This year will be remembered as the year of the Super Bowl of securities litigation, Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), 134 S. Ct. 2398 (2014), the case that finally gave the Supreme Court the opportunity to overrule the fraud-on-the-market presumption of reliance, established in 1988 in Basic v. Levinson.

Yet, for all the pomp and circumstance surrounding the case, Halliburton II may well have the lowest impact-to-fanfare ratio of any Supreme Court securities decision, ever.  Indeed, it does not even make my list of the Top 5 most influential developments in 2014 – developments that foretell the types of securities and corporate-governance claims plaintiffs will bring in the future, how defendants will defend them, and the exposure they present.

Topping my Top 5 list is a forthcoming Supreme Court decision in a different, less-heralded case – Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund.  Despite the lack of fanfare, Omnicare likely will have the greatest practical impact of any Supreme Court securities decision since the Court’s 2007 decision in Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308  (2007).  After discussing my Top 5, I explain why Halliburton II does not make the list.

5.         City of Providence v. First Citizens BancShares:  A Further Step Toward Greater Scrutiny of Meritless Merger Litigation

In City of Providence v. First Citizens BancShares, 99 A.3d 229 (Del. Ch. 2014), Chancellor Bouchard upheld the validity of a board-adopted bylaw that specified North Carolina as the exclusive forum for intra-corporate disputes of a Delaware corporation.  The ruling extended former Chancellor Strine’s ruling last year in Boilermakers Local 154 Retirement Fund v. Chevron, 73 A.3d 934 (Del Ch. 2013), which validated a Delaware exclusive-forum bylaw.  These types of bylaws largely are an attempt to bring some order to litigation of shareholder challenges to corporate mergers and other transactions.

Meritless merger litigation is a big problem.  Indiscriminate merger litigation is a slap in the face to careful directors who have worked hard to understand and approve a merger, or to CEOs who have spent many months or years working long hours to locate and negotiate a transaction in the shareholders’ best interest.  It is cold comfort to know that nearly all mergers draw shareholder litigation, and that nearly all of those cases will settle before the transaction closes without any payment by the directors or officers personally.  And we know the system is broken when it routinely allows meritless suits to result in significant recoveries for plaintiffs’ lawyers, with virtually nothing gained by companies or their shareholders.

Two years ago, I advocated for procedures requiring shareholder lawsuits to be brought in the company’s state of incorporation.  Exclusive state-of-incorporation litigation would attack the root cause of the merger-litigation problem: the inability to consolidate cases and subject them to a motion to dismiss early enough to obtain a ruling before negotiations to achieve settlement before the transaction closes must begin.  Although the problem is virtually always framed in terms of the oppressive cost and hassle of multi-forum litigation, good defense counsel can usually manage the cost and logistics.  Instead, the bigger problem, and the problem that causes meritless merger litigation to exist, is the inability to obtain dismissals.  This is primarily so because actions filed in multiple forums can’t all be subjected to a timely motion to dismiss, and a dismissal in one forum that can’t timely be used in another forum is a hollow victory.  If there were a plenary and meaningful motion-to-dismiss process, less-meritorious cases would be weeded out early, and plaintiffs’ lawyers would bring fewer meritless cases.  The solution is that simple.

Exclusive litigation in Delaware for Delaware corporations is preferable, because of Delaware’s greater experience with merger litigation and likely willingness to weed out meritless cases at a higher rate.  But the key to eradicating meritless merger litigation is consolidation in some single forum, and not every Delaware corporation wishes to litigate in Delaware.  So I regard First Citizens’ extension of Chevron to a non-Delaware exclusive forum as a key development.

4.         SEC v. Citigroup:  The Forgotten Important Case

On June 4, 2014, in SEC v. Citigroup, 752 F.3d 285 (2d Cir. 2014), the Second Circuit held that Judge Rakoff abused his discretion in refusing to approve a proposed settlement between the SEC and Citigroup that did not require Citigroup to admit the truth of the SEC’s allegations.  Judge Rakoff’s decision set off a series of events that culminated in the ruling on the appeal, about which people seemed to have forgotten because of the passage of time and intervening events.

Once upon a time, way back in 2012, the SEC and Citigroup settled the SEC’s investigation of Citigroup’s marketing of collateralized debt obligations.  In connection with the settlement, the SEC filed a complaint alleging non-scienter violations of the Securities Act.  The same day, the SEC also filed a proposed consent judgment, enjoining violations of the law, ordering business reforms, and requiring the company to pay $285 million. As part of the consent judgment, Citigroup did not admit or deny the complaint’s allegations.  Judge Rakoff held a hearing to determine “whether the proposed judgment is fair, reasonable, adequate, and in the public interest.”  In advance, the court posed nine questions, which the parties answered in detail.  Judge Rakoff rejected the consent judgment.

The rejection order rested, in part, on the court’s determination that any consent judgment that is not supported by “proven or acknowledged facts” would not serve the public interest because:

  • the public would not know the “truth in a matter of obvious public importance”, and
  • private litigants would not be able to use the consent judgment to pursue claims because it would have “no evidentiary value and      no collateral estoppel effect”.

The SEC and Citigroup appealed.  While the matter was on appeal, the SEC changed its policy to require admissions in settlements “in certain cases,” and other federal judges followed Judge Rakoff’s lead and required admissions in SEC settlements.  Because of the SEC’s change in policy, many people deemed the appeal unimportant.  I was not among them; the Second Circuit’s decision remained of critical importance, because the extent to which the SEC insists on admissions will depend on the amount of deference it receives from reviewing courts – which was the issue before the Second Circuit.  It stands to reason that the SEC would have insisted on more admissions if courts were at liberty to second-guess the SEC’s judgment to settle without them.  Greater use of admissions would have had extreme and far-reaching consequences for companies, their directors and officers, and their D&O insurers.

