The Supreme Court last week issued two opinions of major importance to the securities bar. In Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 568 U.S. (2013), the court held that no proof of materiality was required to certify a class of claimants under SEC Rule 10b-5, where those claimants sought to invoke the "fraud-on-the-market" presumption of reliance adopted in Basic Inc. v. Levinson, 485 U.S. 224 (1988). In Gabelli v. SEC, 568 U.S. (2013), the court refused to apply a discovery rule to the statute of limitations applicable to SEC enforcement actions seeking civil penalties for violations of the Investment Advisers Act of 1940. Thus, on the same day, the court in essence made it easier for plaintiffs to bring securities class actions and more difficult for the SEC to bring enforcement actions.
AMGEN: PROOF OF MATERIALITY NOT REQUIRED FOR CLASS CERTIFICATION
Connecticut Retirement Plans and Trust Funds filed suit against biotech company Amgen Inc. and several of its officers and directors alleging that Amgen failed to disclose safety information about two of its products. The plaintiff brought claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 on behalf of a putative class of Amgen shareholders. According to the complaint, the misstatements artificially inflated the price of Amgen stock when it was purchased by the plaintiff. The price then fell when Amgen made corrective disclosures.
The plaintiff moved to certify the class under Fed. R. Civ. P. 23(b)(3), arguing that common questions predominated over individualized ones. Amgen opposed certification on the ground that, inter alia, each plaintiff would need to prove his or her own reliance on any alleged misrepresentations or omissions to prevail under Rule 10b-5. Because reliance would thus be an individualized inquiry, the Rule 23(b)(3) predominance requirement could not be met. The plaintiff contended that reliance could be presumed under the "fraud-on-the-market" theory articulated by the Supreme Court in Basic.
The District Court for the Central District of California agreed with the plaintiff and certified a class. Connecticut Ret. Plans & Trust Funds v. Amgen, Inc., No. CV 07-2536, 2009 WL 2633743 (C.D. Cal. Aug. 12, 2009). On appeal, the Ninth Circuit affirmed, holding that the "fraud-on-the-market" presumption was triggered so long as the plaintiff demonstrated the security was traded in an efficient market, the alleged misrepresentations were public and the plaintiff alleged that the misstatements were material. The Court of Appeals further held that Amgen was not entitled to present "truth-on-the-market" rebuttal evidence at the certification stage but could present that evidence at summary judgment. Connecticut Ret. Plans & Trust Funds v. Amgen Inc., 660 F.3d 1170 (9th Cir. 2011).
The Supreme Court granted certiorari to address two issues: (1) whether a Rule 10b-5 plaintiff was required to present proof of materiality for a class to be certified based on the "fraud-on-the-market" presumption; and (2) whether the court must also consider a defendant's rebuttal evidence on the same issue before certifying a class.
Justice Ginsburg delivered the opinion of the court, affirming the Ninth Circuit in a 6-3 decision. She was joined by Chief Justice Roberts and Justices Breyer, Alito, Sotomayor and Kagan. Justice Thomas wrote a dissent in which Justices Scalia and Kennedy joined. Justice Scalia also wrote a separate dissent, while Justice Alito wrote a concurring opinion. In a victory for the class action plaintiffs' bar, the court held that plaintiffs seeking certification of a class under Rule 10b-5 did not need to prove materiality to receive the benefit of the "fraud-on-the-market" presumption of reliance at the class certification stage. Accordingly, defendants were not entitled at that stage to rebut the presumption.
Materiality Must Be Pled, But Not Proved, at Class Certification
To state a claim under Section 10(b) and Rule 10b-5, a plaintiff must establish the following six elements: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation." Matrixx Initiatives, Inc. v. Siracusano, 131 S. Ct. 1309, 1317 (2011). With regard to reliance, in Basic, the court held that reliance can be presumed on a "fraud-on-the-market" theory. Under this theory, in efficient markets, the market price will reflect all publicly available information. If the market for the security at issue is efficient, the court will permit plaintiffs a rebuttable presumption that all investors who traded in the security did so in reliance on any public material misrepresentations that were made regarding the security. Basic, 485 U.S. at 245-47.
