On August 10, 2023, the United States Court of Appeals for the
Second Circuit reversed the district court's class
certification order in a putative class action asserting claims
under Section 10(b) of the Securities Exchange Act of 1934 against
a global financial institution and certain of its officers.
Ark. Tchr. Ret. Sys. v. Goldman Sachs Grp.,
Inc.,—F.4th—, 2023 WL 5112157 (2d Cir. Aug. 10,
2023) ("ATRS III"). This long-running litigation
has been the subject of prior posts in this newsletter in 2018, 2020, and three times in 2021 (wherein we
assessed decisions by the U.S. Supreme Court, the Second Circuit, and the district court). After considering the
district court's latest decision to grant class certification
(for the third time), the Second Circuit held that defendants had
rebutted the presumption of reliance afforded by Basic Inc. v.
Levinson, 485 U.S. 224 (1988), because they had established
that the allegedly misleading statements had not affected the
company's stock price when made and plaintiffs had failed to
sufficiently link specific alleged corrective disclosures to the
more generic alleged misrepresentations. The Court, therefore,
reversed and remanded with instructions to decertify the class. In
doing so, the Court noted that the Supreme Court's rulings on
materiality and class certification are difficult to reconcile,
clarified earlier jurisprudence, and established that courts must
engage in careful parsing of alleged misrepresentations and
disclosures—and their market effects—before certifying
a class.
As the Second Circuit explained, putative class members asserting
claims under Section 10(b) of the Exchange Act do not have to prove
individual reliance on purported misrepresentations because
Basic affords them a presumption that the price of stocks
trading in an efficient market incorporates and reflects all
public, material information. Id. at *1. Defendants can
rebut that presumption, however, by demonstrating that alleged
misrepresentations or omissions did not actually impact a
stock's price. Id. That analysis becomes especially
complicated in cases where, as here, plaintiffs do not allege that
the misrepresentations inflated a company's stock price at the
time they were made but, instead, allegedly "maintained"
artificial inflation that was already built-in to the stock's
price (a "price maintenance" claim). Id. In such
cases, plaintiffs often point to a price drop following an alleged
corrective disclosure "as an indirect proxy for the front-end
inflation," i.e., as evidence of the price
maintaining effect of the misrepresentation. Id. Where the
alleged misrepresentation was a generic statement, however, and the
subsequent disclosure is specific, "it is less likely that the
specific disclosure actually corrected the generic
misrepresentation" and, therefore, less clear that a
stock-price drop following such a specific disclosure is a valid
proxy for the allegedly inflation-maintaining effect of the claimed
misrepresentation. Id. at *2 (citing Goldman Sachs
Grp., Inc. v. Ark. Tchr. Ret. Sys., 141 S. Ct. 1951, 1961
(2021) ("Goldman")). Thus, as dictated by the
Supreme Court's prior ruling in this action, courts at the
class certification stage must compare "the relative
genericness of a misrepresentation with its corrective
disclosure." ATRS III, 2023 WL 5112157 at *2. In this
latest appeal, the Second Circuit was called upon to review the
district court's analyses and conclusions in conducting that
comparison.
Plaintiffs challenged two groups of statements. First were
"business principle" statements reflected in the
company's annual report that stated overarching themes as
guiding the company. These included statements like "We are
dedicated to complying fully with the letter and spirit of the
laws, rules and ethical principles that govern us," and
"Integrity and honesty are at the heart of our business."
Plaintiffs included in this category related statements by
executives at various conferences. Id. Second were
"risk disclosure" statements in the company's SEC
filings regarding conflicts of interest, including "[w]e have
extensive procedures and controls" to address potential
conflicts. Id. at *3. Both sets of statements were alleged
to have been revealed as false when it emerged that the company may
have had conflicts of interest in several collateralized debt
obligation transactions the company facilitated. Id. at
*4–5.
