Fraud-on-the-Market Doctrine

The villain in the fight against securities class actions is the fraud-on-the-market presumption of reliance established by the U.S. Supreme Court in 1988 in Basic Inc. v. Levinson, 485 U.S. 224 (1988).  Without Basic, the thinking goes, a plaintiff could not maintain a securities class action, and without securities class actions, executives could speak their minds without worrying so much about securities law liability.  In the current environment, the risk of further attacks on Basic seems high.  (A general class action reform bill, the “Fairness in Class Action Litigation Act of 2017,”  has already been introduced in the House—analyzed by Alison Frankel here, and by Kevin LaCroix here.)

But Basic ballasts the system of securities-law enforcement by protecting investors, while providing companies with predictable procedures and finality upon settlement.  We have a lead plaintiff and class representative who prosecutes a claim that defendants can settle with a broad class-wide release.  Because the private plaintiffs’ bar is doing its job, the SEC stays away in most cases. Honest executives have nothing to fear with the current system—they routinely get through securities litigation without any real reputational or personal financial risk.

On the other hand, without Basic, plaintiffs’ lawyers would still file securities litigation.  In place of class actions, each plaintiffs’ firm would file an individual or multi-plaintiff collective action, resulting in multiple separate actions in courts around the country.  These would be difficult to manage, expensive to defend, and impossible to settle with finality until the statute of limitations expires.  SEC enforcement would become more frequent.  Companies and their D&O insurers and brokers would be unable to predict and properly insure against the risk of a disclosure problem.

Moreover, I have never understood the supposed benefits of abolishing Basic.  Although it is possible that the frequency of securities litigation would decline, I doubt it would.  A disclosure problem that would trigger a securities class action today would result in at least several non-class securities actions in a post-Basic system.

And any decrease in frequency would come at a high cost—in addition to the increased cost of defending and resolving those cases that are filed, investors and the economy would suffer from more securities fraud resulting from the diminished deterrence that class actions provide. Even an executive who detests securities class actions pictures prominent plaintiffs’ lawyers when he or she decides whether to omit an important fact.

So, to those who bash Basic, be careful what you wish for.

A Brief History of the Fraud-on-the-Market Doctrine

The fraud-on-the-market doctrine concerns the reliance 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 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., 563 U.S. 804 (2011), the Supreme Court unanimously rejected the latter argument, finding that loss causation is not a condition of the presumption of reliance.  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. Conn. Ret. Plans and Trust Funds, 133 S. Ct. 1184 (2013), 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.”

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 Halliburton case ended up before the Supreme Court once again, this time with the viability of Basic squarely presented.  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.  Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014).  Thus, Basic survived the Halliburton battle.

What Would Securities Litigation Look Like without Basic?

Our current securities class action system is straightforward and predictable.  Like any other action, a securities class action starts with the filing of a complaint by a plaintiff.  But after that, the procedure for these actions is unique.  The Reform Act mandates that the first plaintiff to file a securities class action publish a press release giving notice of the lawsuit and advising class members that they can attempt to be the “lead plaintiff” by filing a motion with the court within 60 days of the press release.  Additional plaintiffs will often file their own complaints in advance of the deadline, or they may simply file a motion to become lead plaintiff at the deadline.

The Reform Act provides that the “presumptively most adequate lead plaintiff” is the one who “has the largest financial interest in the relief sought by the class” and otherwise meets the requirements of Rule 23 of the Federal Rules of Civil Procedure, which governs class actions.  The Reform Act’s standards for lead plaintiff selection have caused plaintiffs’ firms to pursue institutional investors and pension funds as plaintiffs, since they are more likely to be able to show the financial interest necessary to be designated as lead plaintiffs.  But as I have chronicled, in recent years, smaller plaintiffs’ firms have won lead-plaintiff contests with retail investors as lead plaintiffs, primarily in securities class actions against smaller companies.  About half of all securities class actions are filed against smaller companies by these smaller plaintiffs’ firms.

