On 27 September 2016, in GAMCO Investors, Inc. v. Vivendi Universal, S.A., the federal appellate court based in New York affirmed the district court's ruling following a bench trial that the defendants had rebutted the presumption under Section 10(b) of the Exchange Act that investors rely on the fairness of the market price of securities when making securities transactions. The court upheld the lower court's finding that the plaintiffs here — a group of funds bringing individual (rather than class) claims — did not rely on the market price of Vivendi's stock because the plaintiffs would have purchased the securities even had they known of the company's alleged misrepresentations concerning its liquidity risk. This ruling was made on the same day that the court affirmed the jury's verdict in the securities class action arising from the same underlying facts.
The plaintiffs in this case were a group of investment funds that took a "value" approach to investing whereby they would make investment decisions based on their own independent estimation of the value of a publicly traded company's securities. Under this approach, the plaintiffs would purchase securities when there was (i) a sufficiently large difference between their independent valuation of the security's "intrinsic value" and the market price of a security and (ii) evidence of a "catalyst" that would raise the security's market price by bringing the security's hidden value to light over time. According to the court, knowledge of the alleged fraud therefore would not have altered the defendants' decision to purchase Vivendi's stock unless it also affected their analysis of these two factors.
Under the US Supreme Court's 1988 decision in Basic, Inc. v. Levinson, an investor's reliance on a security's market price is presumed under what is known as the fraud on the market theory, but this presumption can be rebutted by evidence that the investor did not actually rely on the market price when transacting in the particular security at issue. The court here acknowledged that it would seem unlikely that an investor would purchase a security while aware that the issuer was committing fraud. But the court explained that, under the deferential standard of review that applies to the lower court's factual determinations, the evidence presented in this particular case was sufficient to support the lower court's conclusion that such knowledge would not have affected the plaintiffs' specific investment decision here. That evidence included an acknowledgment by the plaintiffs that in rare circumstances they might purchase a stock inflated by fraud and other testimony that even after Vivendi's liquidity problems began to be disclosed, that information did not actually affect the plaintiffs' valuation of the company's securities or prevent the plaintiffs from increasing their holdings.
The court's decision here shows how an investor's individual investment strategy may preclude a finding that the investor relied on a security's market price, even when the investor has established that the defendants made material misstatements and the court has confirmed that a plaintiff class in a related case is entitled to the benefit of the fraud on the market presumption. While arguments based on investment decisions by individual plaintiffs are not likely to succeed in the class action setting, where reliance is presumed on a class-wide basis, defendants should raise these issues where applicable when litigating against individual plaintiffs who are not part of a class.
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