In a decision handed down on Tuesday, the Second Circuit Court of Appeals issued an important ruling in an attempt to clarify its standards governing class certification. Finding the current state of the law in that Circuit "surprisingly unsettled," a three-judge panel followed the lead of the Third, Fourth, Seventh, Eighth, and Eleventh Circuits, and held that a District Court may (and, depending on the case, must) consider and determine questions relating to the merits of a case when deciding whether a case can proceed as a class action under Rule 23.

The decision, In re Initial Public Offering Securities Litigation, No. 05-3349-cv, reversed a lower court decision granting class certification in six "focus cases" out of 310 consolidated class actions, all alleging that various underwriters committed securities fraud in connection with the underwriting of initial public offerings. (Morrison & Foerster LLP represents more than 30 issuers of securities and their executives who are co-defendants of the underwriters, and serves as liaison counsel for all issuer defendants in the case. The issuer defendants were not parties to the appeal decided by the Second Circuit, however.)

Candidly admitting that "until now, our Court has been less than clear as to the applicable standards for class certification, and on occasion . . . we have used language that understandably led [the lower court] astray," the Court eschewed its prior statements implying that district courts can certify a class based solely on "some showing" that all of Rule 23’s class certification requirements were met, or that a court can rely upon an expert’s report so long as it is not "fatally flawed."

Now, the Court has held that a district court can only certify a class after it "resolves factual disputes relevant to each Rule 23 requirement and finds that whatever underlying facts are relevant to a particular Rule 23 requirement have been established and is persuaded to rule, based on the relevant facts and the applicable legal standard, that the requirement is met." Importantly, "the obligation to make such determinations is not lessened by overlap between a Rule 23 requirement and a merits issue." Just as importantly, however, the Court held that "the determination as to a Rule 23 requirement is made only for purposes of class certification and is not binding on the trier of facts, even if that trier is the class certification judge."

The Court was wary that the inquiry it required could turn class certification into a trial of its own. Accordingly, it confirmed that "a district judge has ample discretion to circumscribe both the extent of discovery concerning Rule 23 requirements and the extent of a hearing to determine whether such requirements are met in order to assure that a class certification motion does not become a pretext for a partial trial of the merits."

The Second Circuit then applied its newly articulated standards to the lower court’s decision granting class certification, and reversed that decision. The Court held that "Plaintiffs’ own allegations and evidence demonstrate that the Rule 23 requirement of predominance of common questions over individual questions cannot be met under the standards as we have explicated them." The Court found that plaintiffs were not entitled to apply the "fraud-on-the-market" presumption of reliance, because "the market for IPO shares is not efficient," and therefore the Court held that individual questions of reliance would predominate over common questions. The Court also cited to other areas where legal and factual questions would require individualized determinations, vacated the District Court’s order granting class certification, and remanded for further proceedings.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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