Originally published on CyberInquirer.
While the Supreme Court's recent jurisprudence has increasingly favored merits inquiries at the class certification stage, there is one area in which the Court has been reluctant to blur the distinction between certification and merits: the "fraud on the market" presumption in securities class actions. This reluctance is manifest in the Court's recent opinion in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds.
The fraud-on-the-market presumption was articulated by the Court in 1988 in Basic Inc. v. Levinson. In Basic, the Court held that securities fraud plaintiffs may invoke a rebuttable presumption of reliance based on the theory that the market price reflects all information, including the defendant's alleged misrepresentations, and that an investor who buys stock at the market price therefore relies on the misrepresentations in doing so. This presumption is a step toward resolving the element of reliance on a classwide basis; by successfully invoking the presumption, class counsel avoids the need for individual adjudications of each class member's knowledge and state of mind at the time of the transaction.
In 2011, the Court reinforced the validity of the fraud-on-the-market presumption by unanimously rejecting the notion that plaintiffs seeking to invoke the presumption at the class certification stage must prove a causal connection between the misrepresentation and the economic loss suffered by investors. The Court's ruling effectively drew a line between commonality—a critical issue at the class certification stage—and the merits.
That line was reinforced in Amgen, a 6-3 decision in which the Court held that securities fraud plaintiffs need not prove materiality at the class certification stage in order to invoke the fraud-on-the-market presumption. At issue was whether a court could make a Rule 23(b)(3) finding that common questions predominate absent proof that the alleged misrepresentation had a material effect on stock price. Justice Ginsburg, writing for the Court, responded that "Rule 23(b)(3) requires a showing that questions common to the class predominate, not that those questions will be answered, on the merits, in favor of the class." (Emphasis in original.)
Because materiality is judged according to an objective standard--i.e., the significance of the misrepresented or omitted fact to a reasonable investor—the Court held that materiality is a question common to all class members. The materiality of the alleged misrepresentations or omissions, or lack thereof, would be the same for all investors. Therefore, the Court reasoned, even if the class fails to prove materiality on the merits, the result would not be the predominace of individual questions, but rather the end of the case.
For the same reason, the Court held that it is unnecessary, at the class certification stage, to consider a defendant's "rebuttal" evidence that the alleged misrepresentations or omissions did not affect the market price of the securities. The Court reasoned that such evidence goes to the materiality of the misrepresentation or omission, and thus is not relevant at the class certification stage.
In dissent, Justice Thomas accused the majority of "all but eliminating materiality as one of the predicates of the fraud-on-the-market theory." According to Justice Thomas, while materiality may be a common question, reliance is not a common question—unless the fraud-on-the-market presumption, which requires a showing of materiality, is established. "Plaintiffs cannot be excused of their Rule 23 burden to show at certification that questions of reliance are common," Justice Thomas wrote, "merely because they might lose later on the merits element of materiality."
At first blush, Justice Thomas' quibble appears at times to exalt form over substance. After all, why would it matter if a class is certified based on the fraud-on-the-market theory even if materiality is later found to be lacking? Either way, won't the lawsuit stand or fall on the common, objective question of whether a misrepresentation or omission was material?
The answer, more practical than legal, lies in a footnote to Justice Thomas' dissent: "Of course, the Court's assertion that materiality will be resolved on the merits presumes that certification will not bring in terrorem settlement pressures to bear, foreclosing any materiality inquiry at all." (Justice Scalia made a similar argument in a separate dissent.) While the timing of a materiality ruling may have little impact on the merits of a securities class action, it can nonetheless have a significant impact on the outcome. Nevertheless, the Court has again limited the scope of inquiry at the certification stage prior to acceptance of the fraud-on-the-market presumption.
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