The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

I am pleased to publish below a guest post written by Robert F. Carangelo, Paul A. Ferrillo, David J. Schwartz, and Matthew D. Altemeier of the Weil, Gotshal & Manges law firm and the authors of The 10b-5 Guide, the most recent edition of which can be found here.. The guest post reflects the authors’ report and analysis of the recent oral argument at the U.S. Supreme Court in the Amgen case. Background regarding the Amgen case can be found here.

I would like to thank the authors for their  willingness to publish their article on this site. I welcome guest posts from responsible commentators on topics of interest to readers of this blog. Any readers who are interested in publishing a guest post on this site are encourage to contact me directly. Here is the authors’ guest post:

On November 5, 2012, the United States Supreme Court heard oral argument in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds (No. 11-1085) (“Amgen”).  In Amgen, Plaintiff/Respondent Connecticut Retirement Plans and Trust Funds (“Connecticut Retirement”) brought a putative class action under the Exchange Act of 1934, alleging that Defendant/Petitioner Amgen and several of its directors and officers misstated and failed to disclose safety information concerning two of its drugs. Amgen contends that it did not mislead investors and that the information it allegedly concealed was widely known.

Background of Amgen and Path to the Supreme Court

The issue in Amgen is the predominance requirement of Federal Rule of Civil Procedure (“Rule”) 23(b)(3), which states that a court may not certify a class for trial without determining that “questions of law or fact common to class members predominate over any questions affecting only individual members.” Because of the near-impossibility of establishing commonality of direct reliance on alleged misstatements in securities fraud litigations, plaintiffs typically rely on a rebuttable presumption of common indirect reliance on the integrity of the market price for the securities at issue. The Supreme Court first recognized this presumption in Basic Inc. v. Levinson, 485 U.S. 224, 241-47 (1988), relying in part on the “fraud-on-the-market” (“FOTM”) theory. The FOTM theory assumes that the market price of securities traded in an efficient market reflects all publicly-available material information, including any material misrepresentations.

Twenty-five years after Basic, Amgen asks the Court to decide whether class action plaintiffs must prove the materiality of alleged misstatements to use the Basic presumption at the class certification stage (and thus allow a Court to find that common issues of reliance predominate). In Amgen, the district court certified the proposed class for trial even though Connecticut Retirement provided no evidence to establish materiality, ruling that plaintiffs “need only establish that an efficient market exists” to take advantage of the Basic presumption at that phase of the litigation. Conn. Ret. Plans & Trust Funds v. Amgen, Inc., 2009 WL 2633743, at *12 (C.D. Cal. Aug. 12, 2009). The Ninth Circuit affirmed this determination, following the Seventh Circuit’s approach in Schleicher v. Wendt, 618 F.3d 679 (7th Cir. 2010), and holding that plaintiffs must “plausibly allege—but need not prove . . . that the claimed misrepresentations were material” at the class certification stage. Conn. Ret. Plans & Trust Funds v. Amgen Inc., 660 F.3d 1170, 1172 (9th Cir. 2011). This approach, however, differs from that of the Second and Fifth Circuits, which require proof of materiality under such circumstances. See In re Salomon Analyst Metromedia Litig., 544 F.3d 474 (2d Cir. 2008); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 401 F.3d 316 (5th Cir. 2005).

The Amgen parties’ prior written submissions to the Court mirror this circuit split. Amgen argues that, because the FOTM theory assumes that efficient markets incorporate only material information, courts have no basis to presume that immaterial statements are reflected in the market price of a security (and thereby affect all plaintiffs in common). Br. for Pet’rs at *17-19, Amgen (No. 11-1085), 2012 WL 3277030 (U.S. Aug. 8, 2012). Connecticut Retirement, on the other hand, contends that the only indispensable FOTM prerequisites are (1) that the security in question was traded in an efficient market, and (2) that the alleged misrepresentations were public. Br. for Resp’t in Opp’n to Cert. at *9, Amgen (No. 11-1085), 2012 WL 1666404 (U.S. May 11, 2012). Once these two predicates are established, says Connecticut Retirement, certification is proper because “falsehood and materiality affect [all] investors alike” and “if the misrepresentations turn out to be immaterial, then every plaintiff’s claim fails on the merits.” Id. at *13.

