Fraud-on-the-Market Doctrine

In 2012, I started the D&O Discourse blog to have a discussion among the repeat players in securities and corporate governance litigation:  insurers, brokers, mediators, economists, plaintiffs’ counsel, and defense counsel.  I share opinions from the defense-counsel perspective, but I call it like I see it.  For example, in a post in anticipation of the

How will the 2017 arrival of Justice Neil Gorsuch influence the US Supreme Court’s securities-fraud jurisprudence?

My colleague Kristin Beneski and I discuss this question in a Washington Legal Foundation Working Paper titled “US Supreme Court Securities-Fraud Jurisprudence:  An Emerging New Direction?

In our Working Paper, we analyze whether Justice Gorsuch may urge

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

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

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.

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

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

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

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

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.

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