Court police officer paces along the steps to the court as snow falls on Tuesday, Jan. 21, 2014.

The court's 1988 decision in Basic v. Levinson says shareholders who claim they were defrauded by false statements in securities filings don't have to prove they actually relied on the statements. Rather, the court reasoned that any misrepresentation would be reflected in the current stock price. Even if investors are not aware of the misstatements, they are presumed to be aware of them because they affect the stock price.

This presumption, known as the "fraud-on-the-market theory," has become the driving force for modern class-action securities cases. But some economists have questioned whether this theory makes sense anymore, saying it doesn't account for the sometimes random and arbitrary nature of stock trading.

Four of the Supreme Court's conservative justices—Antonin Scalia, Clarence Thomas, Anthony Kennedy and Samuel Alito—said in a ruling last year that they were willing to reconsider the Basic decision. If they do, Chief Justice John Roberts could be the difference in whether Basic is overturned.

(Read more: US justices extend whistleblower protections)

The court is also considering whether to at least modify Basic and let companies that are sued for securities fraud show that any alleged misrepresentations did not actually distort the stock price.

The investors suing Halliburton argue that the fraud-on-the-market principle remains sound and that the class-action cases help deter fraud. More than 3,000 private class-action securities fraud lawsuits have been filed since 1997, generating more than $73 billion in settlements, according to a group of former Securities and Exchange Commission members who filed a brief urging the court to overturn the 1988 precedent.

The U.S. Chamber of Commerce and the National Association of Manufacturers argue in court briefs that the current doctrine has led to significant costs for investors and businesses and bred confusion in the courts. But the Obama administration has urged the court not to overrule Basic, saying its premise remains sound.

The justices are expected to make a ruling before summer.

The case is Halliburton Co. v. Erica P. John Fund Inc., 13-317.

By The Associated Press

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