The Second Circuit’s recent rulings in In Re Petrobras Securities may prove to be bittersweet for defendants in securities class actions. While the Court, in decertifying the two Petrobras investor class actions, made it more difficult for investors in foreign securities not listed on a domestic exchange to be certified as a class, it also liberalized two requirements for investors seeking class action certification.

Strict Application of the Predominance Requirement

The Second Circuit recently reversed United States District Court Judge Jed S. Rakoff’s certification of two Petrobras investor class actions – alleging that Petrobras concealed a multi-billion dollar scheme involving money laundering and kickbacks – based on the Second Circuit’s determination that the proposed classes did not satisfy the predominance requirement. To satisfy this initial certification requirement, “the questions of law or fact common to class members [must] predominate over any questions affecting only individual members.”[1]A “common question” is one where the same evidence can be applied to each member of a proposed class, as opposed to an “individual question” where the necessary evidence varies from member to member. Specifically, the Second Circuit found that Judge Rakoff did not adequately consider whether the individual investors that formed the proposed Petrobras investor classes could each satisfy the domesticity requirement of 10(b) of the Securities Exchange Act of 1934, which requires that the securities at issue be purchased in “domestic transactions.”

The Court found that to make such a determination would require individual examinations of each class member’s specific transaction. In other words, individualized discovery would be required for each potential member of the class to determine whether they purchased the securities at issue domestically or abroad. As a result, the Second Circuit determined that the predominance requirement had not been met.

The broader impact of the Second Circuit’s ruling is not known, but this ruling could prove to be a significant blow to investors in foreign securities that are not offered on domestic exchanges. While the Second Circuit did create a potential roadblock to class certification, its ruling left open the possibility that investors in foreign securities could satisfy the predominance test by presenting evidence that the particular transactions share a “common indicia of domesticity.”[2] Accordingly, in response to this ruling, investors in non-exchange traded foreign securities who have proof of the domesticity of their transactions may opt to file individual claims or form smaller groups instead of seeking class certification. At the same time, the Second Circuit’s ruling may have the effect of reducing the number of claims filed by investors without the financial means to independently pursue their potential claims.

Ascertainability Requirement Liberalized

Though the Second Circuit dealt a blow to investors with its predominance ruling, its interpretation of the ascertainability requirement favors investors. The Court ruled that the ascertainability doctrine requires that a proposed class simply be “defined using objective criteria that establish a membership with definite boundaries” and does not compel “administrative feasibility.”[3] Under this interpretation, the ascertainability requirement will only impede the certification of a proposed class definition that is fundamentally “indeterminate.”[4] The Court found the proposed Petrobras investor classes, made up of people who acquired specific securities during a specific timeframe in domestic transactions, satisfy the ascertainability requirement because they were formed based upon objective criteria – subject matter of the security, time, and location – and because the subset of investors who purchased securities in domestic transactions during the class period was sufficiently definite.[5]

Nevertheless, despite the Second Circuit’s ruling rejecting an administrative feasibility requirement, courts may still take into account the difficulty in managing a class action in their predominance considerations. In addition, plaintiffs are still required to clearly define the class and its boundaries. Therefore, the Second Circuit’s liberal interpretation of the ascertainability requirement may only provide a modest benefit to plaintiffs seeking class action certification.

Reliance Requirement Liberalized

The United States Supreme Court, in Basic v. Levinson, found that because investors purchase or sell a given stock at the price set by the market in reliance on the integrity of that pricing, their reliance on public material misrepresentations may be presumed.[6]Accordingly, by showing the existence of an efficient market, plaintiff investors may satisfy the 10b-5 reliance requirement. The Second Circuit, in the Petrobras decision, determined that the Plaintiffs, in order to prove the Petrobras securities were sold on an efficient market, did not need direct evidence of Petrobras’ stock price increasing and decreasing as expected based on precipitating news.[7] Rather, the court held that the Plaintiffs could show reliance using indirect evidence, such as expert reports and testimony, and that the burden to prove reliance is not a heavy one.

The most significant, but at the same time most limited, impact will be the Second Circuit’s strict application of the predominance requirement at the expense of plaintiff investors transacting in non-exchange listed foreign securities. Perhaps the broader impact, however, will be the Second Circuit’s liberalization of the ascertainability and reliance requirements as the ruling did not appear to be limited to cases involving non-exchange listed foreign securities.