It was undisputed that the statements plaintiffs challenged did not
cause statistically significant increases in the company's
stock price when made. Plaintiffs argued, instead, that the
statements maintained an already-inflated price, which fell in
reaction to the alleged corrective disclosures. Id. The
Court construed plaintiffs' theory to be that the challenged
statements were misleading because the company failed to disclose
that it was "actively mismanaging" conflicts.
Id. at *5.
As noted, the focus of this latest appeal was whether the district
court clearly erred in finding a subject-matter match between the
alleged misrepresentations, which the Second Circuit described as
"comparatively generic," and the corrective disclosures.
Absent such a match, the back-end price drop following the alleged
corrective disclosures could not be used as a proxy for the
front-end inflation allegedly maintained by the challenged
misstatements and, thus, defendants would have rebutted the
Basic presumption by showing a lack of price impact.
The Second Circuit first explained that the district court erred in
assessing the generic nature of the challenged business principles
statements. The Court held that although it was correct for the
district court to consider statements such as "integrity and
honesty are at the heart of our business" as "platitudes
when read in isolation," the district court erred when it
minimized their genericness by reading those statements in
conjunction with more specific statements separately made by
executives at different times regarding conflicts of interest.
Id. at *14. Statements made in separate reports at
different times cannot automatically be read together, the Court
held, and plaintiffs had offered no evidence "to support a
finding that, notwithstanding that space in medium and time,
investors would still conjunctively consume those
statements." Id. (emphasis in original). Because
there was no support in the record evidence for reading the
statements together, it was clear error for the district court to
have done so.
Turning to the conflicts risk disclosures, the Court ruled that the
district court had not erred in its genericness analysis when it
found the conflicts disclosure more specific, in form and focus,
than the business principles statements. Id. at
*15–16. Even so, the Second Circuit held that the district
court's price impact analysis was based on an erroneous
application of the inflation-maintenance theory. Specifically, even
though the district court credited a finding by defendants'
expert that the alleged misrepresentations were "unlikely, in
a vacuum, to consciously influence investor behavior," it
incorrectly judged price impact according to what would have
happened if the alleged corrective disclosures in 2010 had been
made at the time of the alleged misrepresentations, which spanned
from 2007 through 2010. Id. at *17.
In determining that was error, the Court summarized the holdings of
two prior Second Circuit inflation-maintenance cases, in addition
to its understanding of the Supreme Court's ruling in
Goldman. The Court explained that, in Waggoner v.
Barclays PLC, 875 F.3d 79 (2d Cir. 2017), there was a
"tight fit between corrective disclosure and
misrepresentation" because the corrective disclosure at issue
there (an enforcement proceeding initiated by the New York Attorney
General) focused on a trading platform that was the subject of the
allegedly misleading statements in the company's securities
filings. ATRS III, 2023 WL 5112157 at *17. The Court also
explained that the link between misstatement and disclosure was
equally strong in In re Vivendi, S.A. Sec. Litig., 838
F.3d 223 (2d Cir. 2016). In that case, the "company's
repeated statements regarding its comfortable liquidity situation
were later contradicted by a body of information ... all of which
revealed that its cash flow was anything but strong." ATRS
III, 2023 WL 5112157 at *18. In contrast, the Second Circuit
noted the Supreme Court had explained in Goldman that a
gap in genericness between misrepresentation and corrective
disclosure reduces the likelihood that investors would understand
the specific disclosure to have actually corrected the generic
misrepresentation. In such a scenario, the inference that a
back-end price drop can serve as a proxy for the front-end
misrepresentation's price impact starts to break down.
Id. at *19 (quoting Goldman, 141 S. Ct. at 1961).
Thus, in that type of situation, the question for a price impact
analysis is not whether the alleged specific corrective disclosures
would have dissipated inflation if made at the time of the alleged
generic misrepresentation; instead, the question is whether a
similarly generic truthful statement made at the time of
the alleged generic misrepresentation would have dissipated
inflation. Id.
