The recent Supreme Court term has produced several decisions that will have a far-reaching impact on future class action litigation. Considering a range of disparate issues like arbitration, commonality, and materiality among others, the Court used this past term to answer questions that have plagued the lower courts for years, while confirming the critical importance of early-stage litigation in putative class actions.
The first of these opinions resolved an issue arising in securities class actions. In the Matrixx Initiatives, Inc. v. Siracusano opinion released on March 22, 2011, a unanimous Court affirmed the Ninth Circuit and held, inter alia, that reports of adverse events could be material to reasonable investors even if they were not statistically significant.
The Supreme Court first noted that “[t]o prevail on a § 10(b) claim, a plaintiff must show that the defendant made a statement that was ‘misleading as to a material fact,’” and that in Basic, “we held that this materiality requirement is satisfied when there is ‘a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.’”
Matrixx urged the Court to “adopt a bright-line rule that reports of adverse events associated with a pharmaceutical company’s products cannot be material absent a sufficient number of such reports to establish a statistically significant risk that the product is in fact causing the events.” On the one hand, the Court acknowledged that the Basic “total mix” standard would not be met by “the mere existence of reports of adverse events—which says nothing in and of itself about whether the drug is causing the adverse events.” But while “[s]omething more is needed,” that “something more is not limited to statistical significance and can come from ‘the source, content, and context of the reports.’” And “[t]his contextual inquiry may reveal in some cases that reasonable investors would have viewed reports of adverse events as material even though the reports did not provide statistically significant evidence of a causal link.”
Applying Basic’s “total mix” standard, the Court concluded that the plaintiffs adequately pled materiality. “Matrixx received information that plausibly indicated a reliable causal link between Zicam and anosmia [loss of smell].” Moreover, the Court held that “[v]iewing the allegations of the complaint as a whole, the complaint alleges facts suggesting a significant risk to the commercial viability” of Zicam, and that “[i]t is substantially likely that a reasonable investor would have viewed this information ‘as having significantly altered the “total mix” of information made available.’” And, “[a]ssuming the complaint’s allegations to be true,” in contrast to its public statements to the market that revenues were going to rise, “Matrixx had information indicating a significant risk to its leading revenue-generating product.”
The Court also held that scienter was adequately pleaded. While stating that “[w]e have not decided whether recklessness suffices to fulfill the scienter requirement,” the Court noted that Matrixx had not challenged the Ninth Circuit’s holding that the scienter requirement could be satisfied by “deliberate recklessness,” and so assumed, without addressing, the correctness of that approach. The Court held that the complaint’s allegations, taken collectively, gave rise to an inference that Matrixx did not disclose the adverse event reports because it understood their likely effect on the market.
The next decision involved arbitration in the class action context. On April 27, 2011, the Supreme Court issued a 5-4 decision in AT&T Mobility v. Concepcion, authored by Justice Scalia, ruling that the Federal Arbitration Act (“FAA”) protects the rights of companies to require arbitration and to preclude individuals from pursuing such arbitration on a classwide basis, even in consumer contracts of adhesion.
The Supreme Court relied on its interpretation of the language of Section 2 of the FAA, which states in relevant part: “A written provision in any maritime transaction or a contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract or transaction . . . shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” The Court stated that this section reflects both “a liberal federal policy favoring arbitration” and the “fundamental principle that arbitration is a matter of contract.” Thus, the Court stated, “courts must place arbitration agreements on an equal footing with other contracts, and enforce them according to their terms.” Ultimately, the Court concluded that “[r]equiring the availability of classwide arbitration interferes with fundamental attributes of arbitration and thus creates a scheme inconsistent with the FAA,” such that such a requirement cannot constitute a “ground . . . for the revocation of any contract” as is permitted under Section 2 of the FAA.
