Since the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank, the lower courts have wrestled with the issue of whether or not the transactions at issue in a particular securities suit were sufficiently “domestic” to bring them under the U.S. securities laws. These inquiries mostly have taken place at the motion to dismiss phase. However, as demonstrated in the Second Circuit’s July 7, 2017 decision in the Petrobras securities case, the “domestic” transactions inquiry is relevant at the class certification stage as well. The appellate court held that in determining whether or not Petrobras noteholders’ claims can proceed on a class-wide basis, the district court must, in light of the federal class action procedure’s “predominance” requirement, determine whether or not common questions outweigh individual questions of transactional domesticity. The appellate court’s ruling, which can be found here, could complicate class certification in cases involving non-U.S. companies whose securities do not trade on U.S. exchanges.
Petróleo Brasileiro S.A. (Petrobras) is a multinational energy company headquartered in Brazil. The company has been caught up in a massive investigation of rampant corruption involving the company’s contracts for the construction of production facilities. Following disclosures surrounding the investigations, investors launched a series of securities class action lawsuits in the U.S., as discussed here. The various U.S. securities class action suits ultimately were consolidated.
The consolidated action against Petrobras, certain of its executives, and its offering underwriters, involves two sets of claimants: investors who purchased Petrobras American Depositary Shares (ADS) on the New York Stock Exchange; and investors who purchased Petrobras debt securities in May 2013 and March 2014 offerings. The Petrobras notes do not trade on any U.S.-based exchange but rather trade over the counter.
The investors’ actions largely survived motions to dismiss (other than with respect to investors who purchased Petrobras securities on the Brazilian stock exchange), as discussed here. The case proceeded forward, and the claimants’ filed a motion for class certification.
On February 2, 2016, Southern District of New York Jed Rakoff granted the plaintiffs’ motion to certify two classes. Because the Petrobras notes do not trade on any U.S. exchange, the noteholders are entitled under Morrison to assert their claims only if they can show they acquired their Notes in “domestic transactions.” In certifying two classes, one on behalf of those asserting Section 10b-5 claims and the other on behalf of those asserting Section 11 claims, Judge Rakoff limited both class definitions to “members who purchased Notes in domestic transactions.”
The defendants sought to appeal the class certification ruling. The Second Circuit agreed to hear the appeal and stayed the district court case.
On appeal, the defendants argued that the class certification order should be set aside because the classes as certified did not meet the implied “ascertainabiltiy” requirement and that the classes as certified did not satisfy the “predominance” requirement because of the individual issues concerning whether or not particular claimant’s transactions were sufficiently domestic. The Petrobras defendants also argued that the district court erred in finding that the plaintiffs has successfully established a class-wide presumption of reliance under the “fraud on the market” theory.
The July 7, 2017 Order
On July 7, 2017, in an opinion written by Eastern District of New York Judge Nicholas Garaufis (sitting by designation) for a unanimous three-judge panel, the Second Circuit affirmed in part and vacated in part Judge Rakoff’s class certification order, and remanded the case to the district court for further proceedings.
First, the appellate court first held that the both class definitions satisfied the implied “ascertainability” requirement for class certification. The defendants, in reliance on Third Circuit precedent, had tried to argue in favor of a “heightened” ascertainability requirement under which any proposed class must be “administratively feasible,” above and beyond whether it is sufficiently definite by objective criteria. The Second Circuit, by its own account taking advantage of the “opportunity to clarify the ascertainability doctrine’s substance and purpose,” joined four other circuits and declined to adopt the “administratively feasible” requirement.
Instead, the Court said, the ascertainability doctrine requires only that a class be defined using “objective criteria that establish a membership with definite boundaries.” The appellate court said that the district court’s certification order met these requirements. The order specifies “clearly objective” criteria, consisting of securities purchases identified by subject matter, timing and location.
However, with respect to the defendants’ challenge of the class certification order on “predominance” grounds, the appellate court concluded that the district court “committed legal error” by finding that the federal procedural rules’ requirement for “predominance” was satisfied “without considering the need for individual Morrison inquiries regarding domestic transactions.” The Court said that in this connection that under Morrison there was a “predicate question” in order to assess predominance, which is whether the determination of domesticity is susceptible to generalized class-wide proof such that it represents a “common” question rather than an individual question. The appellate court said Judge Rakoff “failed to meaningfully address” this question.
