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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During 2010 and 2011, a number of securities class action lawsuits were filed against U.S.-listed Chinese companies. Plaintiffs’ lawyers seemed eager to pursue these cases despite likely procedural and practical challenges such as likely difficulties in obtaining discovery, as well as language and cultural barriers. And if a recent decision in one of these cases is any indication, you can add to the list of potential difficulties the risk that it may not be possible to obtain class certification, at least where the plaintiffs are unable to establish that the defendant company’s shares trade on an efficient market.

China Agritech, a Delaware holding company with its principal place of business in Beijing, China, obtained its U.S. listing through a reverse merger. In February 2011, online analyst reports raised allegations that the company’s factories were either not in operation or were producing far less than reported. In addition, the online reports claimed that the company’s SEC filings reported far higher levels of net revenue than the company reported to the Chinese State Administration for Industry and Commerce. The company’s share price fell on these reports and, as discussed at greater length here, litigation ensured. The plaintiffs moved to have a class of aggrieved investors certified as a plaintiff class.

In May 3, 2012 order (here), Central District of California Judge R. Gary Klausner denied the plaintiffs’ motion for class certification. The court found that the plaintiffs’ allegations satisfied the class certification requirements of numerosity, commonality, typicality, and adequacy. However, the court found that the plaintiffs’ allegations did not satisfy the requirement that the questions of law or fact common to the class members predominate over questions affecting individual members.

The court’s particular concern had to do with the reliance element of the plaintiffs’ securities class action claims. In most contexts, reliance is an individual issue. However, in a securities class action lawsuit, courts will use the fraud-on-the-market presumption to presume reliance if the defendant company’s shares trade in an efficient market.

In order to determine whether or not China Agritech’s shares trade in an efficient market, the Court consider five factors: (1) the average weekly trading volume of the company’s securities; (2) the number of securities analysts following the company; (3) the extent to which market makers trade in the security; (4) the company’s eligibility to file an SEC Form S-3 (the short form registration statement for the sale of new shares); and (5 )the existence of a cause-effect relationship between unexpected corporate news and a change in the price. As Judge Klausner noted, “several courts have recognized that the fifth factor is the most important.”

Judge Klausner found that the plaintiffs had satisfied a number of these factors. However, the plaintiffs were unable to establish the cause and effect relationship between company disclosures and resulting movements in stock price. He concluded that the plaintiffs “are unable to establish that Agritech stock was traded on an efficient market,” as a result of which “they are unable to rely on the fraud-on-the-market presumption of reliance.” Without the presumption, the plaintiffs “are unable to establish that questions of law or fact common to class members predominate over any questions affecting only individual members.” Accordingly, Judge Klausner denied the plaintiffs’ motions for class certification.

As discussed in a May 22, 2012 memorandum from the Debevoise & Plimption law firm about Judge Klausner’s decision (here), the class certification denial in the China Agritech case “appears to be the first China-focused case to reach the procedural stage at which the court had to consider whether the plaintiffs could satisfy the efficient market test and the other requirements of class certification.” The law firm memo notes that the China Agritech plaintiffs’ failure to satisfy the test “may have a significant impact on other China-focused securities cases if the defendants can show that their securities were as thinly traded as China Agritech’s,” adding that “if a company’s securities are thinly traded and the company is not the subject of press coverage, investors may have different levels of knowledge about the company and their reliance on particular statements cannot be presumed.”

The plaintiffs who brought the case “still can pursue claims on their own behalf,” but their inability to proceed with the proposed class action “significantly limits the potential damages that can be awarded in the case.”

Many of the U.S.-listed Chinese companies that have been the subject of securities class action litigation may be able to raise similar questions of whether or not their shares trade or traded in an efficient market. To the extent the companies can show that their shares did not trade in an efficient market, they may be able to overcome the fraud-on-the-market presumption of reliance,  and the value of the claims against them may be substantially diminished. And as I noted at the outset, there are a host of other potential difficulties that may also impede the plaintiffs’ efforts to pursue these claims. Many of these cases were filed, but not all of them will prove to be valuable for the plaintiffs and their counsel.

Kudos: Everyone here at The D&O Diary congratulates Dan Bailey and his colleagues at the Bailey & Cavalieri firm for their selection as the recipients of one of the 2012 Burton Awards for Legal Achievement. The Burton Awards are a series of prestigious national awards for outstanding achievement in legal writing. As reflected I n the firm’s May 22, 2012 press release (here), the firm is the winner of this year’s competition in the category of Best Law Firm Encyclopedic Handbook, for authoring the book entitled Liability of Corporate Directors and Officers.