So it was quite important that the Second Circuit held that the SEC has the “exclusive right” to decide on the charges, and that the SEC’s decision about whether the settlement is in the public interest “merits significant deference.”

3.         Wal-Mart Stores, Inc. v. Indiana Elec. Workers Pension Trust Fund IBEW:  Delaware Supreme Court’s Adoption of the Garner v. Wolfinbarger “Fiduciary” Exception to the Attorney-Client Privilege Further Encourages Use of Section 220 Inspection Demands

On July 23, 2014, the Delaware Supreme Court adopted the fiduciary exception to the attorney-client privilege, which originated in Garner v. Wolfinbarger, 430 F.2d 1093 (5th Cir. 1970), and held that stockholders who make a showing of good cause can inspect certain privileged documents.  Although this is the first time the Delaware Supreme Court has expressly adopted Garner, it had previously tacitly adopted it, and the Court of Chancery had expressly adopted it in Grimes v. DSC Communications Corp., 724 A.2d 561 (Del. Ch. 1998).

In my view, the importance of Wal-Mart is not so much in its adoption of Garner – given its previous tacit adoption – but instead is in the further encouragement it gives stockholders to use Section 220.  Delaware courts for decades have encouraged stockholders to use Section 220 to obtain facts before filing a derivative action.  Yet the Delaware Supreme Court, in the Allergan derivative action, Pyott v. Louisiana Municipal Police Employees’ Retirement System  (“Allergan”), 74 A.3d 612 (Del. 2013), passed up the opportunity to effectively require pre-litigation use of Section 220.  In Allergan, the court did not adopt Vice Chancellor Laster’s ruling that the plaintiffs in the previously dismissed litigation, filed in California, provided “inadequate representation” to the corporation because, unlike the plaintiffs in the Delaware action, they did not utilize Section 220 to attempt to determine whether their claims were well-founded.  Upholding the Court of Chancery’s presumption against fast-filers would have strongly encouraged, if not effectively required, shareholders to make a Section 220 demand before filing a derivative action.

In Wal-Mart, however, the Delaware Supreme Court provided the push toward Section 220 that it passed up in Allergan.  Certainly, expressly adopting Garner will encourage plaintiffs to make more Section 220 demands.  That should cause plaintiffs to conduct more pre-filing investigations, which will decrease filings to some extent.  But increased use of 220 also means that the cases that are filed will be more virulent, because they are selected with more care, and are more fact-intensive – and thus tend to be more difficult to dispose of on a motion to dismiss.

2.         City of Livonia Employees’ Retirement System v. The Boeing Company:  Will Defendants Win the Battle but Lose the War?

On August 21, 2014, Judge Ruben Castillo of the Northern District of Illinois ordered plaintiffs’ firm Robbins Geller Rudman & Dowd to pay defendants’ costs of defending a securities class action, as Rule 11 sanctions for “reckless and unjustified” conduct related to reliance on a confidential witness (“CW”) whose testimony formed the basis for plaintiffs’ claims.  2014 U.S. Dist. LEXIS 118028 (N.D. Ill. Aug. 21, 2014).

I imagine that some readers may believe that, as a defense lawyer, I’m including this development because one of my adversaries suffered a black eye.  That’s not the case at all.  Although I’m not in a position to opine on the merits of the Boeing CW matter, I can say that I genuinely respect Robbins Geller and other top plaintiffs’ firms.  And beware those who delight in the firm’s difficulties: few lawyers who practice high-stakes litigation at a truly high level will escape similar scrutiny at some point in a long career.

But beyond that sentiment, I have worried about the Boeing CW problem, as well as similar problems in the SunTrust and Lockheed cases, because of their potential to cause unwarranted scrutiny of the protections of the Private Securities Litigation Reform Act.  I believe the greatest risk to the Reform Act’s protections has always been legislative backlash over a perception that the Reform Act is unfair to investors. The Reform Act’s heavy pleading burdens have caused plaintiffs’ counsel to seek out former employees and others to provide internal information.  The investigative process is often difficult and is ethically tricky, and the information it generates can be lousy.  This is so even if plaintiffs’ counsel and their investigators act in good faith – information can be misunderstood, misinterpreted, and/or misconstrued by the time it is conveyed from one person to the next to the next to the next.  And, to further complicate matters, CWs sometimes recant, or even deny, that they made the statements on which plaintiffs rely.  The result can be an unseemly game of he-said/she-said between CWs and plaintiffs’ counsel, in which the referee is ultimately an Article III judge.  At some point, Congress will step in to reform this process.

Judge Rakoff seemed to call for such reform in his post-dismissal order in the Lockheed matter:

The sole purpose of this memorandum … is to focus attention on the way in which the PSLRA and decisions like Tellabs have led plaintiffs’ counsel to rely heavily on private inquiries of confidential witnesses, and the problems this approach tends to generate for both plaintiffs and defendants.  It seems highly unlikely that Congress or the Supreme Court, in demanding a fair amount of evidentiary detail in securities class action complaints, intended to turn plaintiffs’ counsel into corporate ‘private eyes’ who would entice naïve or disgruntled employees into gossip sessions that might help support a federal lawsuit. Nor did they likely intend to place such employees in the unenviable position of having to account to their employers for such indiscretions, whether or not their statements were accurate. But as it is, the combined effect of the PSLRA and cases like Tellabs are likely to make such problems endemic.