The appellate court noted further that on the available record the investigation of domesticity appears to be an individual question requiring putative class member to present evidence that varies from member to member. The transaction-specific facts are not obviously susceptible to class wide-proof. The potential for variation across putative class members – who sold them the various securities, how those transactions were effectuated, and what forms of documentation might be offered to support domesticity – “appears to generate a set of individualized inquiries.”
The appellate court did not finally make a determination that the predominance requirement could not be satisfied and indeed expressly stated that it takes no position on whether the district court might properly certify one or more classes that capture some or all of the securities holders who fall within the classes as currently defined. Instead, the appellate court merely remanded the case for the district court to undertake the “robust predominance inquiry” the federal procedural rules require and that the appellate court had outlined.
Finally, the appellate court rejected that Petrobras defendants’ challenge to the district court’s finding that Plaintiffs were entitled to a presumption of reliance under the “fraud on the market” theory. The appellate court said that it found no abuse of discretion in the district court’s determination that Plaintiffs met their burden with a combination of direct and indirect evidence of market efficiency. The appellate court expressly rejected the Petrobras defendants’ argument that the market efficiency requirement could only be met by direct evidence based on an event study. The appellate court agreed with the plaintiffs that “event studies offer the seductive promise of hard numbers and dispassionate truth, but methodological constraints limit their utility in the context of single-firm analyses.”
It has now been six years since the U.S. Supreme Court issued its decision in Morrison but the implications of the case continue to percolate in the lower courts. As I noted at the outset, Morrison’s specification that securities transactions must be domestic in order for the U.S. securities law to apply requires an inquiry not just at the initial motion to dismiss stage, but also apparently at the class certification stage as well, at least where, as here, the specific transactions at issue did not take place on a U.S.-based securities exchange.
The federal procedural rules’ “predominance” criterion does not require that the “domesticity” issue must be susceptible to resolution exclusively with common evidence as to all putative class members, but requires only that the common issues must “predominate” over the individual issues. This case will now return to the district court for Judge Rakoff to consider these questions.
The appellate court’s exploration of these issues not only raises some potentially challenging issues for the putative class here, but it raises potentially troublesome issues for the members of any putative class seeking to pursue U.S. securities laws claims involving securities transactions of a non-U.S. company’s securities that did not take place on a U.S. exchange. As the Proskauer Rose firm noted in its July 7, 2017 memo about the case, the Second Circuit’s Petrobras decision “will likely increase plaintiffs’ burden of satisfying the predominance requirement in putative class actions involving transactions in non-U.S.-listed foreign securities.”
There arguably is another practical implication of the Second Circuit’s treatment of the predominance issue – it may encourage at least some institutional investor claimants to opt-out of putative securities class action lawsuits involving unlisted securities of foreign firms, out of concern that a class may not be certified due to problems meeting the predominance requirement. The attractiveness of opting out rather than staying in the class would seem to be most appealing to those institutional investors comfortable that they individually will have little problem meeting Morrison’s domesticity requirement. Investors in that position may well conclude that their interests are best served by proceeding on their own on an opt-out basis, rather than having their claims bogged down by questions potentially surrounding the domesticity of the transactions by which other putative class members acquired their securities.
(Indeed, these investors may already have independent motivations to consider opting-out of the class. As I noted in my discussion of the U.S. Supreme Court’s recent decision in the ANZ Securities case, here, the Court’s recent determination that the Securities Act’s statute of repose is not subject to equitable tolling based on the prior filing of a securities class action complaint already may provide a motivation for investors to consider filings a preemptive opt-out complaint. In that regard, it is noteworthy that in Petrobras securities case itself, numerous investors already filed opt-out complaints out of concerns arising from the Second Circuit’s prior ruling in the ANZ Securities case that the statute of repose cannot be tolled. In light of the Petrobras decision, claimants in securities cases involving unlisted foreign securities may now have even further reason to consider opting out.)
The appellate court’s analysis of the ascertainability doctrine issue is interesting in its own right. The Second Circuit’s rejection of the Third Circuit’s requirement that in order to meet the ascertainability requirement a court must conclude that class membership is administratively feasible arguably further expands the split in the circuits on this issue. Whether or not this is or will become the kind of circuit split that will attract the interest of the U.S. Supreme Court probably depends on how significant it becomes in the determination of class certification issues. If it becomes clear that the outcome of class certification issues varies between circuits based on whether or not the administrative feasibility requirement applies, it could well become an issue in which the Supreme Court gets involved. On the other hand, from a practical standpoint, it could also be that the administrative feasibility requirement simply shifts from one under the heading of ascertainability to one involved in the issue of predominance.
Special thanks to a loyal reader for providing me with a copy of the Second Circuit’s opinion.