Over the last five years, the U.S. Supreme Court has devoted extraordinary attention to federal securities class actions. The Roberts Court has altered the landscape of federal securities jurisprudence in numerous respects: narrowing the territorial reach of the federal securities laws, limiting claims against secondary actors, redefining the pleading standards to establish scienter and addressing questions of materiality, loss causation and the statute of limitations. Now, the Supreme Court has agreed to consider a key issue at the class certification stage – the “fraud-on-the-market presumption.”
In Basic v. Levinson, a seminal 1988 decision, the Supreme Court created the fraud-on-the-market presumption, holding that reliance may be presumed for a plaintiff who purchased or sold a company’s securities in an efficient market. This is a necessary presumption to obtain class certification in a federal securities fraud suit involving large publicly-traded companies. Otherwise, each plaintiff would have to prove individual reliance, and class certification would be improper. The Supreme Court’s decision in Basic, however, did not address such issues as the proof needed for invoking the presumption or when and how a defendant may rebut the presumption.
Last year, in Erica P. John Fund, Inc. v. Halliburton Co., the Supreme Court unanimously and unsurprisingly overturned a high barrier to class certification in securities cases erected by the Fifth Circuit. The Court ruled that plaintiffs do not have to prove “loss causation” (i.e., that the defendant caused the plaintiffs’ losses) in order to invoke the fraud-on-the-market doctrine. But in Halliburton, the Supreme Court declined to address a related issue on which the circuit courts are deeply divided – whether the district court may consider the materiality of the defendant’s alleged misrepresentation at the class certification stage.
On June 11, 2012, the Supreme Court granted certiorari to address this issue in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds. Specifically, the Court has agreed to consider the following questions in Amgen: (1) whether the district court must require proof of materiality before certifying a plaintiff class based on the fraud-on-the-market theory; and (2) whether the district court must allow the defendant to present evidence rebutting the applicability of the fraud-on-the-market theory before certifying a plaintiff class.
The Supreme Court’s decision in Amgen has the potential to be a watershed event in federal securities litigation. Defending a certified securities fraud class action is often too costly for defendants, regardless of the merits, and brings inevitable settlement pressure. Therefore, the Supreme Court’s Amgen decision may define whether class certification is an easy hurdle for plaintiffs, or a substantial roadblock to the prosecution of investor securities claims.
The Ninth Circuit’s Amgen Decision
In Amgen, the plaintiffs sued Amgen Inc. and several of its officers for securities fraud, alleging that the defendants inflated Amgen stock prices by failing to disclose safety information about two Amgen products. The defendants opposed class certification, arguing that the plaintiffs were not entitled to the benefit of the fraud-on-the-market presumption because there were no material misrepresentations upon which plaintiffs could have relied and/or because the truth was already known to the market. The district court rejected the defendants’ arguments and certified the class.
The Ninth Circuit upheld the district court’s class certification of the class, holding that to invoke the fraud-on-the-market presumption of reliance, the plaintiffs must only:
"(1) show that the security in question was traded in an efficient market (a fact conceded here), and (2) show that the alleged misrepresentations were public (a fact not contested here). As for the element of materiality, the plaintiff must plausibly allege – but need not prove at [class certification] – that the claimed misrepresentations were material. Proof of materiality, like all other elements of a 10b-5 claim, is a merits issue that abides the trial or motion for summary judgment."
In holding that a plaintiff need not prove materiality to invoke the fraud-on-the-market presumption, the Ninth Circuit adopted the approach of the Third and Seventh Circuits. The court acknowledged the contrary holdings of the First, Second and Fifth Circuits, but reasoned that those courts had misconstrued a footnote in Basic discussing materiality, and it concluded that they were mistaken in requiring materiality to be proven as part of the fraud-on-the-market doctrine. In support of its holding, the Ninth Circuit cited the Supreme Court’s recent decision in Halliburton, which did not mention materiality as an element of the fraud-on-the-market presumption.