Rather than tempt Congress to revisit the Reform Act’s protections (which defendants should want to avoid) and/or allow further unseemly showdowns (which plaintiffs and courts should want to avoid), plaintiffs, defendants, and courts can begin to reform the CW process through some basic measures, including requiring declarations from CWs, requiring them to read and verify the complaint’s allegations citing them, and requiring plaintiffs to plead certain information about their CWs.  As I’ve previously written, these reforms would have prevented the problems at issue in the Boeing, SunTrust, and Lockheed matters, and would result in more just outcomes in all cases.

1.         Omnicare:  In My Opinion, the Most Important Supreme Court Case Since Tellabs

Omnicare concerns what makes a statement of opinion false.  Opinions are ubiquitous in corporate communications.  Corporations and their officers routinely share subjective judgments on issues as diverse as asset valuations, strength of current performance, risk assessments, product quality, loss reserves, and progress toward corporate goals.  Many of these opinions are crucial to investors, providing them with unique information and insight.  If corporate actors fear liability for sharing their genuinely held beliefs, they will be reluctant to voice their opinions, and shareholders would be deprived of this vital information.

The standard that the federal securities laws use to determine whether an opinion is “false” is therefore of widespread importance. Although this case only involves Section 11, it poses a fundamental question: What causes an opinion or belief to be a “false statement of material fact”?  The Court’s answer will affect the standards of pleading and proof for statements of opinion under other liability provisions of the federal securities laws, including Section 10(b), which likewise prohibit “untrue” or “false” statements of “material fact.”

In the Sixth Circuit decision under review, the court held that a showing of so-called “objective falsity” alone was sufficient to demonstrate falsity in a claim filed under Section 11 of the Securities Act – in other words, that an opinion could be false even if was genuinely believed, if it was later concluded that the opinion was somehow “incorrect.”  On appeal, Omnicare contends, as did we in our amicus brief on behalf of the Washington Legal Foundation (“WLF”), that this ruling was contrary to the U.S. Supreme Court’s decision in Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1095 (1991).  Virginia Bankshares held that a statement of opinion is a factual statement as to what the speaker believes – meaning a statement of opinion is “true” as long as the speaker honestly believes the opinion expressed, i.e., if it is “subjectively” true.

Other than a passing and unenthusiastic nod made by plaintiffs’ counsel in defense of the Sixth Circuit’s reasoning, the discussion at the oral argument assumed that some showing other than so-called “objective falsity” would be required to establish the falsity of an opinion. Most of the argument by Omnicare, the plaintiffs, and the Solicitor General revolved around what this additional showing should be, as did the extensive and pointed questions from Justices Breyer, Kagan, and Alito.

It thus seems unlikely from the tone of the argument that the Court will affirm the Sixth Circuit’s holding that an opinion is false if it is “objectively” untrue.  If the pointed opening question from Chief Justice Roberts is any indication, the Court also may not fully accept Omnicare’s position, which is that an opinion can only be false or misleading if it was not actually believed by the speaker.  It seems more probable that the Supreme Court will take one of two middle paths – one that was advocated by the Solicitor General at oral argument, essentially a “reasonable basis” standard, or one that was advanced in our brief for the WLF, under which a statement of opinion is subjected to the same sort of inquiry about whether it was misleading as for any other statement.  Under WLF’s proposed standard, plaintiffs would be required to demonstrate either that an opinion was false because it was not actually believed, or that omitted facts caused the opinion – when considered in the full context of the company’s other disclosures – to be misleading because it “affirmatively create[d] an impression of a state of affairs that differs in a material way from the one that actually exists.” Brody v. Transitional Hosps. Corp., 280 F.3d 997, 1006 (9th Cir. 2002).

Such a standard would be faithful to the text of the most frequently litigated provisions of the federal securities laws – Section 11, at issue in Omnicare, and Section 10(b) – which allow liability for statements that are either false or that omit material facts “required to be stated therein or necessary to make the statements therein not misleading . . . .”  At the same time, this standard would preserve the commonsense holding of Virginia Bankshares – that an opinion is “true” if it is genuinely believed – and prevent speakers from being held liable for truthfully expressed opinions simply because someone else later disagrees with them.

Why Halliburton II is Not a Top-5 Development

After refusing to overrule Basic, the Halliburton II decision focused on defendants’ fallback argument that plaintiffs must show that the alleged misrepresentations had an impact on the market price of the stock, as a prerequisite for the presumption of reliance.  The Court refused to place on plaintiffs the burden of proving price impact, but agreed that a defendant may rebut the presumption of reliance, at the class certification stage, with evidence of lack of price impact.

Halliburton II has a narrow reach.  The ruling only affects securities class actions that have survived a motion to dismiss – class certification is premature before then.  It wouldn’t be economical to adjudicate class certification while parties moved to dismiss under Rule 12(b)(6) and the Reform Act, and adjudicating class certification before rulings on motions to dismiss could result in defendants waiving their right to a discovery stay under the Reform Act.  Moreover, most securities class actions challenge many statements during the class period.  Although there could be strategic defense benefit to obtaining a ruling that a subset of the challenged statements did not impact the stock price – for example, shortening the class period or dismissing especially awkward statements – a finding that some statements had an impact would support certification of some class, and thus would allow the case to proceed.

