On June 21, 2021, the United States Supreme Court, in a decision delivered by Justice Amy Coney Barrett, vacated and remanded a decision of the United States Court of Appeals for the Second Circuit upholding a certification of a shareholder class asserting securities fraud against a global financial institution (the “Company”) under the Securities Exchange Act of 1934, on the basis that there was “sufficient doubt” as to whether the Second Circuit properly considered the generic nature of the Company’s alleged misrepresentations in its price impact inquiry.
Goldman Sachs Grp., Inc. et al. v. Arkansas Teacher Ret. Sys. et al., 594 U.S. ____ (2021). The Court held that, in the context of class certification in a case involving claims under Section 10(b) of the Exchange Act: (i) the generic nature of a misrepresentation is important evidence of price impact that courts should consider at the class certification stage, regardless of whether that evidence overlaps with materiality and any other merits issue, and (ii) defendants bear the burden of persuasion to prove a lack of price impact by a preponderance of the evidence in order to rebut the presumption of classwide reliance established under the Supreme Court’s decision in
Basic Inc. v. Levinson.
The
Basic presumption of classwide reliance is premised on the fraud-on-the-market theory—namely, “that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction,” and allows class action plaintiffs to prove reliance through evidence common to the class. Defendants may rebut that presumption, and therefore defeat class certification, by showing that the misrepresentations did not actually affect the price of the stock.
The case began in July 2011, when purchasers of the Company’s common stock brought a securities fraud action against the Company and certain of its executives alleging that defendants made material misstatements about the Company’s efforts to avoid conflicts of interest including statements such as: “We have extensive procedures and controls that are designed to identify and address conflicts of interest . . . .”; “Our clients’ interests always come first”; and “Integrity and honesty are at the heart of our business.” Plaintiffs claimed that these statements were false and misleading because the Company allegedly acted in direct conflict with the interests of its clients in certain collateralized debt obligations transactions involving subprime mortgages between 2006 and 2007. In a history spanning a decade, a class of plaintiffs was twice certified by the district court: the first certification order was vacated by the Second Circuit in a decision previously covered
here, and the second certification order was affirmed by the Second Circuit in a decision previously covered
here. In the decision by the Second Circuit affirming the district court’s certification of the investor class, a divided panel of the Court of Appeals held that defendants may not seek to rebut the
Basic presumption at the class certification stage by pointing to the generic and aspirational nature of the alleged misstatements to demonstrate that the statements had no price impact on the security, because allowing defendants to do so would “smuggl[e] materiality,” which the Second Circuit stated was a merits issue, into the price-impact inquiry reserved for class certification. The Second Circuit also held that defendants bear the burden of persuasion to rebut the
Basic presumption. On petition to the United States Supreme Court, the Company argued that the Second Circuit erred when it held that: (1) the generic nature of the Company’s alleged misrepresentations is irrelevant to the price impact inquiry; and (2) the Company had the burden of persuasion to prove a lack of price impact. In December 2020, the Court granted
certiorari, which was previously covered
here.
The Court first addressed whether the generic nature of a misrepresentation is relevant to price impact. Defendants argued that the Second Circuit’s decision contravenes the Supreme Court’s decision in
Halliburton Co. v. Erica P. John Fund, Inc. (“
Halliburton II”) because it “erroneously bars a defendant from relying on the nature of the alleged misstatements to show the absence of an impact on the price of the relevant security when seeking to rebut the
Basic presumption of reliance at the class-certification stage.” After noting that plaintiffs conceded “a more-general statement will affect a security’s price less than a more-specific statement on the same question,” the Court adopted the view articulated by the Seventh Circuit in
In re Allstate Corp. Securities Litigation, 966 F. 3d 595 (7th Cir. 2020) that “[i]n assessing price impact at class certification, courts ‘should be open to
all probative evidence on that question—qualitative as well as quantitative—aided by a good dose of common sense.’”
Although the Supreme Court did not decide the substantive issue of whether the Company offered persuasive evidence of lack of price impact, it held that the Second Circuit’s holding left “sufficient doubt” on the question of “whether the Second Circuit properly considered the generic nature of [the Company’s] alleged misrepresentations.” The Court thus remanded the case, holding that “the Second Circuit must take into account
all record evidence relevant to price impact, regardless whether that evidence overlaps with materiality or any other merits issue.” The Court’s holding was unanimous as to the first point, although Justice Sotomayor disagreed with the majority’s view that the Second Circuit’s decision should accordingly be vacated and remanded, based on her view that defendants had not properly preserved their argument on appeal.
Next, the Court addressed whether the Company had the burden of persuasion—rather than of production—to prove a lack of price impact. Defendants argued that under Federal Rule of Evidence 301, a plaintiff’s satisfaction of the
Basic prerequisites shifts only the burden of production to defendant, which defendant can discharge by producing any competent evidence of lack of price impact. (Federal Rule of Evidence 301 provides that, “[i]n a civil case, unless a federal statute or these rules provide otherwise, the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption. But this rule does not shift the burden of persuasion, which remains on the party who had it originally.”) The Court rejected this argument, stating that Rule 301 does not restrict the Court’s authority to “change the customary burdens of persuasion,” and stated that its decision in
Basic had also shifted the burden of persuasion – pointing to language there that defendants may make “any
showing that
severs the link between the alleged misrepresentation and the price received (or paid) by the plaintiff.” Justice Gorsuch authored a dissent on this issue, which was joined by Justices Thomas and Alito, that the general rule articulated in Rule 301 should apply and that the majority’s conclusion about the Court’s precedents relied on splicing together stray statements into an interpretation with which the dissent disagreed.
The Court’s holding that the generic nature of alleged misrepresentations is relevant to the price impact inquiry may offer defendants a more realistic chance of rebutting the classwide reliance presumption. As the Court explained, “the generic nature of a misrepresentation often will be important evidence of a
lack of price impact, particularly in cases proceeding under the inflation-maintenance theory.” The Court further provided guidance that the inflation-maintenance theory “starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure,” such as where the alleged misstatement is generic, and the corrective disclosure is specific.
The Court’s decision with respect to the burden of persuasion does not change the predominant existing case law on the issue. However, as the Court noted, the allocation of the burden of persuasion to defendants is “unlikely to make much difference on the ground”: both plaintiffs and defendants typically submit competing expert evidence on price impact, and a lower court must then “assess all the evidence of price impact—direct and indirect—and determine whether it is more likely than not that the alleged misrepresentations had a price impact.” Thus, “[t]he defendant’s burden of persuasion will have bite only when the court finds the evidence in equipoise—a situation that should rarely arise.”
