Ann Lipton has been a practicing securities litigator forseveral years. Beginning this fall, shewill be joining Duke Law School
In Amgen Inc. v. Conn.Ret. Plans & Trust Funds, 2013 U.S. LEXIS 1862 (Feb. 27, 2013), theSupreme Court held that securities fraud plaintiffs seeking to certify a classusing the “fraud on the market” theory need not prove the element ofmateriality at the class certification stage. Although the case is mainly ofsignificance to securities litigators, the reasoning of the majority and thedissents also carries some lessons for other kinds of class actions.
Section 10(b) is the basic antifraud provision of theSecurities Exchange Act. To bring aclaim under Section 10(b), the plaintiff must show that the defendant made amaterial false statement, in connection with a securities transaction, withscienter, on which the plaintiff relied, and which caused losses.
Most Section 10(b) claims concerning open market stocktransactions are brought as class actions, typically alleging that thecompany’s officers portrayed the business in a falsely positive light, and thatthe stock price plunged – resulting in losses to the class – when the truth wasrevealed.
From a Rule 23 perspective, the biggest hurdle to classcertification is the element of reliance. Rule 23(b)(3) requires that in a class action seeking damages,plaintiffs demonstrate that “the questions of law or fact common to classmembers predominate over any questions affecting only individual members.” In a Section 10(b) class action, scienter, falsity,and loss causation will be common to every class member; the existence of apurchase or sale, and the amount of any damages due, represent the kinds ofindividualized issues that can be resolved mechanically through a claimsprocess after liability has been determined, and thus are not said topredominate over common questions. Materiality, it has long been established, is gauged by whether a “reasonableinvestor” would find the information significant, in light of the “total mix ofinformation made available,” and thus is also common to all class members. But reliance is trickier, because not everyshareholder will have read and relied upon the same corporate statements whenmaking an investment decision. Andrealistically, without a class action remedy, most investors will not be ableto recover under Section 10(b) – the typical case is far too expensive tolitigate as an individual action.
So, to facilitate shareholders’ ability to bring claims on aclass basis – and take a moment to marvel at the concept – the Supreme Courtendorsed the “fraud on the market” doctrine in Basic Inc. v. Levinson, 485 U. S.
From this empiricalobservation, the Court endorsed a legaltheory – namely, that the element of reliance is satisfied when an investor purchasesa security at an open-market price that has been influenced by a falsestatement. In that situation, the Courttheorized, the plaintiff “relies” on the market price to reflect the market’sassessment of the security’s value. Because the market’s assessment is distorted by the false statement, theplaintiff has relied on the false statement to the extent that he or she wouldnot have transacted at that price hadthe statement not been made.
The Court then endorsed two legal presumptions thatplaintiffs may use when bringing claims under Section 10(b). First, that a material statement, madepublicly, concerning a stock that trades in an open and developed market, willinfluence the stock’s price. And second,that anyone who purchases at the market price necessarily relied on that priceas a reflection of the stock’s value, or at least relied on the price as areflection of how the market reacted to (truthful) information about thesecurity.
Both of these presumptions are rebuttable by thedefendants. The defendant may try toargue that the false statement did notinfluence stock prices – which might happen, for example, if market makers or largeinstitutional traders were aware of the truth, and they used their power tokeep market prices at their unmanipulated level. Or, the defendant may try to argue thatinvestors – perhaps on a case-by-case basis – did not rely on market priceswhen making their purchasing decisions, either because they knew the truth, orbecause they relied on other facts.
But in most situations, even subject to defendants’ right torebut, these two presumptions transform reliance from an individualizedquestion into a common one. In any casewhere a material misstatement was made publicly and concerned a frequentlytraded stock, all purchasers may bepresumed to have “relied” on the misstatement.
What Basic leftopen, though, was exactly what plaintiffs would have to prove at the classcertification stage in order to be entitled to the fraud-on-the-market presumptionof reliance. It was eventually settledthat plaintiffs would have to prove that the market for the security was “openand developed” – i.e., “efficient,” in economic terms – and that the allegedlyfalse statement was made publicly. But somecourts went further and held that the plaintiff would also have to prove thatthe false statement was material. Immaterialstatements are not presumed to influence prices; thus, the logic went,materiality is necessary to invoke the presumption of reliance, and withoutthat presumption, individualized issues of reliance will predominate overcommon questions. So, for example, ifthe defendant made an immaterialmisstatement, it would not influence stock prices, but some individualinvestors may have heard it and relied on it, and reliance would not be commonacross the class. In such a situation,the argument went, individualized issues of reliance would preclude classcertification.
In Amgen, the SupremeCourt entered the fray, and held that materiality need not be considered at the class certification stage. Justice Ginsburg, writing for a majority thatincluded Chief Justice Roberts, and Justices Breyer, Alito, Sotomayor, andKagan, rested her logic on three principles.
First, she stated that when conducting the Rule 23 inquiry,courts may consider “merits” questions onlyto the extent that they are necessary to determine whether the requirements ofRule 23 are satisfied. (Which,incidentally, was a significant statement in and of itself, because although thatprinciple is commonly recited among lower courts, it had never been articulatedquite so clearly by the Supreme Court).