Dan as the book's co-author, will accept the awardin a June 12, 2012 ceremony at the Library of Congress. The awards ceremony will feature Retired Supreme Court Justice John Paul Stevens, who will be introduced by Supreme Court Justice Sonia Sotomayor. Our congratulations to Dan and to his colleagues for this recognition for their excellent book.

A complete list of the 2012 Burton Award winnerc can be found here.

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In the wake of the U.S. Supreme Court’s landmark June 20, 2011 decision in Wal-Mart Stores v. Dukes, numerous commentators have asserted that the case could have a significant impact on future class actions. For example, one law firm’s memo about the case stated that the decision “should limit the number of class actions that are certified.” Which inevitably leads to the question of what the impact of the Wal-Mart decision will be with respect to class certification in securities class action lawsuits.  This question seems all the more acute given the unanimous opinion the Court issued in the Erica P. John Fund, Inc. v. Halliburton case just days before it issued its opinion in the Wal-Mart case.

First, some background. The Wal-Mart case involves an employment discrimination lawsuit brought by three female Wal-Mart employees on behalf of all female Wal-Mart employees. The plaintiffs did not allege that Wal-Mart had an express discriminatory policy against the advancement of women. (Wal-Mart in fact had a nondiscrimination policy.) Rather, the claimed that local managers’ discretion over pay and promotions had an unlawful disparate impact on women, and that the company’s refusal to constrain its managers’ discretion amounted to disparate treatment.

In order to satisfy Fed. R. Civ. Proc. 23(a)(2)’s class certification prerequisite that “there are common questions of law or fact common to the class,” the plaintiffs argued that the discrimination to which they have been subjected is common to all female Wal-Mart employees. But the commonality of the 1.5 million class members’ claims derived from the local manager’s discretion. In effect, the plaintiffs were arging that the non-policy (allowing local manager discretion) was a policy.

In his majority opinion in the Wal-Mart case, Justice Scalia said (rejecting the statistical evidence and expert testimony on which plaintiffs sought to rely) that the plaintiffs “have not identified a common mode of exercising discretion that pervades the entire company.” He added that “other than the bare existence of delegated discretion, respondents have identified no ‘specific employment practice,’ much less one that ties all their 1.5 million claims together.” The majority concludes that because the plaintiffs “provide no convincing proof of a companywide discriminatory pay and promotion policy, we have concluded that they have not established the existence of any common question.”

In reaching this conclusion, the majority commented that Rule 23 “does not set forth a mere pleading standard”; rather a party seeking class certification “must affirmatively demonstrate his compliance with the Rule – that is, he must be prepared to prove that there are in fact sufficiently numerous parties, common questions of law or fact, etc.” The majority opinion goes on to state that the required “rigorous analysis” will “entail some overlap with the merits of the plaintiff’s underlying claim. That cannot be helped.”

So, it seems, courts determining whether or not to certify a class should not rely on plaintiff’s mere allegations alone, but must examine the merits in order to determine whether or not the plaintiff has met the certification requirements. The “rigorous analysis” requirement apparently applies whenever a claimant seeks to proceed in the form of a class action, regardless of the nature of the underlying claim – including even when the alleged injury is asserted under the securities laws.

So courts determining whether or not to certify a class in a securities lawsuit must examine the merits? As University of Illinois Law Professor Christine Hurt asked in the recent post on the Conglomerate blog (here), isn’t that basically what the Supreme Court just rejected a few days ago in the Erica P. John Fund, Inc. v. Halliburton Co. case?  As Professor Hurt put it, referring to the Halliburton case “we've already had this fight in securities law, and the plaintiffs won in a unanimous ruling.”

Just to review, in the Halliburton case, the Court held that a securities plaintiff relying on the “fraud-on-the-market” theory to establish reliance did not have to separately establish loss causation in order to obtain class certification.

As it happens, the majority opinion in Wal-Mart expressly discussed the Halliburton case, in footnote 6, which footnote accompanies the opinion text in which the majority discussed the need for courts to review the merits of the plaintiff’s underlying claim in determining whether or not to certify a class.