The Concepcion decision will likely reduce the prevalence of classwide arbitrations, and makes arbitration clauses more attractive to companies seeking to protect themselves against consumer or other types of class actions. Indeed, lower courts have already begun relying on that case to defeat attempts to bring consumer class actions where arbitration clauses exist in consumer contracts. See, e.g., In re Apple & AT&T iPad Unlimited Data Plan Litig., No. C-10-02553 RMW, 2011 WL 2886407 (N.D. Cal. Jul. 19, 2011); (In Chambers) Order Granting Defendant’s Motion to Compel Arbitration, In re Gateway LX6810 Computer Prods. Litig., No. SACV 10-1563-JST (JEMx) (C.D. Cal. Jul. 21, 2011) [Dkt. No. 36].
The Court then returned to securities class actions. On June 6, 2011, the Supreme Court issued a unanimous decision in Erica P. John Fund, Inc. v. Halliburton Co., ruling that plaintiffs in a private securities fraud class action need not prove loss causation in order to obtain a certified class.
The Supreme Court again relied upon its prior jurisprudence in Basic. The Court noted that according to the Fifth Circuit Court of Appeals, “EPJ Fund also had to establish loss causation at the certification stage to ‘trigger the fraud-on-the-market presumption.’” But, “[t]he Court of Appeals’ requirement is not justified by Basic or its logic.” Never before had the Court mentioned loss causation as a precondition for invoking Basic’s rebuttable presumption. Indeed, “loss causation addresses a matter different from whether an investor relied on a misrepresentation, presumptively or otherwise, when buying or selling a stock.” The Court noted that while, under Basic’s fraud-on-the-market doctrine, an investor presumptively relies on a misrepresentation if that information is reflected in the market price of a stock at the time of the relevant transaction, loss causation, by contrast “requires a plaintiff to show that a misrepresentation that affected the integrity of the market price also caused a subsequent economic loss.”
According to the Supreme Court, the Fifth Circuit’s rule “contravenes Basic’s fundamental premise – that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction.” “The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation,” the Court explained, “has nothing to do with whether an investor relied on a misrepresentation in the first place, either directly or through the fraud-on-the-market theory.”
The Court thus ruled that the Court of Appeals erred by requiring the Plaintiff to show loss causation as a condition for obtaining class certification. Given its holding, the Court declined to address another issue raised by the briefs (as well as several recent decisions of the Courts of Appeal) as to which there is also a divergence of opinion among the Circuits: whether or not the Basic fraud-on-the-market presumption may be rebutted at the class certification stage.
Smith v. Bayer
The Court then decided an issue on the application of the Anti-Injunction Act to state class action proceedings. In the Smith v. Bayer decision, released on June 16, 2011, the Court reversed the Eighth Circuit Court of Appeals’ affirmance of a district court’s enjoining a West Virginia state court from considering a plaintiff’s request to certify a class. The district court had held that the denial of class certification in a previous federal district court precluded a West Virginia state court from considering a similar motion for class certification under the Anti-Injunction Act’s relitigation exception.
The Supreme Court held that the Anti-Injunction Act precluded the district court’s injunction, because the relitigation exception to that Act did not apply. That exception “authorizes an injunction to prevent state litigation of a claim or issue ‘that previously was presented to and decided by the federal court.’” At least two conditions must be met: (1) the issue the federal court decided must be the same as the one presented in the state tribunal; and (2) the plaintiff in the state action must have been a party to the federal suit, or else fall within one of a few discrete exceptions to the general rule against binding nonparties.
The Court held that neither condition was met. With respect to the “same issue” requirement, “the state court was poised to consider whether the proposed class satisfied West Virginia Rule 23” in contrast to the federal court, which had decided the issue under Federal Rule 23. But the West Virginia Supreme Court, when interpreting its Rule 23, had disapproved the approach to Rule 23(b)(3)’s predominance requirement that the district court had embraced. The federal district court “applied a strict test barring class treatment when proof of each plaintiff’s injury is necessary” whereas the West Virginia Supreme Court has rejected a “rigid test” and adopted an “all-things-considered” test when analyzing the same issue. Unsurprisingly, the Court held that this difference meant that the district court had not decided the same issue that would be presented to the state court.
