On July 7, 2017, in a decision making several significant rulings and clarifications, the United States Court of Appeals for the Second Circuit vacated in part an order certifying classes asserting claims under the Securities Exchange Act of 1934 (the “Exchange Act”) and the Securities Act of 1933 (the “Securities Act”) on the basis that the lower court had insufficiently considered whether individual determinations as to whether over-the-counter bond purchases were “domestic” would predominate over common issues of fact and law. In re Petrobras Securities, -- 3d. -- (2d Cir. July 7, 2017). The Court further clarified that, unlike the Third Circuit, the Second Circuit requires only that a class be “defined using objective criteria that establish a membership with definite boundaries” to meet the threshold ascertainability requirement under Rule 23 of the Federal Rules of Civil Procedure, and that, in Exchange Act cases, plaintiffs may be able to avail themselves of the “fraud on the market” theory presumption of reliance even if they do not establish statistically significant price changes in response to relevant news, provided that the entirety of the plaintiffs’ analysis supports market efficiency.

The case involves securities claims against Petróleo Brasileiro S.A. (“Petrobras”) and certain of its subsidiaries, former officers and directors, underwriters of Petrobras debt securities, and Petrobras’s outside auditor. Plaintiffs assert claims in connection with certain Petrobras American Depository Shares that trade on the New York Stock Exchange, and also in connection with debt securities (both in initial offerings and the secondary market) that traded over the counter. Judge Rakoff of the United States District Court for the Southern District of New York had certified a class of plaintiffs suing under the Exchange Act and a class suing under the Securities Act.

The dispositive issue in the Second Circuit’s decision to vacate class certification, for both the Securities Act and Exchange Act claims, was its holding that the district court was obliged, but failed to, analyze whether individual questions of “domesticity” would predominate over common questions of law and fact. Under the Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), and the Second Circuit’s decision in Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012), claims under the Exchange Act and the Securities Act may only be brought in connection with securities that traded on a U.S. exchange or which were traded in “domestic transactions.” The district court found that two named plaintiffs had adequately alleged domestic transactions, while two other named plaintiffs had not, and held that class certification was appropriate because the classes were ascertainable and administratively manageable. Slip op. at 23-25.

The Second Circuit agreed with the district court on ascertainability.[1] Agreeing with the Sixth, Seventh, Eighth, and Ninth Circuits, and disagreeing with the Third Circuit, the Court held that the ascertainability threshold for class certification under Rule 23 required only that a class be definable using objective criteria that establish a membership with definite boundaries,” and did not require a separate administrative feasibility test. Slip op. at 8-9 & 28. The Court then concluded that “this modest threshold requirement,” id. at 39, was met because a class definition of persons who acquired specific securities during a specific time period in domestic transactions—i.e., “securities identified by subject matter, timing, and location”—was clearly objective, even if making this determination for each class member might be impractical. Id. at 41.

The Court held that the district court had erred, however, by finding that “Rule 23(b)(3)’s predominance requirement was satisfied without considering the need for individual Morrison inquiries.” Slip op. at 9. In so doing, the Court held that a proper assessment of predominance requires consideration of two predicate Morrison questions: (i) is the determination of domesticity material to plaintiffs’ class claims and (ii) if so, is that determination “susceptible to generalized class-wide proof” such that it represents a common question as to which “more often than not, [plaintiffs] can provide common answers.” Id. at 44-45 & 50; see also id. at 52. The Court held that district court’s failure to address the second question required vacatur and remand. Id. at 52-54. In particular, because Petrobras’s debt securities were traded over the counter, and not on a U.S. exchange, the district court was obliged to conduct a fact-specific analysis regarding “markers of domesticity” to determine whether various plaintiffs had purchased debt securities in domestic transactions. Id. at 8. In so holding, the Court rejected plaintiffs’ argument that modern financial records would necessarily make it easy to identify class members, id. at 49, and that trades using the Depository Trust Company (“DTC”) were necessarily domestic, id.at 47-48 n.24, while also noting that a district court might find common indicia of domesticity for particular parties or find that common questions predominate. See id. at 54 & n.27. The Court affirmed the district court’s certification order insofar as it found that plaintiffs adequately supported their Exchange Act claims through their invocation of the “fraud on the market” theory presumption of reliance under Basic Inc. v. Levinson, 485 U.S. 224 (1988), and reiterated the Second Circuit’s multifaceted, “holistic” approach to the question of market efficiency. Slip op. at 61. More specifically, the Court rejected defendants’ argument that plaintiffs had not established market efficiency because their expert had not “offered direct evidence of market efficiency,” i.e., that “the price of the relevant securities predictably moved up in response to good news and down in response to bad news.” Stating that “the Petrobras Defendants are attempting to relabel a sufficient condition as a necessary one,” the Court noted that the burden of establishing market efficiency “is not an onerous one,” and could be met by a combination of direct and indirect evidence, including but not limited to analysis of the so-called Cammer factors. Id. at 60, 63 (emphasis in original). See Cammer v. Bloom, 711 F. Supp. 1264, 1286-87 (D.N.J. 1989) (identifying factors relevant to market efficiency determination).

This decision is significant in multiple respects, including by establishing the importance of careful review of Morrison issues in certifying a class implicating questions of the extraterritorial application of the federal securities laws, as well as by clarifying the Second Circuit’s position on questions of ascertainability and, post Halliburton II[2], the application of the fraud-on-the-market presumption at the class certification stage. 

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