Defendants face legal and economic hurdles as well.  For example, in McIntire v. China MediaExpress Holdings, Inc., 2014 U.S. Dist. LEXIS 113446, *40 (S.D.N.Y. Aug. 15, 2014), the court held that a “material misstatement can impact a stock’s value either by improperly causing the value to increase or by improperly maintaining the existing stock price.”  Under this type of analysis, even if a challenged statement does not cause the stock price to increase, it may have kept the stock price at the same artificially inflated level, and thus impacted the price.  Plaintiff-friendly results were predictable from experience in the Second and Third Circuits before the Supreme Court’s rulings in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 133 S. Ct. 1184 (2013), and Halliburton II.  Despite standards for class certification that allowed defendants to contest materiality and price impact, defendants seldom defeated class certification.

Halliburton II may also be unnecessary; it is debatable whether the decision even gives defendants a better tool with which to weed out cases that suffer from a price-impact problem.  For example, cases that suffer from a price-impact problem typically also suffer from some other fatal flaw, such as the absence of loss causation or materiality.  Indeed, the price-impact issue in Halliburton was based on evidence about the absence of loss causation.

Yet defendants no doubt will frequently oppose class certification under Halliburton II.  But they will do so at a cost beyond the economic cost of the legal and expert witness work:  they will lose the ability to make no-price-impact arguments in settlement discussions in the absence of a ruling about them.  Now, defendants will make and obtain rulings on class certification arguments that they previously could have asserted would be resolved in their favor at summary judgment or trial, if necessary. Plaintiffs will press harder for higher settlements in cases with certified classes.

***

In addition to Halliburton II, there were many other important 2014 developments in or touching on the world of securities and corporate governance litigation, including: rare reversals of securities class action dismissals in the Fifth Circuit, Spitzberg v. Houston American Energy Corp., 758 F.3d 676 (5th Cir. 2014), and Public Employees’ Retirement System of Mississippi v. Amedisys, Inc., 769 F.3d 313 (5th Cir. 2014); the filing of cybersecurity shareholder derivative cases against Target (pending) and Wyndham (dismissed); a trial verdict against the former CFO of a Chinese company, Longtop Financial Technologies; the Second Circuit’s significant insider trading decision, United States v. Newman, — F.3d —, 2014 U.S. App. LEXIS 23190 (2d Cir. Dec. 10, 2014); increasingly large whistleblower bounties, including a $30 million award; the Supreme Court’s SLUSA decision in Chadbourne & Parke LLP v. Troice, 134 S. Ct. 1058 (2014); the Delaware Supreme Court’s ruling on a fee-shifting bylaw in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), and the resulting legislative debate in Delaware and elsewhere; the Supreme Court’s ERISA decision in Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. 2459 (2014); the Ninth Circuit’s holding that the announcement of an internal investigation, standing alone, is insufficient to establish loss causation, Loos v. Immersion Corp., 762 F.3d 880 (9th Cir. 2014); the Ninth Circuit’s rejection of Item 303 of Regulation S-K as the basis of a duty to disclose for purposes of a claim under Section 10(b), In re NVIDIA Corp. Sec. Litig., 768 F.3d 1046 (9th Cir. 2014); and the Ninth Circuit’s holding that Rule 9(b) applies to loss-causation allegations, Oregon Public Employees Retirement Fund v. Apollo Group Inc., — F.3d —, 2014 U.S. App. LEXIS 23677 (9th Cir. Dec. 16, 2014).

Yesterday’s Supreme Court decision in Halliburton Co. v. Erica P. John Fund, Inc. (Halliburton II) may well have the lowest impact-to-fanfare ratio of any Supreme Court securities decision.  Despite the social-media-fueled frenzy within the securities bar leading up to the decision, the Court’s decision will effect little change in class certification law and practice in most securities class actions.

Most of the fanfare concerned whether the Court would overrule the fraud-on-the-market presumption of reliance established in its 1988 decision in Basic v. Levinson.  But the Court refused to overrule Basic.  Instead, the core of the Halliburton II decision focused on defendants’ fallback argument that plaintiffs must show that the alleged misrepresentations had impact on the market price of the stock, as prerequisite for the presumption of reliance.  The Court refused to place on plaintiffs the burden of proving price impact, but agreed that a defendant may rebut the presumption of reliance at the class certification stage, with evidence of lack of price impact.

The Court’s ruling, which in the lead-up to the decision has been called the “middle ground” between overruling Basic or affirming the Fifth Circuit, is a well-reasoned decision, and reaches a good practical result.  Overruling Basic would have led to a securities-litigation train wreck.  Affirming the Fifth Circuit would have been legally dubious.   But the legal middle ground of allowing a defendant to demonstrate a lack of price impact captures class-certification arguments that defendants have been making for many years, although they have often been framed as arguments about materiality or loss causation.   Thus, the Court’s ruling allows defense attorneys to contest the right issue on class certification, by demonstrating that the market just didn’t care about the challenged information.  Although I believe the ruling will not have an impact on the merits of most cases, it sets up an analytically sound framework for addressing arguments that did not fit well in other doctrinal buckets.

And, for those of us who litigate securities class actions full time, the Court’s decision to revisit Basic set up the Super Bowl of securities litigation.  The road to Halliburton II was long.  I trace it below, before discussing and analyzing Halliburton II.  (Kevin LaCroix’s post on Halliburton II in The D&O Diary contains a good discussion of the background and issues as well.)

The Fraud-on-the-Market Presumption: From Basic to Halliburton I to Amgen to Halliburton II

All of the Halliburton hubbub is about reliance, which is an essential element of a Section 10(b) claim.  Absent some way to harmonize individual issues of reliance, class treatment of a securities class action is not possible; individual issues would overwhelm common ones, precluding certification under Federal Rule of Civil Procedure 23(b)(3).  In Basic, the Supreme Court provided a solution: a rebuttable presumption of reliance based on the fraud-on-the-market theory, which provides that a security traded on an efficient market reflects all public material information. Purchasers (or sellers) rely on the integrity of the market price, and thus on a material misrepresentation.  Decisions following Basic have established three conditions to its application: market efficiency, a public misrepresentation, and a purchase (or sale) between the misrepresentation and the disclosure of the “truth.”

