Supreme Court Clarifies Requirements for Invoking Fraud-on-the-Market Presumption at Class Certification

On February 27, 2013, the U.S. Supreme Court in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, 11-1085, -- S. Ct. --, 2013 WL 691001 (U.S. Feb. 27, 2013), resolved a split among the circuits and affirmed the Ninth Circuit’s decision that the issue of materiality need not be proven at the class certification stage in order to invoke the fraud-on-the-market presumption. (Bingham previously published alerts on this case on Dec. 5, 2011 and June 14, 2012). Justice Ginsberg wrote for the majority in a six-to-three decision and was joined by Chief Justice Roberts and Justices Breyer, Kagan, Sotomayor and Alito. Justice Alito wrote a concurring opinion, and Justices Thomas, Scalia and Kennedy dissented.

In Amgen, the plaintiffs sought to invoke the fraud-on-the-market presumption at the class certification stage to overcome individualized issues of reliance that might preclude a finding of predominance under Rule 23(b)(3) of the Federal Rules of Civil Procedure. The fraud-on-the-market theory is based on the premise that the price of a security traded in an efficient market will reflect all publicly available information about a company, and therefore a buyer of a company may be presumed to have relied on that information in purchasing the security. Amgen argued that to invoke the fraud-on-the-market presumption the plaintiff must prove its statements were material “for immaterial misrepresentations or omissions, by definition would have no impact on Amgen’s stock price in an efficient market.” Id. at *3. The Ninth Circuit and the district court held that the plaintiff was not required to prove materiality at the class certification stage. The Supreme Court granted certiorari.

The issue presented to the Court was whether the predominance requirement in Rule 23(b)(3) required the plaintiff to do more than “plausibly plead that Amgen’s alleged misrepresentation and misleading omissions materially affected Amgen’s stock price.” Id. The Court concluded that while the plaintiffs “certainly must prove materiality to prevail on the merits . . ., such proof is not a prerequisite to class certification.” Id. at *4.

In affirming the Ninth Circuit’s order, the Court explained that “‘the pivotal inquiry is whether proof of materiality is needed to ensure that the questions of law or fact common to the class will predominate over any questions affecting only individual members’ as the litigation progresses.” Id. at *8. The Court stated that “the office of a Rule 23(b)(3) certification ruling is not to adjudicate the case; rather it is to select the ‘metho[d]’ best suited to adjudication of the controversy ‘fairly and efficiently.’” Id. at *4. The Court held that since materiality is judged according to an objective standard, it is a question that is common to the class. Id. Further, the Court explained that there is “no risk whatever that a failure of proof on the common question of materiality will result in individual questions predominating.” Id. at *8. The Court explained that “the failure of proof on materiality “would end the case for one and for all; no claim would remain in which individual reliance issues could potentially predominate.” Id. The Court stated to Amgen’s argument that materiality be proven at class certification would “put the cart before the horse.” Id. at *4.

The Court also rejected Amgen’s policy arguments that absent consideration of the materiality issue at the class certification stage, the issue may never be addressed because the defendant “will surrender and settle soon after a class is certified.” Id. at *12. The Court explained that this is no different than any of the other elements of a Rule 10b-5 claim, and Congress could have addressed this issue as it did with many other issues in enacting the Private Securities Litigation Reform Act of 1995 and the Securities Litigation Uniform Standards Act of 1998. Id. at *12—13.

The Court also rejected Amgen’s argument that the lower courts should have considered its evidence showing that its alleged misrepresentations and omissions could not have affected the market price of the stock. The Court explained that Amgen’s evidence addresses the issue of materiality, and “the potential immateriality of Amgen’s alleged misrepresentations and omissions is no barrier to finding that common questions predominate.” Id. at *15.

Also of significance is the majority opinion’s rejection of Justice Scalia’s interpretation of the holding in Basic. Justice Scalia argued in dissent that Basic dictates that a securities class action cannot be certified unless all of the prerequisites of the fraud-on-the-market presumption have first been established. Id. at *14. The majority observed that the Court in Basic reversed the district court’s order granting summary judgment on the materiality issue, but it affirmed the class certification order. The majority opinion also concluded that if Justice Scalia’s view had been correct, the Court would have been required to order the lower courts to reconsider the class certification ruling as well, which it did not do. Id. Justice Scalia’s position is that the Court in Basic stated that the class certification ruling may be subject “on remand to . . . adjustment,” and the Court has recently clarified the requirements for class certification to require that class certification be decided on more than the pleadings, as was the case in Basic. Id. at *16—17.

Finally, it is noteworthy that Justice Thomas, in a portion of his dissent joined by Justice Kennedy and Justice Scalia, stated that “[t]he Basic decision itself is questionable,” but that “the Court has not been asked to revisit Basic’s fraud-on-the-market presumption.” Id. at *19 n.4. On the same score, Justice Alito also wrote in his concurrence that “more recent evidence suggests that the [Basic] presumption may rest on a faulty economic premise” and that “reconsideration of the Basic presumption may be appropriate.” Id. at *16. Thus, there are potentially at least four justices that would reconsider Basic’s fraud-on-the-market presumption.

Conclusion

The Supreme Court’s decision in Amgen resolved the split among the circuits regarding the prerequisites for invoking the fraud-on-the-market presumption at the class certification stage. The Supreme Court’s holding makes it easier for securities class action plaintiffs to overcome the predominance hurdle at the class certification stage by invoking the fraud-on-the-market presumption, which forces defendants to challenge issues of materiality at summary judgment, or at the pleading stage by use of public documents that may be subject to judicial notice.

Of perhaps equal significance going forward, at least four of the Justices now have expressed the view that Basic’s fraud-on-the-market presumption itself might need to be revisited.

*This alert was co-authored by W. Hardy Callcott, Todd Gordinier and Craig Taggart.

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