The footnote states, in pertinent part, that “perhaps the most common example of considering a merits question at Rule 23 stage arises in class-action suits for securities fraud.” The commonality requirement “would often be an insuperable barrier to class certification, since each of the individual investors would have to prove reliance on the alleged misrepresentation.” But the “problem dissipates” if the plaintiff relies on the fraud-on-the-market presumption, by which all traders in an efficient market are presumed to rely on the accuracy of the company’s statements. Citing Halliburton, the footnote states that “to invoke this presumption, the plaintiffs seeking 23(b)(3) certification must prove that their shares were traded in an efficient market,” adding after the citation that this is “an issue they will surely have to prove again at trial in order to make out their case on their merits.”

In light of this footnote, it seems in that in order to establish commonality and obtain class certification, a securities plaintiff must establish that their shares traded in an efficient market. Halliburton held that if a plaintiff has established the right to rely on the fraud on the market presumption, the plaintiff does not have to separately establish loss causation in order to obtain class certification. Footnote 6 in the Wal-Mart opinion seems to suggest that the entitlement to the fraud on the market presumption to establish reliance is sufficient to satisfy the commonality requirement, and no further merits determinations are required at that stage.

The answer to Professor Hurt’s question seems to be that the Court in Halliburton did not say that the merits were not to be considered at the class certification stage in a securities suit; rather, at least as interpreted in footnote 6 in the Wal-Mart decision, the merits determination at the class certification stage is limited to the requirement that securities plaintiffs establish entitlement to rely on the fraud on the market theory, as that is sufficient to establish commonality.

So my answer to Professor Hurt’s question is that Wal-Mart is (or at least can be read to be) consistent with Halliburton. My further view is that Wal-Mart didn’t change much at least when it comes to class certification in securities cases. To be sure, there undoubtedly will be defense attorneys who will attempt to use the Wal-Mart decision in opposition to class certification motions in securities cases. We must await another day to see if these likely efforts produce an impact. For now, my own view is that the impact of Wal-Mart is likely to be limited in the securities class action litigation class certification context.

I am interested in readers’ thoughts on whether Wal-Mart changes anything at the class certification stage for securities plaintiffs.

The one final observation about Wal-Mart relates to the final clause in footnote 6. The clause states that even if a securities plaintiff has established at the class certification stage their entitlement to rely on the fraud on the market presumption, that is “an issue they will surely have to prove again at trial on order to make out their case on the merits.”

In other words, establishing an efficient market at the class certification stage is not ultimately determinative of the issue. This obviously leaves open the door for a contrary determination at trial, with the attendant possibility that the basis for the certification of the class could be eliminated as well. That would seem like a pretty daunting prospect for many securities plaintiffs, at least where there is a real possibility of a trial determination that that the defendant company’s shares did not trade in an efficient market. Something I would think securities class action plaintiffs’ attorneys would have to think pretty hard about before pushing a case to trial.

Special thanks to a loyal reader with whom I exchanged emails about footnote 6.

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I am pleased to reprint below as a guest post a detailed article about the oral argument this past week before the United States Supreme Court in the case of Erica P. John Fund v. Halliburton Co., No. 09-1403. This guest post was submitted by my friend Kimberly M. Melvin. Kim is a partner in the Wiley Rein law firm in Washington D.C. Background regarding the Halliburton case can be found here. The parties’ briefs in the case, including briefs from amici curiae, can be found here.

I would like to thank Kim for her willingness to publish her article on this site. I welcome guest post from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly.

Here is Kim’s guest post: 

This week, the United States Supreme Court heard oral argument in Erica P. John Fund v. Halliburton Co., No. 09-1403 (U.S.). The case involves the denial of a motion for class certification in a securities fraud suit that was affirmed by the United States Court of Appeals for the Fifth Circuit. The argument signals that the Justices are virtually certain to reverse the Fifth Circuit’s decision. Even Halliburton’s attorney, David Sterling of Baker Botts LLP, distanced himself from the Fifth Circuit’s holding that loss causation must be proven at the class certification stage to invoke the fraud-on-the-market presumption of reliance. Yet the Justices’ questions reveal the challenges of determining the specific contours of plaintiffs’ burden of proof at the class certification stage under Basic, Inc. v. Levinson, 485 U.S. 224 (1988), given the scope of inquiry under Federal Rule of Civil Procedure 23. The Supreme Court’s ruling in this case therefore should provide greater guidance to lower courts regarding: (1) what elements plaintiffs must prove to trigger the presumption of reliance at the class certification stage, including whether plaintiffs must prove stock price impact tied to the operative misleading statements; and (2) the contours of plaintiffs’ initial burden of production and ultimate burden of persuasion when defendants present rebuttal evidence.

