On December 5, 2017, the United States District Court for the Northern District of California denied class certification in a putative securities fraud class action against Finisar Corporation (“Finisar”), a technology company focused on fiber optic subsystems, and its current chairman/CEO and former CEO, in which plaintiffs alleged that defendants misled investors by denying that Finisar’s revenue growth was the result of inventory build-up by customers. In re Finisar Corporation Securities Litigation, No. 5:11-cv-01252-EJD (N.D. Cal. Dec. 5, 2017). In denying plaintiffs’ motion for class certification, the Court ruled that defendants successfully rebutted the fraud-on-the-market presumption of reliance by demonstrating that defendants’ statements had no statistically significant impact on Finisar’s stock price.

Plaintiffs’ allege that, prior to the class period, Finisar experienced six consecutive fiscal quarters of growth. During this growth phase, industry analysts opinedthat Finisar’s growth was driven by customers building inventory rather than customers purchasing Finisar’s products for immediate use. On a call with analysts and investors on December 2, 2010, Finisar’s then-CEO allegedly responded to an analyst’s question by assuring the analyst that there were no issues with inventory build-up. The day that Finisar’s former-CEO made this comment, Finisar’s stock price increased, and it continued to increase throughout the class period. On March 8, 2011, Finisar issued a press release, in which it disclosed that its revenues would be lower than projected due in part to “previously undisclosed inventory build-up.” Following the issuance of the press release, Finisar’s stock price dropped 39 percent.

Plaintiffs filed a motion to certify a class of all persons and entities who purchased or otherwise acquired Finisar’s common stock between December 2, 2010 (the date of the alleged misstatement) and March 8, 2011 (the date of the alleged corrective disclosure). With respect to Rule 23(b)(3)’s predominance requirement, plaintiffs contended that class-wide issues predominated over individualized issues with regard to the element of reliance because class members are entitled to a presumption of reliance based upon the fraud-on-the-market theory. The Court analyzed the predominance requirement in two steps. First, the Court ruled that, because Finisar’s stocked traded on an open, well-developed, and efficient market, plaintiffs had made a sufficient showing to invoke the fraud-on-the-market presumption of reliance. Second, the Court ruled that defendants had rebutted the presumption of reliance by presenting evidence that the alleged misstatement did not impact Finisar’s stock price. In reaching this result, the Court relied heavily on defendants’ expert report, which showed that there was an increase in Finisar’s stock price in the hours leading up to the alleged misstatement, but that there was not a statistically significant price increase immediately following the alleged misstatement.

The Court also rejected plaintiffs’ argument that price impact should be inferred from Finisar’s stock price decline following the alleged corrective disclosure on March 8, 2011. While acknowledging that many courts have found price impact based on price movement following a corrective disclosure, the Court ruled that, under existing precedent, defendants are permitted to “sever the link” between the alleged misrepresentation and the price paid by the plaintiff by demonstrating a lack of price movement at the time of the misrepresentation. The Court also rejected plaintiffs’ argument that defendants’ expert’s analysis was flawed because the three-hour timeframe he analyzed following the alleged misstatement was too limited. The Court ruled that the defendants’ timeframe was reasonable because “an efficient market is said to digest or impound news to the stock price in a matter of minutes.”

This case highlights that, even when there is a significant decline in stock price following a corrective disclosure, defendants can still rebut the fraud-on-the-market presumption of reliance by demonstrating through expert evidence that there is no price impact at the time of the alleged misstatement.