The Ninth Circuit also found that the district court correctly rejected the defendants’ efforts to rebut the fraud-on-the-market presumption with evidence of a “truth-on-the-market” defense at the certification stage. The court reasoned that the truth-on-the-market defense is a method of refuting an alleged misrepresentation’s materiality, a merits-based issue that is inappropriate to consider at the class certification stage. The court’s decision on this point is contrary to decisions in the First, Second, Third, and Fifth Circuits.
The Supreme Court Grants Certiorari
Amgen filed a petition for a writ of certiorari, asking the Supreme Court to address what it called “an irreconcilable conflict” among the federal judicial circuits on whether materiality must be considered before certifying a class based on the fraud-on-the-market doctrine. In response, the plaintiffs argued that there is no legitimate circuit split. According to plaintiffs, the Ninth Circuit’s opinion is the first decision to consider the materiality arguments in the aftermath of the Supreme Court’s decision in Halliburton, which they believe to be determinative of the issues. Plaintiffs also argued that the perceived circuit split is merely the product of a “strained” reading of the various courts’ opinions.
The Supreme Court is expected to hear oral argument during its 2012-2013 term, which begins in October.
The Importance of Amgen and the Fraud-on-the-Market Doctrine
While the Supreme Court adopted the fraud-on-the-market doctrine in Basic, it left open a number of questions about how the doctrine should be applied. The Supreme Court was asked to provide guidance on these issues in Halliburton, but declined to do so, stating “we need not, and do not, address any other question about Basic, its presumption, or how and when it may be rebutted.” In Amgen, the Supreme Court will have another opportunity to consider the practical requirements of the fraud-on-the-market doctrine, including how it should operate at the critically-important class certification stage.
As Amgen stressed in its certiorari petition, “[g]iven the well-recognized in terrorem power of class certification to force settlements of even non-meritorious securities fraud complaints . . . the likely effect of the Ninth Circuit’s rule is that, as a practical matter, defendants will rarely be able to test the materiality predicate to the fraud-on-the-market theory, notwithstanding the central importance of that theory in enabling class certification in the first place.”
While the Supreme Court could use the Amgen case as a vehicle to reevaluate the legal and economic theories underpinning the efficient-market hypothesis and the fraud-on-the-market presumption articulated in Basic, that seems unlikely. Rather, as the issues are currently framed, the Court is more likely to focus on a pair of important procedural questions.
The first question is whether the plaintiffs must present affirmative proof of materiality at the class certification stage. The Seventh and Ninth Circuits have said no, arguing that such a requirement is inconsistent with the presumption of reliance articulated in Basic. It also may be inconsistent with Halliburton. If plaintiffs are not required to present proof of loss causation at the class certification stage (with expert reports, event studies, and the like), they arguably should not be required to affirmatively prove the (oftentimes related) element of materiality. But other circuit courts have disagreed, noting that materiality is an essential component of the presumption as described in Basic: “[b]ecause most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action.”
The second question is a matter of timing and proof. There is no dispute that a defendant may rebut the fraud-on-the-market presumption. The question is when defendants must be given an opportunity to rebut the presumption – can they attack the presumption at the class certification stage, or must they wait until summary judgment or trial? Also, are the defendants limited to disproving the existence of an efficient market for the security in question, or may they go further and show that the alleged misstatements did not affect the market?
The Supreme Court may adopt a middle-ground approach by permitting defendants to rebut the presumption in appropriate circumstances, but not requiring plaintiffs to affirmatively prove materiality in every case. Such a result would give defendants an important tool to defend themselves from unmeritorious class actions, but would limit the debate to cases in which materiality (and loss causation) are legitimately at issue. On the other hand, a complete victory for either side would be likely to have widespread and long-term impact on federal securities litigation. If the Supreme Court upholds the Ninth Circuit’s decision, it would be a major victory for the class action plaintiffs’ bar, especially coming on the heels of the Court’s pro-plaintiff rulings in Halliburton and Matrixx. This would eliminate a significant hurdle for class action plaintiffs and likely result in an increase in securities litigation across the country. Conversely, if the Supreme Court rejects the Ninth Circuit’s approach, it would be a significant victory for corporate defendants, substantially raising the bar for class certification and creating an important new battleground in securities cases.