Factual Background

In Halliburton, the shareholder plaintiffs maintain that from 1999 to 2001, Halliburton made false and misleading statements that understated its asbestos liability and overstated its revenues. At the class certification stage, plaintiffs argued that that a class-wide presumption of reliance applied based on the fraud-on-the-market theory. Defendants countered that plaintiffs could not show any statistically significant price movements in response to either the allegedly false statements or the so-called “corrective disclosures” that assertedly revealed the truth about the prior misstatements. As such, they argued that plaintiffs had not satisfied their burden of proving the operative facts necessary to establish the applicability of the fraud-on-the-market presumption of reliance. Without the presumption, plaintiffs would need to show individual reliance by each class member on the alleged misrepresentation to proceed, and therefore common issues would not predominate over individual issues as required to certify a class under Rule 23. 

The district court agreed, denying plaintiffs’ motion for class certification based on the Fifth Circuit’s holding in Oscar Private Equity Investments v. Allegiance Telecom, Inc., 487 F. 3d 261 (5th Cir. 2007). According to the district court, plaintiffs were unable to employ the fraud-on-the-market presumption of reliance because they failed to show any price distortion as a result of defendants’ alleged misrepresentations. The district court reasoned that plaintiffs presented no evidence that “‘false, non-confirmatory positive statements caused a positive effect on the stock price.’” Archdiocese of Milwaukee Supporting Fund, et al. v. Halliburton Co., et al., No. 3:02-CV-1152-M, 2008 WL 4791492, at *3 (N.D. Tex. Nov. 4, 2008) (quoting Ryan v. Flowserve Corp., 245 F.R.D. 560, 569 (N.D. Tex. 2007)). They also did not show: “‘(1) that an alleged corrective disclosure causing the decrease in price is related to the false, non-confirmatory positive statement made earlier, and (2) that it is more probable than not that it was this related corrective disclosure, and not any other unrelated negative statement, that caused the stock price decline.’”  Id. 

The Fifth Circuit affirmed, reasoning that plaintiffs could not invoke the fraud-on-the-market presumption of reliance because they had not proven loss causation. According to the Fifth Circuit, “because loss causation speaks to the semi-strong efficient market hypothesis upon which class wide reliance depends,” loss causation must be proven to determine whether class wide reliance may be presumed so that common issues predominate over individual issues under Rule 23. Oscar, 487 F.3d at 269. The Fifth Circuit requires “this showing ‘at the class certification stage by a preponderance of all admissible evidence.’” Archdiocese of Milwaukee Supporting Fund, et al. v. Halliburton Co., et al., 597 F.3d 330, 335 (5th Cir. 2010) (citation omitted).

On appeal to the Supreme Court, plaintiffs maintain that the Fifth Circuit imposed an improper burden on them because loss causation is a merits issue that is not relevant to the class certification inquiry under Rule 23. Halliburton and its CEO contend that under Basic, defendants are entitled to rebut the presumption of reliance based on lack of market impact, and that the outcome of the Fifth Circuit’s decision is consistent with that theory.

Summary of the Oral Argument

            Plaintiff’s Opening Argument

Counsel for the shareholder plaintiffs, David Boies of Boise Schiller & Flexner, led off the argument by focusing on the limited nature of the inquiry to certify a class under Rule 23. Nearly immediately, however, Mr. Boies was stopped by Chief Justice Roberts, who asked whether the existence of an efficient market could be disputed at the class certification stage.  While noting that the issue had been conceded by defendants below, Mr. Boies responded affirmatively that the efficient market issue is properly addressed at the class certification stage because “the issue of [an] efficient market goes to the presumption of reliance,” and if the court holds that the presumption is not available, “you can have a situation in which the common issues do not predominate over the individualized issues.” Transcript of April 25, 2011 Oral Argument in Erica P. John Fund v. Halliburton Co., No. 09-1403 (U.S. Apr. 25, 2011) (“Tr.”) at 4. 