Oral Argument Reflects a Divided Court

During oral argument, questioning by Justices Kagan, Breyer, Ginsburg and Sotomayor suggested an inclination to affirm class certification, reasoning that once plaintiffs establish the existence of market efficiency and a public statement, materiality becomes a common question that courts need not determine at the class certification stage. Counsel for Amgen emphasized that the question before the Court was not materiality, but indirect reliance via the Basic presumption, the commonality of which cannot be established without proof that the alleged misrepresentations were in fact material (and thus actually moved the market).  Counsel for Amgen added that, as with any other FOTM predicate, a finding that materiality is lacking at the class certification stage does not foreclose individual plaintiffs from later moving forward with actions based on direct reliance. Justices Ginsberg and Kagan disagreed on this point, indicating their view that a finding of immateriality at the class certification stage would effectively end the case.

Justice Breyer also expressed concern that proof of materiality is premature at the class certification stage given materiality’s dual role as both a condition under Basic and an element of the substantive claim. Counsel for Amgen replied that “[t]he point of the class certification . . . is the question whether there is class coherence in the first place. It’s not the merits.” Indeed,

[t]he real question in this case is what is the purpose of Rule 23? If you think that the purpose of Rule 23 is to postpone to the merits everything that can be postponed without a risk of foreclosing valid individual claims, we lose. But that’s not the purpose. The purpose is for a court to determine whether all of the preconditions for forcing everyone into a class action are present before you certify. (emphasis added)

According to Petitioner, the alternative of pushing everything to the end “is like letting the fruits justify the search.”

Counsel for Respondent, on the other hand, contended that a class action is the most efficient method for adjudicating materiality because the presence of an efficient market establishes the relevant security’s “ability to absorb [public] information, both material and non-material,” for all plaintiffs at once. Counsel representing the United States in support of Respondents contributed to this argument:

The most efficient course is to actually focus on common issues. . . . In the current [embodiment] of Rule 23(b)(3), you want to certify class actions that are both meritorious and those that are not, so it reaches a binding judgment.

One major point of dispute during oral argument was Justice Breyer’s suggestion that, unlike other FOTM predicates, materiality “is a common element of the tort . . . it will [always] be litigated, so there is no special reason . . . for litigating [it] at the outset.” However, Justice Scalia strongly disagreed on this point:

But there . . . is a reason for deciding it earlier, and the reason is the . . . enormous pressure to settle once the class is certified. In most cases, that’s the end of the lawsuit. There’s . . . automatically a settlement.

In this vein, Justice Scalia noted several times that materiality is a precondition to obtaining the “shortcut” provided by Basic’s presumption of reliance. Justice Scalia underscored this point by openly wondering whether the Court should overrule Basic “because it was certainly based on a theory that -- that simply collapses once you remove the materiality element.”  As Justice Scalia noted, “[i]t’s not an efficient market if it’s, you know . . . random[.] It takes account of material factors.”

Final Analysis and Conclusions

Unfortunately, the oral argument in Amgen offers few additional clues as to how the Court will rule. The Justices’ questions indicate that the Court is divided along its usual ideological lines, with Chief Justice Roberts holding the swing vote. However, the authors continue to believe that Amgen has the better argument in this case. In our view, Justice Scalia, through his questioning, effectively made the point (and will be able to persuade a majority of the Court) that for a plaintiff to avail itself of the significant procedural benefit that the Basic presumption already provides, it has to show materiality at the class certification stage.

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On Monday, June 11, 2012, the United States Supreme Court granted the petition of Amgen for a writ of certiorari in a securities lawsuit pending against the company. As a result, next term the Court will be addressing the question of whether securities plaintiffs must establish in their class certification petition that the alleged misrepresentation on which they rely was material. The Court’s June 11 order can be found here.

