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).

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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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