This concession shaped the remainder of Mr. Boies’s argument. Thereafter Justices Alito, Kagan, Scalia and Sotomayor posed questions largely focused on why a court could address the efficient market issue at the class certification stage but not the issue of price impact. Mr. Boies repeatedly responded that loss causation was a merits issue only because it is a class-wide common issue whereas market efficiency addresses the reliance issue, which could raise individualized issues if plaintiffs could not invoke the fraud-on-the-market presumption. As such, Mr. Boies maintained that Basic provides that defendants can only rebut the reliance presumption at the class certification stage with “proof generally disproving the efficiency of the market” and other proof (such as a lack of market impact) must be “reserved for trial,” relying on footnote 29 in Basic. Tr. at 6. 

During Mr. Boies’s argument, Justice Scalia honed in on defendants’ position that although the Fifth Circuit used the term loss causation, the court was focused on market impact as a means of rebutting the fraud-on-the-market presumption of reliance. In this regard, Justice Scalia inquired: “Would you be satisfied if we just said we agree with you that the requirement to prove loss causation is -- no good, and sent it back to the Fifth Circuit and then let the Fifth Circuit adopt the theory that Respondents assert they have already adopted?  I mean, it’s sort of a Pyrrhic victory, it seems to me, if you haven’t just disapproved loss causation.” Tr. at 9. Mr. Boies acknowledged in responding that “if [the Fifth Circuit] simply changed the wording and called loss causation reliance, obviously it wouldn’t make any difference.” Id. However, Mr. Boies did reply that loss causation and reliance are distinct elements, and that loss causation could only be a class-wide common issue. Tr. at 9-10. 

            Argument on Behalf of the United States as Amicus Curiae

Nicole A. Saharsky for the government was up next. She focused on three asserted deficiencies in the Fifth Circuit’s decision: “First, the Fifth Circuit [is] conducting a merits inquiry that’s not tethered to the Rule 23 requirements; second, it’s taking a presumption and requiring plaintiffs to prove it; and third, it’s confusing the distinct elements of reliance and loss causation.” Tr. at 15. In addressing the questions posed to Mr. Boies, she affirmed that “[t]he Fifth Circuit could not be more clear” that it “is not talking about rebutting the presumption of reliance . . . [i]t is putting an affirmative burden on plaintiffs [of proving loss causation] that they have to meet in every single case, even if the defendants do not come to court with any evidence.” Tr. at 15. 

Justice Scalia quickly focused Ms. Saharsky on price impact and secured the concession that defendants can rebut the efficient market issue. Ms. Saharsky, however, reiterated Mr. Boies’s view that the rebuttal evidence could not include loss causation-related proof because loss causation raises merits issues that “stand or fall on a class-wide basis.” The response prompted Justice Kennedy to posit, “[t]he rule isn’t . . . that simply because the issue is on a class-wide basis, it can’t be challenged at the certification stage. We don’t have a rule that’s that broad, do we?” Tr. at 17. He, together with the Chief Justice, went on to suggest through further questioning that if a class-wide, merits-based issue must be proven to show that common issues predominate (i.e., to invoke the fraud-on-the-market presumption of reliance), like an efficient market, then inquiry as to that issue is appropriate under Rule 23. Tr. at 17-18. 

Attempting to address this suggestion, Ms. Saharsky replied that the inquiry is more limited: “when the plaintiffs invoke fraud on the market and they show that there is an efficient market, this Court said in Basic, they can all proceed together because they are showing that . . . the material misstatement was reflected in the stock price. This is an impersonal market in which you rely on the stock price. They all rely on it the same way.” Tr. at 19. Justice Alito seized on this response raising the critical issue to be addressed in the Court’s decision: “And if they show that the statement was not incorporated in the price . . . , then why doesn’t reliance cease to be a common issue and become a question of an individual issue that would have to be proved by each . . . member of the class?” Tr. at 19-20. Ignoring that in such a circumstance individual plaintiffs may still be able to prove direct reliance, Ms. Saharsky responded “[w]ell, in that circumstance reliance ceases to be and the case cannot be established on the merits. They stand or fall together on the merits.” Tr. at 20. Justice Alito followed up, questioning: “[B]ut the fact that they would lose on the merits doesn’t necessarily mean that they are entitled to class certification.” Tr. at 20. Ms. Saharsky rejoined, “They’re entitled to class certification if they have a common issue.” Tr. at 20. 

