Seventh Circuit Vacates Decision To Certify Class, Holding That District Court Must Consider Sufficiency Of Defendants’ Evidence To Rebut Fraud-On-The-Market Presumption Of Reliance, As Required Under Halliburton II
On July 16, 2020, the United States Court of Appeals for the Seventh Circuit unanimously vacated the Northern District of Illinois, Eastern Division’s decision to grant class certification to plaintiffs bringing securities fraud claims against a national insurance provider (the “Company”), holding that the district court decision to exclude certain evidence at the class certification stage was based in part on a legal error. Carpenters Pension Trust Fund, et al. v. Allstate Corp., et al., No. 19-1830 (7th Cir. July 16, 2020). The Court remanded to the district court for further proceedings, providing guidance as to what should be considered when applying Rule 23(b)(3)’s predominance requirement in the class certification process.
Plaintiffs, purchasers of the Company’s common stock, brought securities fraud claims against the Company under the Securities Exchange Act of 1934, alleging the Company failed to adequately disclose that the increase it experienced in auto claims was related to a new “growth strategy” it implemented which involved “‘softening’ its underwriting standards.” Plaintiffs alleged that the Company misled the market by falsely attributing the increases in auto claims to other factors such as higher-than-usual precipitation and miles driven rather than the higher risk involved with the new strategy. Defendants argued that “the market understood the risks” involved when the strategy was announced. Plaintiffs sought class certification under Rule 23(b)(3), relying on the fraud-on-the-market presumption established in Basic, Inc. v. Levinson, 485 U.S. 224 (1988) to establish the element of reliance (also referred to as “transaction causation”). The Court noted that this presumption of reliance “allows plaintiffs to avoid [the burden of] proving individual reliance” by each plaintiff on the misrepresentations, and rather, allows them to furnish “common, class-wide evidence” that the markets were efficient, “so that any false information defendants introduced into the market could be presumed to have been baked in to the market price for [the Company’s] stock.” Defendants offered evidence to rebut the Basic presumption—namely, an expert report opining that the alleged misstatements had no impact on the price of the stock. The district court declined to consider defendants’ evidence out of concern that it would “essentially and improperly [require the court] to decide” issues on their merits—which is prohibited at the class certification stage—and instead granted plaintiffs’ motion for class certification.
The Seventh Circuit first provided a detailed overview of Supreme Court precedent in a series of cases which established that in considering “reliance” for class certification, district courts must “consciously avoid deciding materiality and loss causation,” as per Amgen Inc. v. Ct. Ret. Plans & Tr. Funds, 568 U.S. 455 (2013) (Amgen) and Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011) (Halliburton I), respectively, but must also evaluate evidence proffered by the defense in an attempt to rebut the presumption of reliance / transaction causation by showing the lack of impact the misrepresentation had on stock price, as required under Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014) (Halliburton II). The Court noted that it is “obliged to follow all three cases, and must read them together.” It further observed that this dynamic creates a challenging landscape for district courts to navigate as the elements of materiality, reliance, and loss causation often overlap and may require analysis of the same evidence. In particular, a district court “deciding class certification [must] decide whether reliance can be proven by common evidence [while avoiding] delving too far into the merits of the materiality or falsity of the [misrepresentation, and while] reserving loss causation entirely for the merits phase,” as is required by Halliburton I, Amgen, and Halliburton II.
Turning to the district court’s decision in granting class certification without considering the evidence offered by defendants to rebut the Basic presumption, the Seventh Circuit held that the lower court “made a legal error by embracing Amgen at the expense of Halliburton II.” The Court determined that while the district court properly admitted the expert opinion evidence produced by defendants, the district court did not evaluate its sufficiency in rebutting reliance / transaction causation. Instead, the district court “concluded that the issue was tied so closely to the merits that [it] should not decide it on class certification.” While the Seventh Circuit noted that it “underst[ood] that view[,]” the district court must still “decide at the class stage the price impact issue posed by the defendants’ . . . evidence and plaintiffs’ rebuttal. The court may not defer that question for the merits.” As guidance, the Court instructed that on remand, the district court should evaluate whether defendants have met their burden of persuasion, which shifted to them after the Basic presumption was sufficiently invoked by plaintiffs, and advised the district court to assess defendants’ expert report and plaintiffs’ rebuttal reports “only for what it reveals about the core Basic inquiry of transaction causation.”
The Court then turned to a dispute concerning plaintiffs’ theory of transaction causation. According to the Court, the Company’s position was that reliance / transaction causation had not been established because the market had the correct information “at all times” and the statements plaintiffs point to “could not have caused any concurrent price reactions.” To support this, the Company provided an expert report which concluded that because there was no stock price reaction to the alleged misrepresentations, no price impact could be established. Plaintiffs’ position was that the evidence furnished by defendants was in fact a “truth-on-the-market defense” which is “forbidden by Amgen” as “premature” at the class certification stage. Plaintiffs alleged that defendants’ false statements were fraudulent under an “inflation maintenance” theory—that defendants’ false statements “‘caused the stock price to remain higher than it would have been had the statements been truthful,’ even if the price itself [did] not change by a single cent.” The Court observed that the analysis of “price reaction . . . is quite different from the legal concept of price impact” and held that the expert report’s finding “does not actually resolve the legal issue of price impact.” The Court then turned to a “second core dispute over the [expert] report’s findings . . . that [in essence] because nothing came down after the alleged corrective disclosures, nothing could have gone up in the first place.” The Court was unconvinced, observing that it is “hard to square” this with the alleged 10 percent price drop, and further held that the district court “may take into account expert findings with regard to ‘[w]hether the stock price responds when the [alleged] fraud is revealed to the market,’ only as backward-looking, indirect evidence of . . . ‘whether stock price [is] distorted at the time that the plaintiff trades.’”
Accordingly, the Court vacated the district court’s class certification decision and remanded for further proceedings, noting that the district court must evaluate “whether common issues predominate” at the class certification stage, particularly with respect to whether plaintiffs “may [properly] invoke [the Basic] presumption [of reliance].”