Second, she pointed out that materiality itself is gauged byan objective standard, and therefore is common across class members.
Third – and this was the core of the analysis – JusticeGinsburg concluded that if plaintiffs cannot prove materiality, noindividualized reliance issues will arise because plaintiffs will necessarilylose their claims on the merits. Thus,there is no situation in which the presence, or absence, of materiality is adeciding factor in whether a fraud-on-the-market case splinters intoindividualized determinations.
As Justice Ginsburg explained, materiality is both a predicate for thefraud-on-the-market presumption of reliance, and an independent, and necessary, element of a Section 10(b)claim. Therefore, if the misstatement ismaterial, the fraud-on-the-market presumption applies, and reliance is provedcommonly; if the statement is immaterial, allinvestors lose – commonly. Even if,theoretically, a few outlier investors might rely on a false, but immaterial,misstatement, but even if they did, they’d losetheir case – commonly – because they would fail to satisfy the element ofmateriality.
Rule 23 only requires that common questions predominate over individualized ones –not that individualized questions disappear entirely. Because a lack ofmateriality necessary ends the case for all investors, any individualizedquestions of reliance – even if they exist – cannot “predominate,” because theywill never be tried.
Justice Ginsburg further reasoned that in this respect,materiality differs from, say, proof of market efficiency, or proof that astatement was made publicly, both of which are also predicates to thefraud-on-the-market presumption of reliance, and which must be proved at theclass certification stage. If the marketwas inefficient, for example, there might still be substantial numbers of classmembers who personally read and relied upon the false statement, and thus stillhave viable Section 10(b) claims. Plaintiffs would not be entitled to a presumption of reliance across theclass, but particular class members might still be able to prove reliance, aswell as the other elements of their claims. In such a situation, individualized reliance issues would predominateover common issues. Thus, it isnecessary at the class certification stage for plaintiffs to prove efficiency,in order to establish that common issues predominate. But when it comes to materiality, a failureof proof would not result in individualized issues predominating, because noindividual class member could proceed.
Ultimately, then, because the presence or absence ofmateriality has no bearing on whether individualized issues predominate in aSection 10(b) class action, the Court held that plaintiffs are not required toprove materiality in order to have a class certified under Rule 23(b)(3).
Justice Thomas, joined by Justice Kennedy, dissented. In his view, it was improper for the majorityto “conflate” the “doctrinally independent (and distinct) elements ofmateriality and reliance”; instead, each should have been analyzed separately. He rejected Justice Ginsburg’s view thatwithout materiality, the claims would fail on the merits, because in such asituation, the claims “should never have arrived at the merits at all … [w]ithoutmateriality, there is no fraud on-the-market presumption, [and] questions ofreliance remain individualized.” Perhapsmost significantly, he summarized Rule 23(b)(3) as requiring that plaintiffsshow “that the elements of the claimare susceptible to classwide proof,” (emphasis added), and faulted the majorityfor “ignoring at certification whether reliance is susceptible to Rule 23(b)(3)classwide proof simply because one predicate of reliance—materiality—will beresolved, if at all, much later in the litigation on an independent meritselement.”
Justice Thomas’s approach to Rule 23, then, is apparently quiteextreme. Although the rule itself onlyrequires that common questions “predominate” over individualized ones, he wouldapparently add the requirement that eachelement of a claim must be examined separately. Not only would this significantly raise thebar for plaintiffs seeking class certification in a variety of contexts, but itwould also entirely reorient courts’ approaches to class certification. Right now, the Rule 23 inquiry is a fairlypractical one: courts examine how a case will, realistically, be tried, and tryto predict whether any individualized issues are so unwieldy that that theywill overwhelm the issues that bind the class. Justice Ginsburg’s pragmatic reasoning fits neatly within this approach:whatever the theoretical distinction between reliance and materiality, as a practical matter, there will be no casein which individualized reliance issues overwhelm common issues when there hasbeen a failure of proof on the element of materiality. Justice Thomas, however, would apparently takethe focus off the practical realities of litigation, and instead focus on theoreticaldifferences among class members.
Justice Scalia, it should be noted, dissented as well, buthe did not agree with Justice Thomas’s reasoning. Instead, he conceded that if thefraud-on-the-market doctrine were purely a “substantive” method of provingreliance, the majority would be correct. However, he believed that fraud-on-the-market is a hybrid doctrine thatcontains both procedural and substantive elements, in that that Basic itself held that materiality mustbe proved at class certification, regardless of what Rule 23 might otherwiserequire.
Although the reasoning of the Amgen opinions seems rather straightforward, there are severaladditional wrinkles.
The first is that although Justice Ginsburg’s reasoning iscompelling, in fact, it does not entirely hold up on close examination, giventhe particular facts of the case.