As discussed at greater length here, the plaintiff first sued Amgen and certain of its directors and officers in the Central District of California in April 2007. The plaintiff alleged that Amgen made misrepresentations about the safety of two of its products. The plaintiff also alleged that the company made misrepresentations about a May 2004 FDA advisory meeting; about clinical trials involving one of the products; about the safety of on-label uses of the two drugs and about the marketing of the drugs.

The plaintiff moved to certify a class of Amgen shareholders. The defendants opposed the motion, arguing that the plaintiff was not entitled to a class-wide presumption of reliance based on the fraud-on-the-market theory, because the plaintiff could not show that the alleged misrepresentations were material. To the contrary, the defendants argued that as a result of analyst reports and public documents, the market was aware of the information that the plaintiff alleged had been concealed.

In an August 12, 2009 Minute Order (here), Central District of California Judge Phillip Gutierrez granted the plaintiff’s class certification motion, rejecting the defendants’ argument that the plaintiffs’ had to establish the materiality of the alleged misrepresentation to trigger the presumption.

The Ninth Circuit granted the defendants leave to appeal the class certification ruling. In a November 8, 2011 decision written by Judge Barry Silverman for a three-judge panel of the Court, the Ninth Circuit affirmed the class certification.

The Ninth Circuit rejected the defendants’ contention that the plaintiff must provide proof of materiality at the class certification stage. The Ninth Circuit said that, as a predicate to class certification, a plaintiff need only show that the market for a company’s shares is efficient and that the supposed misstatements were public. The Ninth Circuit reasoned that because materiality is “an element of the merits” of a securities class action, it need only be addressed at the trial stage or in a summary judgment motion. The Ninth Circuit also approved the district court’s refusal to consider the company’s rebuttal evidence on the issue of materiality.

Amgen then filed a petition to the United States Supreme Court for a writ of certiorari. In its petition, a copy of which can be found here, Amgen argued that there is an “irreconcilable conflict” in the federal judicial circuits on the question of whether or not a plaintiff must establish materiality at the class certification stage. According to the cert petition, the Second and Fifth Circuits have held that a plaintiff must prove materiality for class certification and that defendants may present evidence to rebut the applicability of the fraud-on-the-market theory at the class certification.

The Third Circuit, according to the petition, has adopted an “intermediate approach” which holds that a plaintiff does not need to demonstrate materiality as part of an initial showing before class certification, but that defendants may rebut the applicability of the fraud-on-the market theory by disproving the materiality of the alleged misrepresentation.

The Seventh and Ninth Circuits, by contrast, hold that district courts are barred from considering materiality at the class certification stage.

Amgen argues in its petition that

The issue at the heart of the circuit split here is whether the defendants should be forced to defend securities fraud litigation against a class of plaintiffs, based on a rebuttable presumption, in instances where the named plaintiff has yet to prove all the predicates of the very theory that allows for class certification in the first place, and where the defendant is given no opportunity for rebuttal prior to certification.

Amgen stressed not only the logic concerns, but fairness concerns as well,l because of the “in terrorem power of certification” in the securities litigation context, which often compels defendants to enter into  massive settlements. The presence or absence of this kind of pressure will, Amgen argued, depend on the circuit in which the case was filed. In the Seventh and Ninth Circuits, the company argued, defendants “will frequently be forced by practical realities, to settle cases for enormous sums regardless of whether they have a meritorious materiality defense,” while in the Second and Fifth Circuits, the plaintiffs would have to establish materiality as a precondition to class certification, and in the Third Circuit, the defendants would have the opportunity to rebut any materiality showing.