With respect to the second condition for the relitigation exception, the Court also rejected the idea that a person who would have been a non-named member of a class in a case where certification was ultimately denied could be considered a “party” to such a prior suit. Accordingly, the Court held that the plaintiff in the state suit had not been a party to the prior federal suit and did not fall within any exception to the prohibition against binding nonparties.
Finally, on June 20, 2011, the Supreme Court released its opinion in the Wal-Mart Stores, Inc. v. Dukes case, reversing the certification of a class of 1.5 million female employees of Wal-Mart who had alleged that the company discriminated against them in violation of Title VII of the Civil Rights Act of 1964. A divided Court (5-4) held that the class of all female employees at Wal-Mart stores had not met the commonality requirement of Rule 23(a)(2), while the Court unanimously agreed that the case should not have been certified under Rule 23(b)(2). The Court’s decision, and in particular its ruling with respect to commonality, will have a significant effect on class action practice going forward.
The Wal-Mart case was brought as a putative class action where the named plaintiffs alleged employment discrimination on behalf of a nationwide class of all women at Wal-Mart, seeking, inter alia, injunctive relief and declaratory relief as well as backpay. The plaintiffs claimed that local managers’ discretion over pay and promotions at Wal-Mart stores was exercised disproportionately in favor of men, leading to an unlawful disparate impact on female employees. “The basic theory of [Plaintiffs’] case is that a strong and uniform ‘corporate culture’ permits bias against women to infect, perhaps subconsciously, the discretionary decisionmaking of each one of Wal-Mart’s thousands of managers . . .,” leading to an alleged common discriminatory practice affecting all female employees.
The Court announced that “[t]he crux of this case is commonality—the rule requiring a plaintiff to show that ‘there are questions of law or fact common to the class.’” And as to commonality, it requires a demonstration that “the class members have ‘suffered the same injury.’” The Court clarified that it is the “capacity of a classwide proceeding to generate common answers” that matters to class certification, not merely the raising of common questions.
The Court also made clear that “Rule 23 does not set forth a mere pleading standard,” but that “[a] party seeking class certification must affirmatively demonstrate his compliance with the Rule—that is, he must be prepared to prove that there are in fact sufficiently numerous parties, common questions of law or fact, etc,” and “[f]requently that ‘rigorous analysis’ will entail some overlap with the merits of the plaintiff's underlying claim.”
To bridge what the Court deemed a “conceptual gap” present in the commonality analysis, the plaintiffs needed to put forth “‘significant proof’ that Wal-Mart ‘operated under a general policy of discrimination.’” “That,” the Court wrote, “is entirely absent here.” Wal-Mart’s announced policy forbade sex discrimination. The fact that discretion was given to local supervisors was “just the opposite of a uniform employment practice that would provide the commonality needed for a class action,” “it is a policy against having uniform employment practices.” Plaintiffs’ evidence, the Court concluded, fell well short of identifying “a common mode of exercising discretion that pervades the entire company . . . .” In addition to finding a failure to satisfy Rule 23(a), the Court unanimously concluded that Respondents’ claims for backpay should not have been certified under Rule 23(b)(2). Claims for monetary relief may not, where the monetary relief is not incidental to the injunctive or declaratory relief, be certified under Rule 23(b)(2). At a minimum, the Court held, “claims for individualized relief (like the backpay at issue here) do not satisfy [Rule 23(b)(2)].”
Lower courts have quickly picked up on the import of the Wal-Mart decision, and relied on the decision to defeat class certification. See, e.g., Cruz v. Dollar Tree Stores, Inc., Nos. 07-2050 SC, 07-4012 SC, 2011 WL 2682967 (N.D. Cal. Jul. 8, 2011).
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While these decisions arguably represent a natural evolution of prior Supreme Court precedent rather than a sea change, it is clear that they will ensure that a putative class action complaint is subject to considerable scrutiny prior to certification. It remains to be seen how lower courts will ultimately interpret and enforce these decisions, but what is unquestionable is that the Court has both clarified the groundwork for class actions, and made certain types of class actions much less likely to succeed.