For over 20 years, the “fraud on the market” theory, which the Supreme Court endorsed in Basic Inc. v. Levinson, 485 U.S. 224 (1988), has been a key tool for plaintiffs in class action securities fraud litigation under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5. The theory posits that the price of a security trading in an efficient market reflects all publicly available information about that security. Based on that premise, the theory gives rise to a rebuttable presumption that investors rely on material misrepresentations reflected in market prices at the time they transact. Without this presumption, plaintiffs purporting to assert class action securities fraud claims would have difficulty showing reliance on a class-wide basis, and hence satisfying the typicality and predominance prerequisites to class certification under Fed. R. Civ. P. 23(a) and 23(b)(3). Decisions as to class certification strongly influence the balance of leverage as between plaintiffs and defendants in class actions generally. Thus, the showing plaintiffs must make in order to invoke the “fraud on the market” theory is a critical issue in securities litigation.
Last year, in Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011), the Supreme Court held that plaintiffs in proposed securities fraud class actions need not prove loss causation – that is, a sufficient causal connection between an alleged material misstatement or omission and actual economic loss – in order to invoke the “fraud on the market” theory at the class certification stage. However, the Halliburton Court expressly noted that it was not “address[ing] any other question about Basic, its presumption, or how and when it may be rebutted.” Earlier this year, the Supreme Court granted certiorari in Amgen, Inc. v. Connecticut Retirement Plans & Trust Funds, No. 11-1085, to review a Ninth Circuit ruling that raises important questions concerning the “fraud on the market” theory, and class certification in private securities fraud actions, that Halliburton left open. The Court has scheduled oral argument in Amgen to take place on November 5, 2012. Because Amgen presents questions that bear directly on the ability of defendants to terminate proposed securities fraud class actions at an early stage, the Supreme Court’s decision in the case will almost certainly be a very significant one for public companies and their directors and officers, insurance carriers and outside professionals.
Plaintiff in Amgen, purporting to sue on behalf of itself and a proposed class of purchasers of Amgen Inc. common stock, asserted federal securities fraud claims based on alleged misstatements concerning the safety and marketing of a number of Amgen’s products. Absent any dispute that Amgen common stock traded in an efficient market, and that the misrepresentations plaintiff had alleged were public, the district court found that plaintiff could invoke the “fraud on the market” theory, and certified a plaintiff class under Fed. R. Civ. P. 23(b)(3). On discretionary review of the class certification order, the Ninth Circuit rejected defendants’ argument that, because an immaterial misrepresentation “by definition would not affect Amgen’s stock price in an efficient market, and thus no buyer could claim to have been misled by an artificially inflated stock price,” the district court should have required proof that the alleged misrepresentations were material before permitting plaintiff to invoke the “fraud on the market” presumption. Rather, the Ninth Circuit held that while plaintiffs in federal securities fraud actions must plausibly allege the materiality of purported misstatements or omissions in their complaints sufficient to withstand a motion to dismiss, and prove materiality in order to prevail at trial on the merits, no proof of materiality is necessary at the class certification stage in order to invoke the “fraud on the market” presumption of reliance. The Ninth Circuit also held that defendants may not attempt to rebut that presumption before the certification of a class by offering a “truth on the market” defense – that is, showing that the alleged misstatements were not material, and could not have influenced the market price of Amgen common stock, because market participants knew the true facts.
The federal courts of appeals have split on the questions that Amgen presents. In Amgen, the Ninth Circuit endorsed the minority view, relying on Schleicher v. Wendt, 618 F.3d 679 (7th Cir. 2010), a Seventh Circuit decision likewise holding that proof of materiality of the alleged misrepresentation or omission is not a precondition to invoking the “fraud on the market” presumption at the class certification stage, and that defendants may not contest materiality to rebut the presumption at that point. Id. at 687. The Third Circuit has taken a slightly different, intermediate approach, holding that plaintiffs need not prove materiality before class certification, but that defendants should have an opportunity at that stage to rebut the “fraud on the market” presumption by showing, for example, that the alleged misrepresentations or omissions were immaterial or had no market price impact. In re DVI, Inc. Securities Litigation, 639 F.3d 623, 638 (3d Cir. 2011). By contrast, the majority view – reflected in holdings of the Second and Fifth Circuits and dicta in First and Fourth Circuit decisions – requires securities class action plaintiffs to prove materiality at the class certification stage. See In re Salomon Analyst Metromedia Litigation, 544 F.3d 474, 484-86 (2d Cir. 2008); Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F.3d 261, 264-65 & 267-68 (5th Cir. 2007), abrogated on other grounds by Halliburton, 131 S. Ct. at 2185; In re PolyMedica Corp. Securities Litigation, 432 F.3d 1, 5-6 & 8 n.11 (1st Cir. 2005); Gariety v. Grant Thornton LLP, 368 F.3d 356, 366-67 (4th Cir. 2004).