In opposing the cert petition, the plaintiffs first argued that there is in fact no circuit split, but rather, the Ninth Circuit opinion stood alone as the first decision to consider the materiality arguments in light of the U.S. Supreme Court’s recent decisions in Erica P. John Fund v. Halliburton and in WalMart v. Dukes. The plaintiff also argued that the supposed circuit split on which Amgen relies is merely the product of a “strained” reading of the various courts’ opinions. The plaintiff also opposed the petition on procedural grounds, among other things.

There were also several amicus briefs filed in connection with Amgen’s cert petition, including one filed by several former SEC commissioners and certain law and finance professors, which was filed in support of Amgen’s petition. In their amicus filing, the commissioners and professors argued that the U.S. Supreme Court’s seminal decision in Basic v. Levinson (which recognized the fraud-on-the-market presumption)

recognized that any showing that severs the link between an alleged misrepresentation and the market price of a security – including a showing that a misrepresentation was immaterial – rebuts the presumption of reliance and makes class certification improper.

The commissioners and professors also argued that what they described as a “three-way circuit split” has produced a “deep and persistent conflict” that “invites forum shopping.”

Amgen was also supported in its petition in amicus briefs filed by the U.S. Chamber of Commerce and the Pharmaceutical Research and Manufacturers of America.

Discussion

In granting Amgen’s petition, the Roberts court once again demonstrates its willingness to take up securities cases. Over the past several terms the Court has taken up numerous securities cases that have individually and collectively had a significant impact on securities litigation. In that sense, the plaintiff definitely has a point about the fact that the lower courts are trying to work through all of the issues and implications of the recent raft of securities law and class action procedure questions coming out of the Supreme Court.

Though the Supreme Court is still generally weighted toward a more conservative predisposition, and though the Court’s decisions in recent years have included a number of defendant-friendly securities law decisions (for example, the Tellabs and the Morrison decisions), the Court’s decisions have not been uniformly defendant- friendly. For example, the Court’s 2011 decision in the Matrixx Initiatives case rejected the defense argument that in order to establish materiality, a plaintiff had to show that the allegedly omitted information was “statistically significant.”

Another element that adds to the unpredictability is the possibility that the Court will go off in an unexpected direction, as it did in the Morrison decision. In Morrison, Justice Scalia’s majority opinion set aside decades of lower court case law on the “cause and effects” test to establish the extraterritorial effect of the securities laws, and promulgated a new “transaction” based test in its stead. There is always the possibility here that the Supreme Court --rather than narrowly interpreting the existing standard under Basic v. Levinson for the applicability of the fraud-on-the-market presumption -- does something more radical instead,  like entirely redefining whether, when and how the fraud-on-the market presumption might apply. Indeed, this case presents the Court with its first clear chance to revisit the doctrine since it was first arrticulated in the Basic case nearly a quarter of a century ago.

One final factor that could affect the outcome is the possibility that Justice Breyer may not participate in the consideration of the Amgen case. In its June 11 order granting the cert petition, the Court noted that Breyer “took no part in the consideration or decision of this petition.” If he were to similarly remove himself from the Court’s consideration of the merits of the case, there would be at least the numerical possibility for a dreaded 4-4 split among the justices.

This will in any event be an interesting case to watch. Issues relating to class certification potentially have a very significant impact on the seriousness of the case. To the extent Amgen prevails on the merits and establishes that plaintiffs must show materiality at the class certification stage, the defendants will have one more tool in the toolkit to undermine the plaintiff’s case and to try to reduce the threat that the case represents to the defendants.

As the Morrison & Foerster firm said in its June 11, 2012 memorandum about the Supreme Court's cert grant in the Amgen case,

A clear answer from teh Supreme Court to these questoins coud have a significant impact on securities litigation. A decision that endorses the Ninth Cirtcuit's approach could made securities litigation more costly for defendants, particularly in circuits where plaintiffs are presently required to prove materiality at class certification. Conversely, a decision rejecting the Ninth Circuit's approach could provide defendants an early opportunity to challenge the viability of class action claims.

David Bario’s June 11, 2012 Am Law Litigation Daily about the grant of the Amgen cert petition can be found here.

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