At the end of Ms. Saharsky’s argument, Justice Scalia asked a series of question trying to show that reserving price movement for consideration later because it is a “class-wide common issue” makes little sense when the efficient market issue itself is a common issue: “Instead of proving the efficient market,” what if plaintiff “can prove that there was a statement correcting the alleged misrepresentation, the price of stock went down . . . and they can certify the class.” Tr. at 22.  Ms. Saharsky responded that such an approach does not square with Basic, which provided that “in order to establish the presumption that you need to show the efficiency of the market.” Tr. at 22. Scalia pressed further, “They’re not relying on that assumption. . . . [T]hey come in and show that there was a correction of what we alleged was a misstatement and the market went down. . . . And of course, that proves anything only if there’s an efficient market. But that will be a common question to the whole class, so we’ll . . . save that for later.” Tr. at 22. Ms. Saharsky simply responded “Certainly in the courts of appeals now, that’s not the way the plaintiffs proceed. The way they proceed is on the Basic theory.” Tr. at 23. Justice Scalia rejoined, “I understand that. I’m just saying that seems to me it’s a crazy way to run a railroad.” Tr. at 23. Ms. Saharsky concluded by indicating that the courts have applied Basic for 20 years, Congress “has not seen fit to change it,” and respondents have never suggested that it should be revisited. Tr. at 24. The “problem in this case,” according to Ms. Saharsky, is that the Fifth Circuit “was not satisfied with the rules as they exist, and it took the class certification stage and turned it into a merits inquiry stage.” Tr. at 24. 

            Defendants’ Argument

Mr. Sterling then faced the Court. Almost immediately, he conceded that defendants “are not defending all of the language in Oscar, clearly, but the basic test in the Fifth Circuit . . . is not loss causation; it’s price impact, because Basic says . . . any showing that severs the link between the misrepresentation and the stock price defeats the presumption.” Tr. at 26 (citing Basic, 485 U.S. at 248). According to Mr. Sterling, “Basic makes clear . . . that a showing that the stock price was not distorted by the misrepresentation defeats the presumption.” Tr. at 26. He also acknowledged that “the Fifth Circuit put the initial burden on plaintiff and that’s contrary to Basic.” Tr. at 29. 

In response to Justice Kagan’s questions, Mr. Sterling described the Fifth Circuit’s essential test espoused by defendants: The test is “not loss causation as this Court knows it in Dura; the test is simply price impact,” meaning plaintiffs had to show price impact to invoke the presumption of reliance. Tr. at 27. This showing can be made one of two ways. First, “[t]hey can show price inflation upon a misrepresentation, which, as this Court made clear in Dura, is not synonymous with loss causation.” Second, they can “show a price decline following a corrective disclosure.” Drawing the distinction between this showing and loss causation, Mr. Sterling posited “while [the price impact] showing is similar to loss causation, it’s an easier, less rigorous showing of loss causation, because under the price impact test at the Fifth Circuit, all the plaintiff needs show is that it’s reasonable to infer that some portion of the decline was attributable to the revelation of the truth.” 

In an interesting exchange, Justice Breyer interposed a hypothetical in which a Company issues a false statement saying it found oil in a well, numerous people buy the company’s stock and when it turns out there is no oil, those people lose their money. Tr. at 30. Under his hypothetical, Breyer explains that the presumption of reliance says to a typical plaintiff, “[w]e’re going to say what happened to the typical person on the stock market during that period happened to you, and there are a lot of people who bought and sold on the stock market. And that’s why efficient markets is needed to show at the certification stage.” Tr. at 30. Turning to defendants’ position, Justice Breyer opined, “[b]ut what you’re just saying in terms of whether the revelation lowered the price has nothing to do with the question of what happened to the typical person. . . . It has to do with whether anybody was hurt” and “that has nothing to do with the certification stage.” Tr. at 20. 