The Supreme Court’s decision last year in Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541 (2011), may provide some guidance as to how the Court will resolve Amgen. Although Wal-Mart considered the requirements for class certification in an employment discrimination action under Title VII, the Court’s general holding that “[a] party seeking class certification must affirmatively demonstrate his compliance with [Fed. R. Civ. P. 23] – that is, he must be prepared to prove that there are in fact sufficiently numerous parties, common questions of law or fact, etc.,” requires federal courts to conduct a “rigorous analysis” of whether the plaintiff has satisfied his burden under Rule 23, even if that analysis must address issues that overlap with the merits of the underlying claims. Id. at 2551. Significantly, the Wal-Mart Court observed in dicta that proposed federal securities fraud class actions where plaintiffs seek to invoke the “fraud on the market” presumption present “the most common example of considering a merits question at the Rule 23 stage,” because plaintiffs must show market efficiency – one of the prerequisites under Basic to application of the presumption – at the class certification stage and again at trial. Id. at 2552 n.6. The Supreme Court’s analysis in Wal-Mart suggests that to satisfy Rule 23, a securities fraud class action plaintiff must demonstrate all of the prerequisites for the “fraud on the market” presumption, including that the alleged statements or omissions were material.
The Ninth Circuit’s opinion in Amgen discussed Wal-Mart, but concluded that materiality is purely a “merits” question that plaintiffs need not prove at the class certification stage. Relying on Schleicher, the Ninth Circuit reasoned that, absent materiality, it would still be “possible to certify a class under Rule 23(b)(3) even though all [alleged false] statements turn out to have only trivial effects on stock prices.” Defendants will contend that this reasoning overlooks Wal-Mart’s guidance that plaintiffs seeking class certification must demonstrate that the “fraud on the market” presumption applies, even if doing so requires proof on issues that are also relevant to the merits of the underlying securities claim. Defendants also will argue that the Ninth Circuit’s ruling is inconsistent with Basic and subsequent, well-reasoned appellate decisions describing the “fraud on the market” doctrine as giving rise to a presumption of reliance only on misstatements or omissions that are material. For example, the Second Circuit has explained that “if plaintiffs can show that the alleged misrepresentation was material and publicly transmitted into a well-developed market, then reliance will be presumed . . . .” Salomon, 544 F.3d at 483 (emphasis added) (citing Basic, 485 U.S. at 232); see also, e.g., PolyMedica, 432 F.3d at 7 & 8 n.11 (observing that the Basic Court’s “fraud on the market” theory depends on the presence of material misstatements or omissions, and holding that a plaintiff must prove an efficient market and materiality before the presumption of reliance applies); Gariety, 368 F.3d at 364 (recognizing that a plaintiff must demonstrate materiality to obtain the presumption of reliance). As the defendants argued before the Ninth Circuit in Amgen, absent a material misstatement or omission, there can be no presumption of stock price movement in an efficient market. See Salomon, 544 F.3d at 483 (“The point of Basic is that an effect on market price is presumed based on the materiality of the information and a well-developed market’s ability to readily incorporate that information into the price of securities.”).
The Supreme Court’s decision in Amgen promises to add clarity to an area of the law in which there has been diversity of views in the courts of appeals. Among other things, the Court will likely speak to the operation of the “fraud on the market” presumption under Basic, as well as the extent to which courts may consider, in evaluating class certification in securities cases, matters relevant to both class certification and the merits of the plaintiff’s claim. The Amgen decision is likely to have a substantial impact on the strategies and techniques that parties employ during the early stages of litigation in securities fraud class actions, the relative leverage of the parties in such cases, and the ability of plaintiffs to obtain monetary settlements.
Stephen M. Sinaiko and Steven S. Sparling, Partners in the firm’s litigation department, focus their practices on complex commercial litigation, white collar criminal defense, and regulatory matters, including securities class actions.