The issue before the court in Amgen was whether a plaintiff needed to prove at the class certification stage that the misstatements at issue were material in order to trigger the "fraud-on-the-market" presumption or whether that was purely a merits issue. Amgen argued that only material information gets integrated into the market price. Therefore, if the statements at issue were not material, they would not have been included in the price paid by the plaintiff and reliance on those statements could not be presumed.
While the court agreed that materiality was a necessary element of the "fraud-on-the-market" presumption, the court found that it was not necessary to prove materiality to warrant class certification. Rather, the court reasoned, the only issue under Rule 23(b)(3) is whether common questions predominate over individual questions. Because materiality is an objective inquiry -- determining what would have been important to a "reasonable investor" -- the question was necessarily amenable to class-wide resolution. Even if the statements were ultimately deemed immaterial, that determination would effectively end the case, such that there would never be a risk of individual issues predominating later in the litigation. Amgen, 568 U.S. at *7-9.
The court admitted that it has come out differently on different aspects of the Basic factors, e.g., whether a named plaintiff must establish that he or she executed trades at the relevant time. Justice Ginsburg reasoned, that aspect of the Basic presumption goes to the Rule 23(a)(3) and (4) criteria of typicality and adequacy of representation, making them preliminary inquiries appropriate for the certification decision. The dissent viewed this as a distinction without a difference.
Meanwhile, Amgen is consistent with the court's decision last year in Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179 (2011), in which the court held that a plaintiff need not prove loss causation at the certification stage.
Defendants Are Not Entitled to Rebut the Presumption at Class Certification
The court also agreed with the Ninth Circuit that any evidence defendants might have to rebut the "fraud-on-the-market" presumption must wait for the merits phase of the case, at least so long as that rebuttal evidence related to the issue of materiality. As the court had explained in addressing the first question, the issue of materiality is not relevant to class certification because — whether the statements are material or immaterial — the issue is susceptible to class-wide resolution. "Therefore, just as a plaintiff class's inability to prove materiality creates no risk that individual questions will predominate, so even a definitive rebuttal on the issue of materiality would not undermine the predominance of questions common to the class." Amgen, 568 U.S. at *15.
Justice Thomas's and Justice Scalia's Dissents
Justice Thomas filed a dissent in which Justice Kennedy joined in its entirety and Justice Scalia joined in large part. Justice Thomas interpreted Basic as requiring proof of materiality in order to get the benefit of the "fraud-on-the market" presumption at the class certification stage. Justice Thomas reasoned that, without the presumption of reliance, questions of reliance are individualized: "Without materiality, there is no fraud-on-the-market presumption, questions of reliance remain individualized, and Rule 23(b)(3) certification is impossible." Justice Scalia, meanwhile, reasoned that the Basic decision itself applied to class certification and that it was thus improper to confine it to the merits stage of the action. Moreover, allowing a plaintiff to meet the Basic presumption purely on its pleading is contrary to the court's call for a "rigorous" analysis of the class certification criteria, based on more than just the pleadings, most recently reiterated in Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2551 (2011).
Implications for Future Litigation
The Amgen decision may have generated as many questions as it resolved. First, in some ways, the decision seems inconsistent with Wal-Mart.1 As Justice Scalia pointed out, a class certification decision should go beyond the pleadings and can, and often does, overlap with the merits. Wal-Mart, 131 S. Ct. at 2551. Justice Ginsburg reasoned that "Rule 23 grants courts no license to engage in free-ranging merits inquiries at the certification stage. Merits questions may be considered to the extent — but only to the extent — that they are relevant to determining whether the Rule 23 prerequisites for class certification are satisfied." Amgen, 568 U.S. at *7. What, then, is the proper divide now between certification and merits inquiries — the so-called "Eisen" question remains unresolved. Eisen v. Carlisle & Jacquelin, 417 U.S. 156 (1974).
Second, just as Wal-Mart seemed to add teeth to the commonality requirement of Rule 23(a), the court now arguably may be weakening the predominance requirement of Rule 23(b)(3), at least with respect to the "fraud-on-the-market" presumption of reliance. To the extent the plaintiffs' bar tries to export this ruling to other contexts, there is again likely to be continued debate on what needs to be proven at the class certification stage.
Third, in deciding that materiality could not defeat the predominance requirement, the court focused on the fact that materiality is an objective standard. Are all "objective" issues now arguably appropriate for class-wide resolution? The plaintiffs' bar is likely to argue just that.