This deeper and more diverse new roster of plaintiffs’ firms means that securities litigation won’t just go away if they can’t file securities class actions.  The larger plaintiffs’ firms have strong client relationships with the institutional investors the Reform Act incentivized them to develop.  Claims by the retail investors that the Reform Act sought to replace have made a resurgence through relationships with smaller plaintiffs’ firms.  Together, these plaintiffs and plaintiffs’ firms fully cover the securities litigation landscape.  These firms are competitive with one another. One will rush to file a case, and if one files, others will too.  They are specialized securities lawyers, and they aren’t going to become baristas or bartenders if Basic is abolished.  They will seek out cases to file.

So the plaintiffs’ bar would adjust, just as they have adjusted to limited federal-court jurisdiction under Morrison v. National Australia Bank, 561 U.S. 247 (2010).  And if the post-Morrison framework is any indication of what we would face post-Basic, look out—Morrison has caused the proliferation of unbelievably expensive litigation around the world, without the ability to effectively coordinate or settle it for a reasonable amount with certain releases.

In a post-Basic world, the plaintiffs’ firms with institutional investor clients would likely file large individual and non-class collective actions.  Smaller plaintiffs’ firms would also file individual and non-class collective actions.  The damages in cases filed by smaller firms would tend to be smaller, but the litigation burdens would be similar.

Non-class securities actions would be no less expensive to defend than today’s class actions, since they would involve litigation of the same core merits issues.  In fact, non-class litigation would be even more expensive in certain respects because, for example, there would be multiple damages analyses and vastly more complex case management.  And if securities class action opt-out litigation experience is indicative of the settlement value of such cases, they would tend to settle for a larger percentage of damages than today’s securities class actions.

In a new non-class era of securities litigation, the settlement logistics would be vastly more difficult.  It’s hard enough to mediate with one plaintiffs’ firm and one lead plaintiff.  Imagine mediation with a dozen or more plaintiffs’ firms and even more plaintiffs.  We often object to lead-plaintiff groups because of the difficulty of dealing with a group of plaintiffs instead of just one.  In a world without securities class actions, the adversary would be far, far worse—a collection of plaintiffs and plaintiffs’ firms with no set of rules for getting along.

Even when settlement could be achieved, it wouldn’t preclude suits by other purchasers during the period of inflation, because there would be no due process procedure to bind them, as there is when there’s a certified class with notice and an opportunity to object or opt out.  Indeed, there likely would develop a trend of random follow-up suits by even smaller plaintiffs’ firms after the larger cases have settled.  There would be no peace absent the expiration of the statute of limitations.

These unmanageable and unpredictable economics would disrupt D&O insurance purchasing decisions and cost. Under the current system, D&O insurers and brokers can reliably predict the risk a particular company faces based on its size and other characteristics.  A company can thus purchase a D&O insurance program that fits its risk profile.

Compounding the uncertainty of all of this would be the role of SEC and other government enforcement.  Even with the current U.S. administration’s relatively hands-off regulatory approach, the job of the human beings who work at the SEC is to investigate and enforce the securities laws.  They aren’t going to not do their jobs just because government regulation has been eased in the bigger picture.  And they will step in to fill the void left by the inability of plaintiffs to bring securities class actions.  Experienced defense counsel can predict how plaintiffs’ firms will litigate and resolve a case, but they have much less ability to predict how an enforcement person with whom he or she may never have dealt will approach a case.

Conclusion

Executives who do their best to tell the truth really have nothing to fear under the securities laws.  The law gives them plenty of protection, and the predictability of the current system allows them to understand their risk and resolve litigation with certainty.  It would be a mistake to try to abolish securities class actions.  Abandoning Basic would backfire—badly.

I am committed to helping shape a system for securities litigation defense that helps directors and officers get through securities litigation safely and efficiently, without losing their serenity or dignity, and without facing any real risk of paying any personal funds.