Mr. Sterling replied that Basic created “an exception to the long understood rule that fraud cases were not appropriate vehicles for class actions because each individual would have to say . . . I read Halliburton’s statement and I relied upon it.” Because such proof would be impractical in most cases, the presumption assumes the entire stock market is like the typical plaintiff and relies on the integrity of the stock price when the stock price is distorted by the misrepresentation.  But if the stock price was not in fact distorted by the misrepresentation, it makes no sense to say everybody relied on the misrepresentation through its effect on the stock price.” Tr. at 31. Mr. Sterling further stressed, “it’s not just enough to allege the operative facts” to invoke the presumption, Basic says plaintiffs “have to plead and prove them” subject to rebuttal proof. Tr. at 32. Ultimately, he explained these operative facts are “just surrogates of whether it is reasonable to believe or to infer that the stock price was in fact distorted by the misrepresentation.”  Tr. at 33. In contrast to “circumstantial proof” of general market efficiency or the other operative facts, proof of no market impact is “direct proof” undermining “the whole premise of the Basic class-wide presumption of reliance.” According to Mr. Sterling, the lack of price movement “is the DNA proof” and “it makes no sense for district courts to be certifying class actions based upon this indirect or circumstantial proof while ignoring the direct proof of the absence of price impact.” Tr. at 35. Appealing to the Court’s conservative Justices, Mr. Sterling opined that “it would do violence to [the Court’s] admonition [in Stoneridge Investment Partners v. Scientific-Atlanta, 552 U.S. 148 (2008),] that the 10b cause of action ought not be further expanded to make [the] rebuttable presumption of reliance irrebuttable at the class certification stage.” Tr. at 35. 

In response to Justices Ginsburg’s and Kagan’s questions regarding what would be left to decide on the merits after the class certification inquiry, Mr. Sterling argues that “falsity, scienter, actual proof of loss causation and damages” would all be undetermined at class certification. Tr. at 37. Along the same lines, Justice Kagan expressed concern about permitting defendants to rebut the presumption by putting an expert on the stand, and then the “Basic presumption falls away, and the plaintiffs have to actually prove their case at the very early stage.” Tr. at 40. Mr. Sterling explained, however, that showing price impact is “not a hard burden to show”: plaintiffs needed only to show a statistically significant price movement in response to any one of the 22 alleged misstatements or one of the alleged corrective disclosures. Tr. at 40. 

Mr. Sterling also attempted to address the concern regarding an early hearing on merits issues by indicating that Rule 23 provides district courts with discretion to permit discovery into the merits to the extent such discovery is relevant to the class certification issue, noting that plaintiffs asked for no such discovery in the instant case. Tr. at 41-42. This response drew sharp questioning from the Chief Justice and Justice Scalia, who asked why defendants would want to move up discovery if the class certification stage is so significant because of its in terrorem effect. Mr. Sterling responded that the grant of class certification is indeed a “seminal event” with “huge repercussions for the defendant.” Tr. at 43. The Chief Justice further posited that if one of Halliburton’s objections to plaintiffs’ view is that “it would just postpone the defendant’s ability to rebut the presumption” and “result in countless classes being certified with the certain knowledge that they would have to be decertified later,” if it is so certain, why is there an in terrorem effect? Tr. at 43. Mr. Sterling aptly replied that the Chief Justice’s question assumed “that the defendant has the wherewithal to stick it out through it all, but the sheer grant of class certification which aggregates hundreds . . . tens of thousands of these claims together in one big case makes every one of these cases, in effect, a company case, and it puts huge settlement pressure on the defendant.” Tr. at 43. 

            Plaintiffs’ Rebuttal Argument

Mr. Boies’ rebuttal attacked Mr. Sterling’s recitation of plaintiffs’ burden of proof under the price movement test as overly simplistic. In this regard, he pointed to the fact that plaintiffs showed a 42% stock price drop in response to a Halliburton asbestos-related statement that plaintiffs’ alleged was a corrective disclosure, which, as defendants’ expert conceded, did not disclose any other unrelated information. Tr. at 46. Nevertheless, the Fifth Circuit held such a showing was not sufficient because the statement did not specifically reference the prior announcement it was alleged to have corrected and therefore that statement was not a corrective disclosure. Tr. at 47. According to Mr. Boies, the Fifth Circuit therefore looked at more than just price movement in rejecting class certification; it looked at merits issues. 

Key Takeaways

Predicting how the Supreme Court will rule in a case by reading the tea leaves from oral argument is no easy feat. Yet, a few observations can be gleaned from the argument:

1. The Supreme Court appears likely to overturn the aspects of Oscar that require plaintiffs to prove loss causation (as opposed to price impact) at the class certification stage. 

2. The fundamental issue to be decided by the court is whether defendants are permitted to rebut plaintiffs’ evidence of an efficient market solely with proof that generally disproves the efficiency of the market. Mr. Boies conceded that the sole basis for plaintiffs’ position that defendants’ proof is limited to such evidence is footnote 29 of Basic, which Justice Alito described as “thin” support since the footnote was dictum and Basic was “issued at a time when conditional class certification was permitted.” Tr. at 6. A number of other Justices also seemed to struggle with why the inquiry should be so limited when the lack of price movement itself may at least be an indicator of an inefficient market and, even more, may in fact be direct evidence that the fraud-on-the-market presumption does not apply. Yet the challenge for the Court, if it does not stand on Basic’s footnote 29, will be in drawing the line between what proof should and should not be considered at class certification. For example, as raised in Mr. Boies’s rebuttal, will plaintiffs have to prove that certain statements were in fact corrective disclosures or will it suffice to allege that a statement was a corrective disclosure?  