Perhaps some of these issues will be given more clarity in Comcast v. Behrend, No. 11-864, an antitrust class action argued the same day as Amgen. In Comcast, the court is considering whether a trial court must require the presentation of "admissible evidence, including expert testimony, to show that the case is susceptible to awarding damages on a class-wide basis," also addressing the Eisen divide. Comcast Corp. v. Behrend, 133 S. Ct. 24 (2012).
Thus, in Amgen, decided in the wake of Wal-Mart, the court is continuing to grapple with critical questions relating to class action certification and highlighting for securities litigants -- especially issuers -- the perils that arise at various stages of securities class action litigation.
GABELLI: NO DISCOVERY RULE TOLLING FOR SEC ACTIONS SEEKING CIVIL PENALTIES
The court also issued a decision in Gabelli regarding the statute of limitations applicable to certain SEC enforcement actions. Gabelli involved a civil action by the SEC against the COO and portfolio manager for the mutual fund, Gabelli Funds, LLC, a registered investment adviser. The SEC claimed the individuals had allowed a fund investor to engage in "market timing" -- a strategy that takes advantage of time delays in the valuation systems mutual funds utilize. The complaint alleged claims for aiding and abetting violations of §§ 80b-6(1) and (2) and requested the imposition of civil penalties under § 80b-9, pursuant to the Investment Advisers Act.
Defendants moved to dismiss the complaint as untimely, invoking the five-year statute of limitations under 28 U.S.C. § 2462. Judge Deborah Batts of the Southern District of New York agreed with defendants and dismissed the action. The Second Circuit reversed, and the Supreme Court granted certiorari to provide guidance regarding the application of § 2462.
Chief Justice Roberts wrote the opinion for a unanimous court, reversing the Second Circuit and finding that the statute of limitations in § 2462 begins to run when the violation takes place -- not when the violation was or should have been discovered. Section 2462 provides: "an action . . . for the enforcement of any civil fine, penalty, or forfeiture . . . shall not be entertained unless commenced within five years from the date when the claim first accrues." This general provision applies to enforcement actions brought by the SEC for violations of the Investment Advisers Act. The court held that the most natural reading of the language "when the claim first accrues," in this particular context, is when the fraud in fact occurred. Gabelli, 568 U.S. at *4. The court rejected the SEC's invitation to read a discovery rule into the provision.
While the claims at issue did involve fraud, the court drew a distinction between fraud actions brought by a private plaintiff and those enforcement actions brought by a government entity. The court recognized that Congress has explicitly provided a discovery rule for certain other government actions but distinguished those actions as involving claims where the government is the victim, where there is a cap on how long the discovery period can run or where the statute identifies the official who would have the relevant knowledge. At bottom, the court rejected a longer statute of limitations for SEC enforcement actions, treating the limitations period for § 2462 as one of repose.
Although the decision in Gabelli was definitive, it was also quite narrow, and it is important to understand the opinion's limitations. The decision applies only to civil penalties. Gabelli, 568 U.S. at *4 n.1. The SEC had also requested injunctive relief and disgorgement of profits. The District Court held that the statute of limitations in § 2462 did not apply to equitable remedies aimed at protecting the public or remedying past wrongs, including the remedies of injunction and disgorgement. SEC v. Gabelli, No. 08 CV 3868, 2010 WL 1253603, at *5 (S.D.N.Y. Mar. 17, 2010). The Supreme Court did not revisit these holdings. Because the ruling addresses only actions for civil penalties, it will not impact most SEC enforcement actions, which seek injunctive relief.2
The decision is also limited to the application of a discovery rule -- the court did not address other tolling mechanisms. For instance, the court explicitly excluded any consideration of the application of the fraudulent concealment doctrine to § 2462. Gabelli, 568 U.S. at *4 n.2. Thus, it is possible the SEC could salvage claims brought more than five years after the conduct at issue took place by arguing that the defendant fraudulently concealed its actions. However, many of the policy considerations supporting the court's decision in Gabelli may also apply to a fraudulent concealment argument -- those considerations being that it is the government's job to work diligently to uncover fraudulent behavior, and it is important to place a definitive time limit on penalty actions. Gabelli, 568 U.S. at *6-7. Thus, though Gabelli limits the government's reach, it also leaves unanswered questions.