Over the years, defendants have argued that, absent a showing by plaintiffs that the challenged statements were material, or upon a showing by defendants that they were not, the presumption is not applicable or has been rebutted.  And, in a twist on such arguments, defendants sometimes argued that the absence of loss causation rebutted the presumption. In Erica P. John Fund, Inc. v. Halliburton Co. (Halliburton I), the Supreme Court unanimously rejected loss causation as a condition of the presumption of reliance.

In Halliburton I, the defendants did not dispute that proof of loss causation is not required for the fraud-on-the-market presumption to apply.  Instead, they argued to the Supreme Court that, although the Fifth Circuit ruled on loss-causation grounds, it really ruled that the absence of loss causation means that the challenged statements were not material because the challenged statements did not impact the price of Halliburton’s stock, and a lack of materiality defeats the application of the presumption.  The Supreme Court disagreed: “Whatever Halliburton thinks the Court of Appeals meant to say, what it said was loss causation: ‘[EPJ Fund] was required to prove loss causation, i.e., that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in the losses.’ . . . . We take the Court of Appeals at its word. Based on those words, the decision below cannot stand.”

But the Court explicitly left the door open for the argument that plaintiffs must prove materiality for the presumption of reliance to apply.  Later, the Court granted certiorari in Amgen Inc. v. Connecticut Retirement Plans to review the Ninth Circuit’s decision that plaintiffs are not required to prove materiality for the presumption to apply, and that the district court is not required to allow defendants to present evidence rebutting the applicability of the presumption before certifying a class.

In a majority opinion authored by Justice Ginsburg, and joined by Chief Justice John Roberts and Justices Breyer, Alito, Sotomayor, and Kagan, the Amgen Court concluded that proof of materiality was not necessary to demonstrate, as Rule 23(b)(3) requires, that questions of law or fact common to the class will “predominate over any questions affecting only individual members.”  The Court reasoned that this was because: 1) materiality was judged according to an objective standard that could be proven through evidence common to the class, and 2) a failure to prove materiality would not just defeat an attempt to certify a class, it would also defeat all of individual claims, because it is an essential element to a claim under Section 10(b).

The majority’s conclusion was dubious.  Its chief flaw was its avoidance of the central question through circular reasoning.  The materiality of a statement is an essential prerequisite for the application of the fraud-on-the market presumption that the Court developed in Basic, as a device to overcome the need to prove actual, individual reliance.  In Basic, the Court used then-emerging economic theory to create a rebuttable presumption of reliance, based on the assumption that a security traded in an efficient market reflects all public material information, and that traders in that market rely on the market price, and thus on any material misrepresentations that are reflected in the price.  The Amgen Court did not dispute that the materiality of a misrepresentation is necessary to create the fraud-on-the-market presumption, nor that the fraud-on-the-market presumption is essential to show under Rule 23 that common questions predominate for the class.

Instead, to avoid the logical conclusion that a showing of materiality was thus necessary to certify the class, the Court reasoned backwards: because plaintiffs must also show the materiality of the alleged misstatements in order to prove the underlying merits of a Section 10(b) claim, a finding that there was no materiality would defeat claims for all plaintiffs, whether brought as a class or individually.  Therefore, the Court concluded, materiality (or the lack of it) was a “common question,” that should not be decided until summary judgment, or theoretically, trial.

The holding was properly subject to wide criticism, but the criticism was quickly displaced by intrigue.  The Court’s opinions signaled a willingness to re-evaluate Basic, with four votes already supporting the view that the decision was “questionable,” and the other five failing to come to its defense.  In addition, as I wrote following the Amgen argument, the justices seemed intrigued by Amgen’s argument that market efficiency depends on the type of specific information at issue.

The Holding in Halliburton II

That leads us back to Halliburton II.  As Amgen was being litigated in the Supreme Court, the parties in Halliburton were briefing the plaintiffs’ class certification motion on remand.  The district court certified a class, prior to the Supreme Court’s decision in Amgen.  Halliburton sought and obtained Rule 23(f) certification from the Fifth Circuit, which affirmed, after the Supreme Court decided Amgen.

The Fifth Circuit held that a price-impact inquiry is more analogous to materiality than it is to the permissible prerequisites to the fraud-on-the-market presumption (market efficiency and a public misrepresentation).  Based upon that view, the Fifth Circuit reasoned that while price impact is not an element, as is materiality, “a plaintiff must nevertheless prevail on this fact in order to establish loss causation.”  Thus, “if Halliburton were to successfully rebut the fraud-on-the-market presumption by proving no price impact, the claims of all individual plaintiffs would fail because they could not establish an essential element of the action.”  Because the Fifth Circuit believed that the absence of price impact would doom all individual claims, it concluded that price impact is not relevant to common-issue predominance and is therefore not relevant at class certification.

The Supreme Court vacated the Fifth Circuit’s decision and remanded with the decision issued yesterday.  The Court’s opinion is remarkably straightforward.  First, the Court refused to overrule Basic.  The Court rejected Halliburton’s argument that Basic is inconsistent with modern economic theory, under which market efficiency is not a binary “yes or no” issue, finding that “Halliburton’s criticisms fail to take Basic on its own terms.”  Halliburton II at 9.    According to the Halliburton II Court, the Basic Court expressly refused to enter into such economic debate and instead “based the presumption on the fairly modest premise that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.”  Basic “thus does not rest on a “binary’ view of market efficiency.”  Indeed, in “making the presumption rebuttable, Basic recognized that market efficiency is a matter of degree and accordingly made it a matter of proof.”  Id. at 10.