In an ordinary dispute over materiality, the defendant mightargue that a particular statement simply was not very important – like, say,the details of a CEO’s resume, or that an accounting error was too small tomatter much to investors. But in thiscase, defendant Amgen’s materialityargument was different. Amgen waspursuing what is known as the truth-on-the-market corollary to thefraud-on-the-market doctrine. Simplyput, this corollary holds that if the truth behind a false statement issufficiently well-known among traders, a false statement will have no effect onstock prices. The principle is that ifthe truth is sufficiently well-known, the false statement – which, standingalone, might have influenced stock prices – becomes immaterial in light ofother available information.
(This corollary is therefore merely a twist on one of therebuttals to the fraud-the-market presumption noted in Basic, i.e., that stock prices were not influenced because majortraders did not believe the lie.)
In this case, Amgen argued that the “truth” behind any allegedlyfalse statements had been published in the Federal Register and was known tomarket analysts.
Justice Ginsburg’s logic regarding the relevance ofmateriality to class certification does not apply as neatly whentruth-on-the-market is on the table. If,say, the false statement is immaterial in its own right – the CEO lies aboutthe color tie he wore to a business meeting – then any investor who tries tobring a case individually will necessarily lose on the element ofmateriality. But if a false statementis, standing alone, material, and only immaterial in light of some otherstatement made available in some other source, there remains a theoretical possibility that theindividual investor – who heard the former statement but not the latter – mightstill have a claim. Or, to put itanother way, perhaps materiality is not alwaysa common question, in that there may be a “space” between whether a truth issufficiently well-known among sophisticated traders that it counteracts theeffects of a false statement on stock prices, while being sufficiently hiddenfrom ordinary investors such that they might reasonably rely on the falsestatement, unaware of the truth.
There is no definitive answer to this question, which ismade more complicated by the fact that materiality itself is evaluated based onthe “total mix of information made available” – which only begs the questionwhat counts as “information made available” in situations where someinformation has only been published in sources not usually consulted byordinary investors (like, say, the Federal Register). But neither the majority nor the dissentsaddressed this issue, apparently because of the way Amgen chose to litigate thecase. Rather than emphasize itstruth-on-the-market defense specifically, it chose to pursue a general rulethat all materiality disputes must beresolved at the class certification phase, leaving no room for arguments aboutthe special qualities of truth-on-the-market.
The second interesting aspect of Amgen is Justice Ginsburg’s subtle dig at the Supreme Court’searlier decision in Wal-Mart Stores, Inc.v. Dukes, 131 S. Ct. 2541 (2011). Dukes considered the requirements forproving commonality under Rule 23(a). Although the Rule itself requires only that plaintiffs prove theexistence of “questions of law or fact common to the class,” the Dukes majority interpreted the rule torequire that plaintiffs show that a class action can generate common answers to those common questions. Justice Ginsburg dissented, arguing, interalia, that the rule itself is explicitly limited to common questions.
In Amgen, JusticeGinsburg carried on the fight, repeatedly emphasizing that Rule 23(b)(3)’s requiresonly a predominance of common “questions” – with the word “questions” italicizedseveral times. Nowhere did JusticeGinsburg discuss the need for common “answers.” And, surprisingly, her opinion was joined by two members of the Dukes majority, who were apparentlyunwilling to fight over the verbiage – Chief Justice Roberts and Justice Alito.
But these are mere sidebars when compared to the real significanceof Amgen, which is what it portendsfor the fraud-on-the-market doctrine more generally. As part of its argument, Amgen and its amicichallenged the empirical aspects of Basic, insisting that as a factual matter, all material informationis not necessarily impounded into the price of a stock. They contended that more recent researchshows that markets can be imperfectly efficient, absorbing some informationquickly and other information more slowly, if at all. Therefore, they argued, the first Basic presumption – namely, that public,material information influences stock prices – needs to be reconsidered.
All of the Justices remarked on the argument and agreed thatthe Amgen case did not present theproper vehicle to revisit Basic, butfour went further and invited such challenges in the future. Justice Alito wrote a separate concurrence tostate that it might be appropriate to reconsider Basic in light of new economic developments; Justice Thomas’sdissent – in a section joined by Justices Scalia and Kennedy – described Basic as “questionable.”
Were the Court to overrule Basic, it would represent a radical change in securities law andclass actions generally. Section 10(b)actions are among the largest and most common types of class actions today, andsuch class actions are the primary mechanism by which investors seek andrecover damages for securities fraud. Moreover, in 1995 and again in 1998, Congress revamped the lawsgoverning private securities actions in the Private Securities Litigation Actand Securities Litigation Uniform Standards Act, but made no change to thefraud-on-the-market presumption (despite proposals that it should belegislatively overruled). Indeed, bothstatutes explicitly rest on the assumption that plaintiffs will continue tobring their claims as class actions, something that would be if not impossible,then considerably less probable, in the absence of the fraud-on-the-marketpresumption. This legislation, however,apparently leaves at least Justice Thomas unmoved; although Justice Ginsburgpointed out in her majority opinion that Congress left Basic intact after passing the PSLRA, Justice Thomas answered indissent that “The Court retains discretion over the contours of Basic unless and until Congress sees fitto alter them.”
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