Fraud-on-the-Market Doctrine

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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