Second, the Court rejected Halliburton’s argument that trading that is based on factors other than price undermines Basic’s premise that purchasers and sellers invest in reliance on the integrity of the market price.  The Court held that “Basic never denied the existence” of investors that believe that the market price does not fully reflect public information, and,  in any event, surmised that such investors do indeed “implicitly” rely on the integrity of the market price.

Third, the Court found that the presumption of reliance does not conflict with Rule 23 or the Court’s recent decisions ratcheting up the degree of proof at class certification:  “Basic does not, in other words, allow plaintiffs simply to plead that common questions of reliance predominate over individual ones, but rather sets forth what they must prove to demonstrate such predominance.”  Id. at 14.

Finally, the Court found that Halliburton’s concerns about the “serious and harmful consequences” that the Basic presumption produces are more appropriately addressed by Congress, which has already addressed them in part through the Private Securities Litigation Reform Act of 1995 and the Securities Litigation Uniform Standards Act of 1998.

Having refused to overrule Basic, the Court turned to Halliburton’s alternative arguments that (1) plaintiffs should be required to prove that a misrepresentation impacted the stock price as a condition to invoking the presumption of reliance; and (2) if plaintiffs do not bear the burden of proving price impact, defendants should be allowed to introduce evidence of lack of price impact to rebut the presumption.  The Court refused to place the burden of proof on the plaintiffs:  “By requiring plaintiffs to prove price impact directly, Halliburton’s proposal would take away the first constituent presumption,” i.e., that the misrepresentation was public and material and that the stock traded in a generally efficient market.  In response to Halliburton’s concern that a misrepresentation might not impact the price of a stock even in an efficient market, the Court held that “Basic never suggested otherwise; that is why it affords defendants an opportunity to rebut the presumption by showing, among other things, that the particular misrepresentation at issue did not affect the stock’s market price.”  Id. at 18.

But the Court did hold that defendants could rebut the presumption by proving at the class-certification stage that the misrepresentations did not impact the market price of the stock.  The Court based its holding in part on the fact that price impact evidence is part of the market-efficiency determination.  Given this, it found that plaintiffs’ argument that defendants may not introduce such evidence at class certification “makes no sense, and can readily lead to bizarre results.”  The presumption is an “indirect proxy” of showing price impact, and “an indirect proxy should not preclude direct evidence when such evidence is available.”  Id. at 20.  In so holding, the Court distinguished Amgen:  price impact “is ‘Basic’s fundamental premise.’  It thus has everything to do with the issue of predominance at the class certification stage.”  Id. at 22 (quoting Halliburton I).   In contrast, “materiality is a discrete issue that can be resolved in isolation from the other prerequisites.”  Id.

The Court summarized its price-impact holding as follows:

Our choice in this case, then, is not between allowing price impact evidence at the class certification stage or relegating it to the merits.  Evidence of price impact will be before the court at the certification stage in any event.  The choice, rather, is between limiting the price impact inquiry before class certification to indirect evidence, or allowing consideration of direct evidence as well.  As explained, we see no reason to artificially limit the inquiry at the certification stage to indirect evidence of price impact.  Defendants may seek to defeat the Basic pre­sumption at that stage through direct as well as indirect price impact evidence.

Id. at 22-23

Halliburton II is Important, but Will Not Impact the Merits of Many Cases

Halliburton II presented two very important issues: the viability of Basic, and the need to prove price impact.  After the Court granted cert in Halliburton II, most defense lawyers seemed to actively hope that the Court would put an end to securities class actions.  But after some time, most defense lawyers seemed to come around to the view that the end of Basic would result in a securities litigation train wreck, with plaintiffs’ firms filing individual and large collective actions that would be quite difficult and expensive to manage, while the government would also step up enforcement, since the federal and state governments wouldn’t allow under-regulation of the securities markets, at least for long.  And those who still hoped for the end of Basic had their hopes dashed by the Halliburton II oral argument, in which the justices did not seem interested in overruling Basic, and instead seemed focused on the price-impact argument.  Since that argument, most of the discussion has been about the potential price-impact ruling.

What impact will the price-impact ruling have?  For starters, it’s important to remember that the ruling will only affect securities class actions that have survived a motion to dismiss – class certification is premature before then.  It wouldn’t be economical to adjudicate class certification while parties moved to dismiss under Rule 12(b)(6) and the Reform Act, and adjudicating class certification before rulings on motions to dismiss could result in defendants waiving their right to a discovery stay under the Reform Act.

It’s also important to remember that most securities class actions challenge many statements during the class period.  Although there could be strategic benefit to a ruling that a subset of the challenged statements did not impact the stock price – for example, shortening the class period or dismissing especially awkward statements – a finding that some statements had an impact would support certification of some class, and thus would allow the case to proceed.

It is impossible to say what percentage of the cases that survive motions to dismiss would be good candidates for price-impact disputes at class certification.  To be sure, defendants will make price-impact arguments in most cases in which there is some basis to make the argument.  But the number of cases in which there is a real issue, much less a knock-out blow, is likely relatively small.  Some types of cases, such as biotech cases and cases involving companies with a low volume of public statements, tend to present fewer economic problems.  More generally, the experience in the Second and Third Circuits before Amgen is cause for some skepticism.  Despite standards for class certification that allowed defendants to contest materiality and price impact, defendants seldom defeated class certification.

