In its long-awaited June 2014 decision in the Halliburton case, the U.S. Supreme Court declined to jettison the fraud on the market theory on which the presumption of reliance is based, but it did provide that defendants could attempt to rebut the presumption of reliance by showing that the alleged misrepresentation that is the basis of the plaintiffs securities claim did not impact the share price of the defendant company’s securities. Commentators have since debated what the opportunity for defendants to rebut the presumption of reliance by showing the absence of price impact will mean for securities cases.
While time will tell what the impact from this part of the Supreme Court’s holding in Halliburton will be, a September 29, 2014 order from the Southern District of Florida certifying a class in the Catalyst Pharmaceutical Partners securities class action lawsuit sheds some interesting light on the subject. The Court’s order can be found here.
On August 27, 2013, Catalyst issued a press release stating that its drug, Firdapse, which treats Lambert-Eaton Myasthenic Syndrome (LEMS), had been designated as a Breakthrough Therapy by the FDA and that there was no other effective and available treatment for LEMS. The company’s share price climbed 42% on the news. However, an article published on October 18, 2013 disclosed that another substance that had been available for years and that is nearly identical to Firdapse is an effective treatment for LEMS and is offered to LEMS patients free of charge. Following publication of the second article, the company’s share price declined 42%.
The plaintiffs filed a securities class action lawsuit against Catalyst and certain of its directors and officers on behalf of all investors who purchased their securities in Catalyst between August 27, 2013 and October 18, 2013. The plaintiffs filed a motion seeking class certification, which the defendants opposed, arguing among other things that the alleged misrepresentations on which the plaintiffs sought to rely did not impact the company’s share price.
In her September 29, 2014 order, Southern District of Florida Judge Ursula Ungaro granted the plaintiffs’ motion for class certification with respect to the purchasers of the company’s common stock, but she denied the motion as to purchasers of the company’s other securities, as the plaintiffs had not shown that the other securities traded in an efficient market.
In granting the plaintiffs’ motion, Judge Ungaro held that the plaintiffs had established that they were entitled to a presumption of reliance in support of their motion for class certification, which the defendants sought to rebut by showing that the alleged misrepresentation had not impacted the share price of the company’s common stock.
In attempting to establish the absence of price impact, the defendants raised three arguments: (1) that the “truth” (that is, that the alternative LEMS therapy was effective and available) was already known to the public not have affected the company’s share price (the so-called “truth on the market” argument); (2) that the 42% spike in the company’s share price following the August 27, announcement was in response to the accurate announcement of Firdapse’s Breakthrough Therapy status: and the 42% decline in share price was due to bad publicity and market overreaction; (3) that expert testimony showed that the rise in the company’s share price was entirely consistent with the rise in market capitalization of other companies that have announced Breakthrough Therapy designation. Judge Ungaro rejected each of these arguments.
First, with respect to the defendants attempt to rely on the “truth on the market” theory, Judge Ungaro said that this argument, “stripped down, is merely an argument that the alleged misrepresentation was immaterial in light of other information in the market.” Were defendants to succeed with the truth-on-the-market defense, it would “defeat materiality as to every putative class member and would thus end this controversy in its entirety” and therefore, she said, citing to the U.S. Supreme Court’s 2013 decision in the Amgen case (about which refer here), “for purposes of determining at this early stage in litigation whether the alleged misrepresentation had any impact on the price of Catalyst stock, the Court must disregard the evidence that the truth was known the public.” That issue, she said, is a matter for trial or for summary judgment.
Second, with respect to the defendants’ argument that aspects of the August 27, 2013 and October 18, 2013 disclosures other than the alleged misrepresentation accounted for the spike and decline in the company’s share price, Judge Ungaro basically said that even if the other aspects of the disclosures were “substantially more important” than the alleged misrepresentation that there existed no effective and available treatment for LEMS, it does not follow that the misrepresentation did not account for any of the change in the share price. The defendants, she said, have not shown that the disclosure of the other therapy as an effective and available alternative “had no impact on the price of Catalyst stock.”
Third, with respect to the expert testimony that the rise in the company’s share price following the announcement that Firdapse had been given the Breatkthrough Therapy designation is consistent with the rise in share price of other company’s announcing the Breakthrough Therapy designation, she said that the mere fact that the price movement was consistent with the price movement of other company’s does not show that the alleged misrepresentation did not contribute at all to the 42% spike in the company’s share price.
As Judge Ungaro herself noted, this was always going to be a tough case for the defendants to try to show absence of price impact. She noted that in this case the burden on the defendants of establishing the absence of price impact is “particularly onerous.” She observed that “not only is there a clear and drastic spike following the alleged misrepresentation and an equally dramatic decline following the revelation of the truth, but all agree that the publications containing the misrepresentation and its revelation respectively caused those price swings.”
She added that under these circumstances, “proving an absence of price impact seems exceedingly difficult, especially at the class certification stage in which it must be assumed that the alleged misrepresentation was material.”
While the Halliburton decision undeniably gave the defendants a theoretically valuable tool with which to try to rebut the presumption of reliance in order to defeat a motion for class certification, it is clear that the defendants will not always succeed in establishing the absence of price impact required to rebut the presumption. Indeed, as this case shows, in at least some cases, it will be very difficult for defendants to show that the alleged misrepresentation had no impact at all on the company’s share price.
It is, as Judge Ungaro herself observed, particularly significant at the class certification stage that the Court must assume that the alleged misrepresentation is material. Where, as here, there have been discernible price swings following the key disclosures, it will be, as Judge Ungaro noted “exceedingly difficult” for the defendants to establish the absence of price impact. Since many cases involve discernible price swings, the ability to rebut the presumption of reliance through a showing of the absence of price impact may simply not be available in many cases. It may turn out that there only be a narrow category of cases where the ability to try to show the absence of price impact will turn out to make a difference. In any event, it may prove to be quite significant that defendants will not be able to establish absence of price impact by showing (or trying to show) absence of materiality.
In the wake of Halliburton, one uniform prediction was that the ability of the defendants to attempt to rebut the presumption of reliance through a showing of the absence of price impact would increase defense expenses, perhaps significantly. There is no way to know how much the ability to make this argument added to defense costs here, as the defendants would have opposed the motion for class certification in any event. While the arguments over the absence of price impact arguably only contributed to defense expense incrementally, there were additional costs associated with the argument. Among other things the defendants did retain an expert to try to support their argument. In some cases these kinds of additional expenses could be substantial.
It will be interesting to monitor is how significantly the assertion of these arguments contribute toward defense expenses and what impact that has on the insurance dynamic. At this point, carriers have proven eager to show that they will cover these costs; indeed, even before the Supreme Court ruled in Halliburton one carrier came out with an endorsement providing that no retention would apply to costs associated with trying to establish the absence of price impact. Since the decision, other carriers have followed suit. It will be interesting to see as the costs associated with these kinds of motions come into focus whether the carriers remain as willing to absorb these costs, particularly if it turns out that the expenditure of the costs is effective in only a smaller number of cases.
Special thanks to a loyal reader for sending me a copy of the ruling in this case.