3. Finally, the Justices will have to determine whether on the record before it, they can apply their ruling to the instant case or whether they will remand it. If the court adopts plaintiffs’ more limited class certification inquiry, it appears the Court could reverse the Fifth Circuit and grant class certification given Halliburton’s concession that the market for its stock was efficient. If the Court, however, adopts a middle ground approach, it is likely to remand the case to the Fifth Circuit even if such a result may only be a “Pyrrhic victory,” as Justice Scalia suggests.  

No matter how the Court rules, the decision should have a significant impact on the large number securities class actions working their way through the courts. By determining whether class certification will give defendants a real opportunity to test plaintiffs’ claims that the class wide presumption of reliance should apply, the Court’s decision will determine whether class certification can be an important event for settlement and will provide defendants with an opportunity to bring an early appeal. The threat of a negative ruling on the merits at the class certification stage or of an early appeal provides companies, their directors and officers and their insurers with additional leverage and an incentive to “stick it out,” as Mr. Sterling suggested, if a motion to dismiss is denied. 

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On June 19, 2009, the Fifth Circuit, in a per curiam opinion (here) written by a panel that included retired Supreme Court Justice Sandra Day O’Connor sitting by designation, reversed and remanded the district court’s denial of class certification and entry of summary judgment in defendants’ favor in the Flowserve securities class action lawsuit.

CORRECTION: The original version of this post suggested that Justice O'Connor herself had written the June 18 opinion. In light of  reader comments (please see below) I have revised this post to reflect the fact that the Fifth Circui's decision was in the form of a per curiam opinion that does not indicate which member of the panel authored the opinion. The entire staff here at The D&O Diary apologizes for any confusion our original post may have caused.

With respect to the class certification issue, the Fifth Circuit vacated the district court’s refusal to certify the class based on what the Fifth Circuit found was the district court’s application of an erroneous standard on the loss causation issue, and remanded the case for further proceedings. In addition, the Fifth Circuit reversed the district court’s entry of summary judgment, essentially on the ground that the district court’s analysis on the loss causation issue for class certification purposes was not in any event dispositive of the loss causation issue on the merits, and therefore was not the appropriate basis for entry of summary judgment.

The Fifth Circuit’s opinion is noteworthy for a number of reasons. First, it represents a rare occasion where securities class action plaintiffs have succeeded, even if only provisionally and for the time being, in a circuit that is generally perceived as heavily defense oriented. It should be noted that there is nothing in the Fifth Circuit’s opinion that precludes the district court from ruling against the plaintiffs on either issue on remand; even with application of what the Fifth Circuit described as the correct legal standard, the district court could nonetheless again rule in the defendants’ favor.

Second, the Flowserve case represents the latest example of the Fifth Circuit’s struggles with the question of the proper consideration of loss causation issues at the class certification stage. These same or similar issues are presented in both the Belo securities case (about which refer here) and the Halliburton securities case (here), both of which are now also pending before the Fifth Circuit. Given the continuing controversy on these issues, it seems increasingly likely that these issues could wind up before the U.S. Supreme Court.

Finally, the opinion is perhaps most interesting for the final commentary provided in the opinion's concluding paragraph:  

To be successful, a securities class-action plaintiff must thread the eye of a needle made

smaller and smaller over the years by judicial decree and congressional action. Those ever higher hurdles are not, however, intended to prevent viable securities actions from being brought.

Whether or not these remarks perhaps represent an expression of concern with how far the pendulum had swung in the Fifth Circuit in these kinds of cases, these words undoubtedly will be repeated by plaintiffs’ counsel in future filings, both inside and outside the Fifth Circuit, in support of the claims.

Very special thanks to a loyal reader for providing a copy of the Fifth Circuit’s Flowserve opinion.

Speakers’ Corner: During the period June 21-23, 2009, I will be in Palo Alto, California, where I will be participating as a faculty member at the Stanford Law School Directors’ College. A summary agenda for the event can be found here.

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