But we are actually moving in the opposite direction of this goal, and unless some changes are made, securities litigation will pose greater and greater risk to individual directors and officers.  It is time for the “repeat players” in securities litigation defense – D&O insurers and brokers, defense lawyers, and economists – to make some fundamental changes to how we do things.  Although most cases still seem to turn out fine for the individual defendants, resolved by a dismissal or a settlement that is fully funded by D&O insurance, the bigger picture is not pretty.  The law firms that have defended the lion’s share of cases since securities class actions gained footing through Basic v. Levinson – primarily “biglaw” firms based in the country’s several largest cities – are no longer suitable for many, or even most, securities class actions.  Fueled by high billing rates and profit-focused staffing, those firms’ skyrocketing defense costs threaten to exhaust most or all of the D&O insurance towers in cases that are not dismissed on a motion to dismiss.  Rarely can such firms defend cases vigorously through summary judgment and toward trial anymore.

Worse, these high prices too often do not yield strategic benefits.  A strong motion to dismiss focuses on the truth of what the defendants said, with support from the context of the statements, as directed by the U.S. Supreme Court in Tellabs and Omnicare.  Yet far too often, the motion-to-dismiss briefs that come out of these large firms are little more than cookie-cutter arguments based on the structure of the Reform Act.  And if a motion is lost, settlements are higher than necessary because the defendants often have no option but to settle in order to avoid an avalanche of defense costs that would exhaust their D&O insurance limits.  On the other hand, if settlement occurs later, it can be difficult to keep settlement within D&O insurance limits – and defense counsel’s analysis of a “reasonable” settlement can be influenced by a desire to justify the amount they have billed.

At the same time that defense costs are continuing to rise exponentially, securities class actions are becoming smaller and smaller, with two-thirds of cases brought against companies with market caps less than $2 billion, and almost half under $750 million.  Although catawampus securities litigation economics is a systemic problem, impacting cases of all sizes, the problem is especially acute in the smallest half of cases.  Some of those cases simply cannot be defended both well and economically by typical defense firms.  Either defense costs become ridiculously large for the size of the case and the amount of the D&O insurance limits, or firms try to reduce costs by cutting corners on staffing and projects – or both.  We see large law firms routinely chase smaller and smaller cases.  From a market perspective, it makes no sense at all.

So how do we achieve a better securities litigation system?  Five changes would have a profound impact:

  1. Require an interview process for the selection of defense counsel, to allow the defendants to understand their options; to evaluate conflicts of interest and the advantages and disadvantages of using their corporate firm to defend the litigation; and to achieve cost concessions that only a competitive interview process can yield.
  2. Increase the involvement of D&O insurers in defense-counsel selection and in other strategic defense decisions, to put those who have the greatest overall experience and economic stake in securities class action defense in a position to provide meaningful input.
  3. Make the Supreme Court’s Omnicare decision a primary tool in the defense of securities class actions.  Obviously, Omnicare should be used to defend against challenges to all forms of opinions, including statements regarded as “puffery” and forward-looking statements protected by the Reform Act’s Safe Harbor for forward-looking statements.  But defense counsel should also take advantage of the Supreme Court’s direction in Omnicare that courts evaluate challenged statements in their full factual context.  Omnicare supplements the Court’s previous direction in Tellabs that courts evaluate scienter by considering not just the complaint’s allegations, but also documents incorporated by reference and documents subject to judicial notice.  Together, Omnicare and Tellabs allow defense counsel to defend their clients’ honesty with a robust factual record at the motion to dismiss stage.
  4. Increase the involvement of boards of directors in decisions concerning D&O insurance and the defense of securities litigation, including counsel selection, to ensure their personal protection and good oversight of the defense of the company and themselves.
  5. Move damages expert reports and discovery ahead of fact discovery, to allow the defendants and their D&O insurers to understand the real economics of cases that survive a motion to dismiss, and to make more informed litigation and settlement decisions.

These five changes are among the top wishes I have to improve securities litigation defense, and to preserve the protections of directors and officers who face securities litigation.  Over the next several months, I will post about each one.  Here are links to the posts in the series so far:

Wish #1:  5 Wishes for Securities Litigation Defense: A Defense-Counsel Interview Process in All Cases

Wish #2:  5 Wishes for Securities Litigation Defense: Greater Insurer Involvement in Defense-Counsel Selection and Strategy

Wish #3:  5 Wishes for Securities Litigation Defense: Effective Use of the Supreme Court’s Omnicare Decision

Wish #4:  5 Wishes for Securities Litigation Defense: Greater Director Involvement in Securities Litigation Defense and D&O Insurance

Wish #5:  5 Wishes for Securities Litigation Defense: Early Damages Analysis and Discovery

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).