The district court therefore erred in judging price impact based on
the news coverage and commentary surrounding the alleged corrective
disclosures. The corrective disclosures, the Court held, were too
different from the alleged generic misrepresentations. The
commentary plaintiffs relied on discussed the issue of conflicts of
interest but did "not suggest that the market relied on
the conflicts statements" themselves. Id. at *23
(emphasis in original). Defendants, in contrast, identified over
880 analyst reports, none of which referenced the alleged
misrepresentations, and showed that other analyst reports touching
on the conflicts issue did not refer to the alleged misstatements
either. Id. at *24. As such, the Court held that
plaintiffs had not established a sufficient link between the
alleged corrective disclosures and misrepresentations to establish
price impact, and that defendants had established by a
preponderance of the evidence that the challenged representations
had no such impact—i.e., defendants had severed the
link between the alleged misrepresentations and the price
plaintiffs paid for the company's securities.
Id.
The Court provided as "[g]uidance moving forward" that
courts must conduct a "searching price impact analysis"
where (1) there is a "considerable gap" between the
genericness of the alleged misstatement and the alleged corrective
disclosure; (2) the corrective disclosure does not directly refer
to the alleged misstatement; and (3) plaintiff claims that a
company's generic disclosure was misleading by omission.
Id. at *22.
In a separate concurrence, Judge Richard J. Sullivan emphasized he
would have found that defendants had sufficiently rebutted the
presumption of reliance by showing that the company's stock
price was unaffected by earlier disclosures of its alleged
conflicts of interest, as he had indicated in his dissent in the
prior case that was appealed to the Supreme Court. Id. at
*25 (citing Ark. Tchr. Ret. Sys. v. Goldman Sachs Grp.,
Inc. (ATRS II), 955 F.3d 254, 275, 279 (2d Cir. 2020)
(Sullivan, J., dissenting)). Judge Sullivan also noted that
"common sense tells us" the challenged statements were
"exceptionally 'general'" and "not capable
of affect[ing] the 'price'" of the company's
securities. Id. at *26. The concurrence continued that the
more "searching" price-impact analysis set forth in the
majority opinion should be applicable not only for
inflation-maintenance cases but for "all questions of
reliance." Id. at *26 (emphasis in original).
The difficulty and complexity demonstrated by this case, and with
these analyses in general, was identified in the concurrence and
acknowledged by the majority: The "predicament that the
Supreme Court has created for lower courts tasked with assessing
reliance at the class-certification stage of securities actions
like this one" is that "the Supreme Court [in Amgen
Inc. v. Conn. Ret. Plans & Tr. Funds, 568 U.S. 455,
480–82 (2013),] has held that defendants may not challenge
materiality at class certification, while also acknowledging that
materiality evidence may be introduced to rebut price impact and
reliance [in Goldman]." ATRS III, 2023 WL
5112157 at *27. "This instruction places district courts in a
peculiar position," because, among other things "it's
hard to imagine how class-wide reliance based on the Basic
presumption can be established under Federal Rule of Civil
Procedure 23 without consideration of the statements'
materiality." Id. The majority opinion addressed this
by recognizing that evidence regarding the effect of generic
statements was always likely to overlap with evidence relevant to
materiality, but that its consideration was "by design"
because the Supreme Court had directed courts to consider
"all record evidence relevant to price impact,"
regardless of such overlap. Id. at *10. Borrowing a phrase
from Judge David F. Hamilton of the Seventh Circuit, the majority
likened having to analyze price impact without drawing conclusions
on materiality to trying to avoid "thinking about a pink
elephant." Id. at *2. You can't do it. But courts
have been instructed that this is the analysis that is required. As
the majority recognized in acknowledging Judge Sullivan's
concerns regarding the difficult task of thinking about materiality
but not ruling on it, "Someday the Supreme Court will revisit
the issue. In the meantime, we have work to do." Id.
at *24.
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