It also is debatable whether a price-impact rule will weed out many more bad cases on a net basis.  For example, cases that suffer from a price-impact problem typically also suffer from some other fatal flaw, such as the absence of loss causation or materiality.  Indeed, the price-impact issue in Halliburton was based on evidence about the absence of loss causation.  (Nevertheless, it may be helpful to have a cleaner legal argument to make about the underlying lack of logic to the claims.)

Defendants will lose an important feature of the pre-Halliburton II world: the ability to make no-price-impact arguments in settlement discussions in the absence of a ruling about them.  Now, defendants will make and obtain rulings on class certification arguments that they previously could have asserted would be resolved in their favor at summary judgment or trial, if necessary. Plaintiffs will press harder for higher settlements in cases with certified classes.  Prominent plaintiffs’ lawyers make this point in Alison Frankel’s blog about Halliburton II.  The more sophisticated firms already think through price impact and related issues as they evaluate which cases to pursue, and I expect plaintiffs’ lawyers to make that point in the wake of Halliburton II as well.

Yet plaintiffs certainly would have preferred to have the Court eliminate any fight over price impact at class certification.  They will face another hurdle and greater costs, and will have to adapt.  Plaintiffs’ lawyers likely will attempt to bring more Section 11 claims, where reliance is not an element.  However, Section 11 claims aren’t possible without a registered offering, and the damages are limited.  Plaintiffs’ lawyers also will try to re-cast their misrepresentations as omissions claims, and thus invoke Affiliated Ute’s presumption of reliance for claims of omission.  But plaintiffs face an uphill legal battle on this issue, as we wrote last winter.  And they likely will not file cases in which it is clear that they face a difficult and expensive class-certification battle – or they will try to settle them before class certification.

One thing that is certain is that Halliburton II will increase defense costs.  Whether the increased defense costs will be worth it will be the subject of much debate in individual cases, and in the big picture over time.  In the coming months, I will write about post-Halliburton II issues, including the shape of the price-impact dispute, and the cost-benefit of the new world of class-certification.

In our post in the immediate wake of the Supreme Court’s decision in Amgen Inc. v. Connecticut Retirement Plans, we concluded that rather than being a new threat to the defense of securities class actions, Amgen basically endorsed the status quo: In holding that plaintiffs do not need to establish that allegedly false statements were material to the market before they can gain class certification, the Amgen Court reinforced the rule that is already followed in most courts.  At the same time, we promised to dive deeper in a future post, to discuss the effect of Amgen in those circuits that had previously entertained disputes over materiality in determining whether to certify a class.

This was a weighty task.  In the absence of clear guidance from the Supreme Court, the law on class certification has developed in myriad, complex, and contradictory ways across the circuit courts. The precise legal effect of the Amgen decision will therefore vary from one circuit to the next, as the law in many circuits has not been fully developed, and other circuits have developed distinct doctrines in their effort to find a principled way to implement the fraud-on-the-market presumption from Basic v. Levinson.  Yet a survey of these circuit court decisions, and the way that they have been interpreted in the district courts, merely reinforces our conclusion that Amgen will have relatively little negative practical impact on defendants – in any jurisdiction.  Far from being a “crushing blow” to the defense bar that will “make it easier” for plaintiffs to maintain securities class actions, as many commentators have claimed, the Amgen decision seems to close very few strategic doors to the defense, no matter where a case is litigated.

This is true for three primary reasons.  First, most of the arguments that defendants have made to dispute materiality at class certification are the same as arguments that can be made – and often are, with greater success – on a motion to dismiss, because they challenge fundamental flaws in the complaint that point to plaintiffs’ inability to make sufficient allegations of falsity and loss causation.  Second, the only circuit that required plaintiffs to “prove” materiality before a class would be certified was the Fifth Circuit, whose holdings in this regard had already been largely neutralized by the Supreme Court’s 2011 ruling in Erica P. John Fund, Inc. v. Halliburton.  Finally, in those circuits that had allowed defendants a chance to rebut materiality and thus defeat class certification – in particular, the Second and Third Circuits – the bar was already set so high that this opportunity seemed to be largely illusory.

As an initial matter, it is necessary to identify those circuits that have holdings which are incompatible with the Amgen opinion.  While many circuit courts have yet to grapple explicitly with the issue, the Amgen ruling is in line with the approach articulated by the Ninth Circuit (see that court’s decision in Amgen, 660 F.3d 1170 (9th Cir. 2011)) and the Seventh Circuit (see Schleicher v. Wendt, 618 F.3d 679, 687 (2010)), and the emerging doctrine of the First Circuit (see, e.g., In re Boston Scientific Corp., 604 F. Supp.2d 275 (D. Mass. 2009)) and the Fourth Circuit (see, e.g., In re Red Hat, Inc., Sec. Litig., 261 F.R.D. 83 (E.D. N.C. 2009)).  On the other hand, as discussed below, Amgen raises questions when examined in connection with the extreme approach formerly taken by the Fifth Circuit (see Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F.3d 261, 267 (5th Cir. 2007)) as well as the more moderate doctrines articulated by the Second Circuit (see In re Salomon Analyst Metromedia Litigation, 544 F.3d 474, 484 (2d Cir. 2008)) and the Third Circuit (see In re DVI, Inc. Securities Litigation, 639 F. 3d 623, 631 (3d Cir. 2011)).