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 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 the 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 Hosps. 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 class-wide 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.*

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 class-wide reliance.

 

* 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.

At long last, the United States Supreme Court is going to address the viability and/or prerequisites of the fraud-on-the-market presumption of reliance established by the Court in 1988 in Basic v. Levinson.  Securities litigators, on both sides of the aisle, are understandably anxious, because our entire industry is about to change – either a little or a lot.

I say “change,” and not something more ominous like “be obliterated,” because the Supreme Court’s ruling in Halliburton cannot and will not do away with securities litigation.  If the Court’s ruling were to undermine class actions, the plaintiffs’ securities bar would adjust – likely through burdensome large individual and non-class collective actions, and class actions that attempt to work around whatever ruling the Court makes – and the government would act to facilitate some type of securities class action and/or expand government enforcement of the securities laws.  Worse outcomes for companies in a new no-Basic era are far easier for me to imagine than better ones.  I’ll explain why, after a quick review of how we got here.

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

Reliance is an essential element of a Section 10(b) claim. Absent some way to harmonize individual issues of reliance, however, 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., the Supreme Court unanimously rejected loss causation as a condition of the presumption of reliance.

In Halliburton, 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 Supreme Court explicitly left the door open for the argument that plaintiffs must prove materiality for the presumption of reliance to apply.  The Supreme 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 based on the presumption.

In a majority opinion authored by Justice Ginsburg, and joined by Chief Justice John Roberts and Justices Breyer, Alito, Sotomayor, and Kagan, the 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 on a false or misleading statement – which made securities class actions all but impossible to bring.  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.

As Justice Thomas wrote in his dissent (joined by Justice Scalia (in part) and Justice Kennedy), the majority essentially “reverse[d]” the inquiry.  Although class certification is supposed to be decided early in the litigation, and depends upon a showing of materiality to invoke the fraud-on-the-market presumption, the majority effectively said that that portion of the class certification inquiry can be skipped, merely because it is also a question that will be asked at the merits stage. Justice Thomas wrote: “A plaintiff who cannot prove materiality does not simply have a claim that is ‘dead on arrival’ at the merits. . .he has a class that never should have arrived at the merits at all because it failed in Rule 23(b)(3) certification from the outset.”

Perhaps the most striking part of the Amgen decision was Justice Alito’s one paragraph concurrence, which baldly called for a reconsideration of the fraud-on-the-market presumption.  Alito concurred with the majority, but only with the understanding that Amgen had not asked for Basic to be revisited. Alito thus signaled that he agreed with Thomas’s contention in footnote 4 of the dissent that the Basic decision was “questionable.”  The majority, in turn, did not come to the defense of Basic, but simply noted with apparent relief (in footnote 2) that even Justice Thomas had acknowledged that the Court had not been asked to revisit that issue.  Considered together, these three opinions put out a welcome mat for the right case challenging Basic’s fraud-on-the-market presumption, with four votes already supporting the view that the decision was “questionable,” and the other five failing to come to its defense.

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 the inquiry of the challenged statements’ lack of impact on the price of Halliburton’s stock was more analogous to materiality than it is to the permissible prerequisites to the fraud-on-the-market presumption (market efficiency and a public misrepresentation).  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.

Halliburton filed a petition for a writ of certiorari, and the Court granted the petition on Friday November 15, 2013.  That day, many plaintiffs’ and defense lawyers predicted the demise of securities litigation as we know it.  One defense lawyer put it in blunt terms:  “If the Supreme Court rejects the ‘fraud-on-the-market presumption of reliance altogether, then it would effectively end securities class action litigation in the United States.”

I disagree.

What’s Next?  How Will the Supreme Court Rule?  If the Court Overrules Basic, What Will Happen?   

There are three primary possible outcomes in the Supreme Court:

1.  The Court will affirm the Fifth Circuit without overruling or adjusting Basic.  This seems unlikely.

2.  The Court will adjust Basic.

One adjustment might be to require that a putative class plaintiff show that the market for the issuer’s stock be efficient as to the specific information that the defendants allegedly misrepresented – which is Halliburton’s alternative grounds for relief, and a proposition that Amgen included in a footnote in its Supreme Court briefs.  I predict that this will be what the Supreme Court decides.  Such a decision would address the primary economic criticism of the fraud-on-the-market presumption – that market efficiency is not a binary “yes” or “no” question, and instead depends on the specific information at issue – and would preserve salutary features of private securities litigation, which long has been an important means of securities regulation.

Another adjustment might be to allow the fraud-on-the-market presumption for purposes of satisfying the element of reliance, but require proof of actual reliance on the challenged statements for purposes of recovering money damages.  This is the position taken in an amicus brief in support of cert filed by a group of prominent law professors and former SEC commissioners, primarily relying on the elements of the Exchange Act’s only express private right of action, set forth in Section 18.

3.  The Court will overrule Basic and leave nothing in its place – thus negating the primary support for securities class actions.

What would happen then?

The plaintiffs’ securities bar would adjust. 

The plaintiffs’ bar would seek to work around Halliburton in some fashion.  That would result in much uncertainty and expensive litigation of the scope of Halliburton in the district courts, circuit courts, and likely the Supreme Court.

Worse, the largest firms with large institutional investor clients – clients the Private Securities Litigation Reform Act encouraged them to court, and with which they now work closely to identify and pursue securities claims – would file large individual and non-class collective actions.  Smaller plaintiffs’ firms would also file individual and non-class collective actions.  The damages in cases filed by smaller firms would tend to be smaller, but the litigation burdens would be similar.

Non-class securities actions would be no less expensive to defend than today’s class actions, since they would involve litigation of the same core merits issues.  Non-class litigation would be even more expensive in certain respects – e.g. multiple damages analyses and vastly more complex case management.  And if securities class action opt-out litigation experience is indicative of the settlement value of such cases, they would tend to settle for a larger percentage of damages than today’s securities class actions.

In a new non-class era of securities litigation, the settlement logistics would be vastly more difficult – it’s hard enough to mediate with one plaintiffs’ firm and one lead plaintiff.  Imagine mediation with a dozen or more plaintiffs’ firms and even more plaintiffs.  One reason we sometimes oppose lead-plaintiff groups is the difficulty of dealing with a group of plaintiffs instead of just one.

Even when settlement could be achieved, it wouldn’t preclude suits by other purchasers during the period of inflation, because there would be no due process procedure to bind them, as there is when there’s a certified class with notice and an opportunity to object or opt out.  Indeed, there likely would develop a trend of random follow-up suits by even smaller plaintiffs’ firms after the larger cases have settled.  There would be no peace absent the expiration of the statute of limitations.

The government would act.

The government would not allow the securities markets to be profoundly less regulated.  So it would do something.  It might legislatively enable securities class actions.  If it did so, would it also make other adjustments, such as lessen the Reform Act’s protections?  Who knows, but I wouldn’t bet on an improvement for companies.  I strongly believe that the biggest securities-litigation threat to companies is erosion of the Reform Act’s protections.

The government might also, or instead, enhance public enforcement of the securities laws.  This would be a negative development.  Companies have much greater ability to predict the cost and outcome of today’s securities class action than they do the outcome of a government enforcement action.  Experienced defense counsel can predict how plaintiffs’ firms will litigate and resolve a case.  Defense counsel have much less ability to predict how an enforcement person with whom he or she may have never dealt will approach a case.

Finally, I must say that I am not one who thinks that the fraud-on-the-market presumption results in much injustice, especially given the protections of the Reform Act.  The Reform Act weeds out a lot of cases.  To be sure, some cases incorrectly survive motions to dismiss.  The only real policy problem with class actions regarding Basic is with the subset of these cases that also are certified as class actions at the class-certification stage but are destined to be decertified at summary judgment or trial – defendants in those cases are unjustly subjected to burdensome class action litigation.  The combination of these errors, however, isn’t frequent.  And even when it does occur, experienced plaintiffs’ and defense counsel are able to handicap the merits on both counts, i.e. the lack of merit to the claims and to the case temporarily surviving as a class action, and adjust the settlement value of the case accordingly.