Until 2011, the Fifth Circuit took the most aggressive approach toward class certification, requiring not only proof that an alleged misstatement “actually moved” the market in order to invoke the fraud-on-the-market presumption, but also requiring plaintiffs to prove loss causation.  This doctrine was summarily rejected by a unanimous Supreme Court in Halliburton, which found that the requirement that plaintiffs prove loss causation to gain class certification was “not justified by Basic or its logic.”  (See 131 S.Ct. 2179 (2011)). It is not clear what, if anything, remained of the Fifth Circuit’s doctrine after Halliburton.  Arguably, a requirement survived that plaintiffs make a showing prior to class certification that either the misrepresentation or the corrective disclosure had an impact on stock price, but that is unclear, because the Fifth Circuit’s justification for this requirement was closely tied to its demand that plaintiffs prove loss causation – and neither the Fifth Circuit nor its district courts have made rulings on this basis since the Halliburton decision.

By contrast, the rule in the Second Circuit survived Halliburton, but was overturned by Amgen. According to the Second Circuit, plaintiffs were required to make “some showing” of materiality in order to trigger the fraud-on-the-market presumption, either through showing an impact of information on the stock price, or simply by arguing that there was a “substantial likelihood” that the misrepresented or omitted information “would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.” (See Salomon, 544 F.3d at 485).  At that point, the burden shifted to the defendants to rebut the presumption of reliance, with evidence that “severs the link” between the alleged misrepresentation and the price of the stock.

Similarly, the Third Circuit ruled in 2011 that district courts may consider evidence to rebut the presumption of reliance, and thereby defeat class certification.  The court reasoned that evidence that a corrective disclosure did not affect the market price could defeat class certification in one of two ways.  If the statement was material, it could show that the market was not efficient in absorbing information (an acknowledged prerequisite to the Basic presumption).  On the other hand, if the market was efficient but the corrective disclosure did not affect the stock price, the Third Circuit held that it could demonstrate that the challenged statement was immaterial as a matter of law. (See In re DVI, 639 F. 3d at 638).

Before Halliburton, the Fifth Circuit’s standard undoubtedly made it difficult for plaintiffs to gain class certification – not only because loss causation was explicitly incorporated into the class certification inquiry, but because plaintiffs bore the burden of proving loss causation before certification was granted.  As noted above, much or all of this hurdle was removed by Halliburton, leaving little or nothing for Amgen to resolve.  By contrast, the standard used by in the Second and Third Circuits placed the burden on the defendants to rebut the presumption of materiality.  Although this gave defendants the opportunity to present evidence about materiality, including expert testimony, the courts implementing this standard generally found that the defendants had failed to meet their burden, and granted class certification despite this evidence.  In ruling that defendants could not present evidence to rebut materiality until summary judgment or trial, the Amgen Court eliminated the possibility that this materiality evidence will be considered at the class certification stage – but this ruling will likely have little practical effect in the Second and Third Circuits, where that opportunity did not seem to give defendants any real advantage.

What is most striking in the pre-Amgen cases that considered materiality on class certification was that nearly all of the arguments that defendants advanced could have been advanced – and often, already had been advanced – at the motion-to-dismiss stage.  If the courts had already accepted these arguments on a motion to dismiss, in most cases the issue would not have reached class certification.  On the other hand, if the courts had already rejected these contentions once at the motion-to-dismiss stage, they did not seem to be any more willing to accept them when they were reframed on class certification.  For example, defendants in these cases sought to defeat materiality by contending that the defendant company had disclosed the truth to the market, rendering the allegedly false statement material.  This argument is easily recast, especially in the case of alleged omissions, to contend that plaintiffs failed to adequately allege of the existence of a false or misleading statement in the first place. Similarly, at class certification, defendants advanced arguments that the plaintiffs had failed to connect the alleged misstatements with any corrective disclosure that revealed the truth to the market, or that they were unable to point to a drop in the stock price following the corrective disclosure – failures that the courts already routinely recognize as fatal to adequate pleading of loss causation, which can be adjudicated on motions to dismiss.

Indeed, the only arguments advanced by defendants in these cases that were unique to the class certification procedure were those that used expert testimony to assert that a price drop was not due to an alleged corrective disclosure, but rather to other negative information that was released simultaneously, or general adverse market conditions.  These contentions involved difficult factual distinctions that the district courts were reluctant to make, particularly in the Second Circuit, where the defendants carried the burden of disproving materiality.

In sum, the Amgen decision seems to foreclose very little in terms of defense strategy.  It may eliminate the use of expert testimony regarding materiality on class certification motions – although such testimony can still be relevant regarding the “efficiency” of the market for the company’s stock.  And it will likely foreclose defendants’ efforts to contend, based largely on expert testimony, that a stock price drop was not the result of a corrective disclosure, but of other factors present at the same time – although defendants should still be able to offer evidence and expert testimony to define the proper contours of the class period based on market events and the timing of corrective disclosures.  But most of the defense arguments that have been used to oppose class certification – whether they are phrased in terms of materiality, falsity, or loss causation – will continue to be available, and effective, through motions to dismiss.

More significantly, the Amgen decision suggests room for doubt on the larger question of reliance – the most fundamental and problematic issue for plaintiffs in obtaining certification of a securities class action.  The decision all but invites the defense bar to use its creativity to find the right argument to advance in the right case, to engage district and circuit courts that are already struggling with the fraud-on-the-market doctrine, and in turn, to tempt the Supreme Court into reconsidering the wisdom of Basic (which it has shown a clear inclination to do).  While Amgen may have closed the door on a few defense strategies – which were rarely successful, in any case, in defeating class certification – it has simultaneously opened the window for defense counsel to find new ways to illustrate the shortcomings of the Basic presumption, and thus to mount a much more serious challenge to ability of the plaintiffs’ bar to bring securities class actions.