This is just a start on our analysis.  We’ll certainly write more during the long wait for the Court’s ruling.

 

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.

The Supreme Court released its anxiously awaited decision in Amgen Inc. v. Connecticut Retirement Plans yesterday. On the face of the decision, it was a loss for defendants in that case, and for companies everywhere that are forced to defend themselves against securities class action lawsuits – as the Court found that plaintiffs do not need to establish that allegedly false statements were material to the market before they can gain class certification.

As I have written before (see here and here), the Court had an opportunity in Amgen to make class certification a more meaningful stage in securities class actions, providing defendants with a new tool for stopping unmeritorious cases early in the process.  On the surface of the Amgen decision, the Court declined to take that step.  For this reason, many of the early reports indicate that the defense bar is concerned about the impact of Amgen.  I’m not concerned.  At worst, Amgen leaves defendants in most circuits in the same position they were before.  (Look for our upcoming post analyzing the effect that Amgen will have in the minority of circuits, such as the Second Circuit, which have previously ruled that materiality can be considered on class certification.)  The decision leaves open several arguments that will allow defendants to continue to challenge lack of materiality in the early stages of litigation.  And, perhaps most significantly, the decision seems to tee up the Court’s re-consideration of the legitimacy and scope of the fraud-on-the-market presumption of reliance that it adopted in Basic v. Levinson.

I explore Amgen’s impact after discussing its majority, concurring, and dissenting opinions.

In a majority opinion authored by Justice Ginsburg, and joined by Chief Justice John Roberts and Justices Breyer, Alito, Sotomayor, and Kagan, the 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).

Much can be said, and doubtless will be said, in criticism of the majority’s decision.  Its chief flaw is 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 v. Levinson, as a device to overcome the need to prove actual, individual reliance on a false or misleading statement – which made securities class actions all but impossible to bring.  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 does 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 reasons 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.

As Justice Thomas writes in his dissent (joined by Justice Scalia (in part) and Justice Kennedy), the majority essentially “reverses” the inquiry.  Although class certification is supposed to be decided early in the litigation, and depends upon a showing of materiality to invoke the fraud-on-the-market presumption, the majority effectively says that that portion of the class certification inquiry can be skipped, merely because it is also a question that will be asked at the merits stage.  Writes Thomas:  “A plaintiff who cannot prove materiality does not simply have a claim that is ‘dead on arrival’ at the merits. . .he has a class that never should have arrived at the merits at all because it failed in Rule 23(b)(3) certification from the outset.”

Despite the flaws of the decision, the Court has spoken, and there is limited usefulness to arguing about whether or not its decision is correct.  But lurking under the surface of the opinion are a number of issues that leave ample room for continued litigation over “materiality” issues:

1) The Court affirmed the district court in rejecting Amgen’s effort to offer rebuttal evidence upon class certification that would demonstrate that the misstatement was not material because the truth of the matter had already been disclosed to the market.  If this argument is framed as a “truth on the market” defense, alleging that truthful information had already entered the market by other means, then it is traditionally a question that is entertained at the summary judgment stage.  On the other hand, in its narrow focus on “materiality,” the Court overlooked that this may also be a question properly raised on a motion to dismiss:  if plaintiffs challenge a statement as misleading because it fails to disclose certain information, then the fact that the same information was actually disclosed (in that statement or other statement by the company), negates the existence of a false or misleading statement in the first place.  The Amgen decision will not affect defendants’ ability to make this challenge on a motion to dismiss, as an argument not against materiality, but rather against the sufficiency of plaintiffs’ allegations of falsity.

2) Because Amgen conceded that the market for its stock was “efficient,” the Court avoided more searching examination of what this term means, and how the efficiency of a market – an undisputed prerequisite to the application of the fraud-on-the-market presumption at the class certification stage – can be challenged.  In footnote 6, the Court noted that Amgen had advanced an argument founded on modern economic research tending to show that market efficiency was not a “binary, yes or no question.”  Rather, the efficiency of a market in absorbing information depends upon the type of information – a market might be able to readily process easily digestible information like public merger announcements, while the same market could be slow to respond to potentially important technical or scientific disclosures in an SEC filing. The Court sidestepped the issues raised by this argument, by saying that it did not impact the “materiality” question.

But the argument does raise the question of how efficiency should be defined, and whether the efficiency of a market may depend on the type of statement in question and/or its price impact.  The Court thus left the door open to question on class certification whether a statement was “efficiently” absorbed into, and thus reflected by, the market price.  This argument is a close cousin to materiality, with one important distinction:  I can imagine a circumstance in which a court could find that a public statement was not absorbed into, or reflected by the market price, and that the fraud-on-the-market presumption should not apply – but that, regardless, the statement was still “material,” in that a reasonable investor would find it significant.  In such an instance, the certification of a class would properly be defeated, but the ultimate question of materiality would be left open for an independent determination on the merits should an individual investor bring suit.  Such a circumstance would break the circle upon which the Court based its holding in Amgen.

3) Perhaps the most striking part of the decision was Justice Alito’s one paragraph concurrence, which baldly called for a reconsideration of the fraud-on-the-market presumption created in Basic.  Alito concurred with the majority, but only with the understanding that Amgen had not asked for Basic to be revisited.  Alito thus signaled that he agreed with Thomas’s contention in footnote 4 of the dissent that the Basic decision was “questionable.”  The majority, in turn, did not come to the defense of Basic, but simply noted with apparent relief (in footnote 2) that even Justice Thomas had acknowledged that the Court had not been asked to revisit that issue.  Considered together, these three opinions put out a welcome mat for the right case challenging Basic’s fraud-on-the-market presumption, with four votes already supporting the view that the decision was “questionable,” and the other five failing to come to its defense.  When, and if, Basic is reconsidered, the result could have a much larger impact on the future of class actions than would have been felt by any decision on the “materiality” questions raised in Amgen.

In summary, my first take on the Amgen decision is that far from settling the question of what plaintiffs must prove to gain class certification, it has merely opened the doors wider for continued litigation on the matter.  I predict that these issues are going to continue to be challenged, and that another case on class certification will be before the Court within the next few years.  After considering class-certification issues in Halliburton in 2011, and now in Amgen, the Court seems destined at long last to reach the ultimate question – the legitimacy and scope of the fraud-on-the-market presumption.

That doesn’t mean that Amgen will be forgotten – in addition to leaving behind a number of crumbs to feed continued litigation of “materiality” questions, the majority seemed to signal a shift away from its historic narrow construction of the securities laws based on the Court’s observation in Blue Chip Stamps v. Manor Drug Stores that “litigation under Rule 10b-5 presents a danger of vexatiousness different in degree and in kind from that which accompanies litigation in general.”  421 U.S. 723, 739 (1975).  Here, the Court flatly rejected Amgen’s argument based upon the public policy interest of containing that “vexatiousness.”  Amgen argued that if materiality was not addressed in class certification, it was likely not to be ever addressed at all, because after class certification, plaintiffs are able to bring substantial pressure to bear on defendants to get them to settle before the merits phase – even on frivolous claims.  But the Court contended that Congress had already taken steps, through the Reform Act, to curb the “‘extraction’ of ‘extortionate settlements’” of frivolous claims,” and, in doing so, had consciously decided not to challenge the fraud-on-the-market presumption. And while continuing to recognize the potential for abuse, the Court nonetheless chose to emphasize the possibility that securities class actions also serve an important public policy purpose, by supplementing the criminal prosecutions and civil enforcement actions brought by the DOJ and the SEC.  As the debate over the “materiality” question continues to play out, this passage may prove to be the most enduring takeaway from Amgen – and the one most likely to haunt us in plaintiffs’ briefs in the coming years.

 

I attended the Supreme Court argument in Amgen yesterday.  Law360 and the 10b-5 Daily, written by my former Wilson Sonsini partner Lyle Roberts (now at Cooley), have posted good summaries of the argument.

Here are links to (1) my October 15 blog post about Amgen and its significance and (2) the Amgen argument transcript.

After a reminder about the legal issue, I offer some thoughts about the argument, including Justice Scalia’s statement, “So maybe we should overrule Basic ….”

The Legal Issue

Reliance is an essential element of a Section 10(b) claim. Absent some way to harmonize individual issues of reliance, however, 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 v. Levinson, 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 in 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.”

At issue in Amgen is whether the materiality of an alleged misrepresentation is also a condition to the presumption’s application for purposes of Rule 23(b)(3).

The Core of the Dispute

Most of the Amgen argument centered on the following debate:  Materiality is a substantive element of a Section 10(b) claim.  Amgen and the plaintiffs agree that materiality, as a substantive element, is a legal question common to the class.  The United States (and I suspect the plaintiffs too, if they had been asked) agreed that materiality is a condition to the application of the fraud-on-the-market doctrine for purposes of the merits, but not for purposes of Rule 23.

So the dispute boils down to this: if courts were to determine materiality at class certification, they would be deciding a “common question” (i.e. materiality as a substantive element), albeit for purposes of determining whether reliance is a common question; but if courts do not determine materiality at class certification, they are either prematurely or improperly certifying a class, because materiality is necessary to make reliance a common question.  Justice Scalia amplified the latter point as follows:

Materiality is a common issue.  Reliance is only a common issue if you accept the fraud-on-the-market theory.  That’s the problem.  And you are using the one, which is a common issue, to leapfrog into the second, to make the efficiency of the market reasoning something that it isn’t.

There was a lot of fairly technical discussion about the considerations bearing on these issues, including (a) the legal and practical effect of an immateriality ruling at class certification on a class member’s individual claim, (b) the difference between adjudication of materiality at class certification and summary judgment, and (c) the fact that market efficiency and a public statement – both undisputed conditions to the presumption’s application – also are common to all class members.

I’m not a Supreme Court observer and thus will leave the oral argument tea-leaf reading to others.    But it seems to me that, in resolving the technical legal question, the Court will be influenced by precedent proscribing the limits of securities class actions because of the “danger of vexatiousness” they present and the extraordinary pressure a certified class places on defendants to settle.  Justice Scalia emphasized the settlement-pressure point.  In response to a question from Justice Breyer, Seth Waxman of Wilmer Hale, on Amgen’s behalf, synthesized the technical legal point and policy point nicely:

the point of Rule 23 is to say, you get to use this very useful and powerful device if you have the key to the gate, and the key to the gate is showing that the answer to the question, will reliance be proven commonly – not lost commonly, but proven commonly – is in fact yes.

Continue Reading Supreme Court Argument in Amgen

The Supreme Court’s decision in the Amgen securities case will have a profound impact on the future of securities class action litigation.  If the Court affirms the Ninth Circuit’s decision, it will eliminate an important event: a determination of whether the alleged false or misleading statements materially impacted the price of the company’s stock sufficient to invoke the “fraud-on-the-market” presumption of reliance.  That would mean, absent settlement, that the vast majority of all securities class actions that survive a motion to dismiss will remain alive until at least summary judgment, even those that are doomed to fail because the challenged statements were not, in fact, material.  If the Court reverses the Ninth Circuit, many future securities class actions will involve a meaningful class certification process.  That would yield several important strategic and economic consequences.   Argument is scheduled for November 5, 2012.

Before getting to my prediction and a discussion of the consequences of the Court’s ruling, following is a brief overview of the law and practice surrounding the issue the Court will decide.

Reliance is an essential element of a Section 10(b) claim.  Absent some way to harmonize individual issues of reliance, however, 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 v. Levinson, 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.”  At issue in Amgen is whether the materiality of an alleged misrepresentation is also a condition to the presumption’s application.

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.  This argument was accepted by the Fifth Circuit in Oscar Private Equity Investments v. Allegiance Telecom, Inc.  But  Oscar rested on shaky analytic grounds, and indeed the Supreme Court in Halliburton unanimously rejected loss causation as a condition of the presumption of reliance.

Continue Reading “Materiality” of Class Certification Procedure in Securities Class Actions at Issue in Amgen