Ann Lipton has been a practicing securities litigator for several years. Beginning this fall, she will be joining
as a Visiting Assistant Professor, where she will teach a class on securities
litigation. In the interests of full
disclosure, it should be noted that she assisted with drafting certain amicus
briefs in support of the Amgen
plaintiffs. Her views are her own. Duke
In Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 2013 U.S. LEXIS 1862 (Feb. 27, 2013), the Supreme Court held that securities fraud plaintiffs seeking to certify a class using the “fraud on the market” theory need not prove the element of materiality at the class certification stage. Although the case is mainly of significance to securities litigators, the reasoning of the majority and the dissents also carries some lessons for other kinds of class actions.
Section 10(b) is the basic antifraud provision of the Securities Exchange Act. To bring a claim under Section 10(b), the plaintiff must show that the defendant made a material false statement, in connection with a securities transaction, with scienter, on which the plaintiff relied, and which caused losses.
Most Section 10(b) claims concerning open market stock transactions are brought as class actions, typically alleging that the company’s officers portrayed the business in a falsely positive light, and that the stock price plunged – resulting in losses to the class – when the truth was revealed.
From a Rule 23 perspective, the biggest hurdle to class certification 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 class members 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 a purchase or sale, and the amount of any damages due, represent the kinds of individualized issues that can be resolved mechanically through a claims process after liability has been determined, and thus are not said to predominate over common questions. Materiality, it has long been established, is gauged by whether a “reasonable investor” would find the information significant, in light of the “total mix of information made available,” and thus is also common to all class members. But reliance is trickier, because not every shareholder will have read and relied upon the same corporate statements when making an investment decision. And realistically, without a class action remedy, most investors will not be able to recover under Section 10(b) – the typical case is far too expensive to litigate as an individual action.
So, to facilitate shareholders’ ability to bring claims on a class basis – and take a moment to marvel at the concept – the Supreme Court endorsed the “fraud on the market” doctrine in Basic Inc. v. Levinson, 485
224 (1988). This doctrine is part legal principle, and
part economic theory, and the two sometimes sit uneasily together. In Basic,
the Supreme Court concluded – as an empirical
matter – that when a stock is heavily traded in an “open and developed market,”
its stock price will react to any material information that is publicly
released. Any one trader may miss a
particular announcement, or ignore it and rely on other factors when deciding
whether to purchase or sell a security, but traders as a whole, who make up the entire universe of buyers and sellers, will
collectively absorb material information and factor that in to their purchasing
decisions, causing the stock price to go up or down in reaction. U. S.
From this empirical observation, the Court endorsed a legal theory – namely, that the element of reliance is satisfied when an investor purchases a security at an open-market price that has been influenced by a false statement. In that situation, the Court theorized, the plaintiff “relies” on the market price to reflect the market’s assessment of the security’s value. Because the market’s assessment is distorted by the false statement, the plaintiff has relied on the false statement to the extent that he or she would not have transacted at that price had the statement not been made.
The Court then endorsed two legal presumptions that plaintiffs may use when bringing claims under Section 10(b). First, that a material statement, made publicly, concerning a stock that trades in an open and developed market, will influence the stock’s price. And second, that anyone who purchases at the market price necessarily relied on that price as a reflection of the stock’s value, or at least relied on the price as a reflection of how the market reacted to (truthful) information about the security.
Both of these presumptions are rebuttable by the defendants. The defendant may try to argue that the false statement did not influence stock prices – which might happen, for example, if market makers or large institutional traders were aware of the truth, and they used their power to keep market prices at their unmanipulated level. Or, the defendant may try to argue that investors – perhaps on a case-by-case basis – did not rely on market prices when making their purchasing decisions, either because they knew the truth, or because they relied on other facts.
But in most situations, even subject to defendants’ right to rebut, these two presumptions transform reliance from an individualized question into a common one. In any case where a material misstatement was made publicly and concerned a frequently traded stock, all purchasers may be presumed to have “relied” on the misstatement.
What Basic left open, though, was exactly what plaintiffs would have to prove at the class certification stage in order to be entitled to the fraud-on-the-market presumption of reliance. It was eventually settled that plaintiffs would have to prove that the market for the security was “open and developed” – i.e., “efficient,” in economic terms – and that the allegedly false statement was made publicly. But some courts went further and held that the plaintiff would also have to prove that the false statement was material. Immaterial statements are not presumed to influence prices; thus, the logic went, materiality is necessary to invoke the presumption of reliance, and without that presumption, individualized issues of reliance will predominate over common questions. So, for example, if the defendant made an immaterial misstatement, it would not influence stock prices, but some individual investors may have heard it and relied on it, and reliance would not be common across the class. In such a situation, the argument went, individualized issues of reliance would preclude class certification.
In Amgen, the Supreme Court entered the fray, and held that materiality need not be considered at the class certification stage. Justice Ginsburg, writing for a majority that included Chief Justice Roberts, and Justices Breyer, Alito, Sotomayor, and Kagan, rested her logic on three principles.
First, she stated that when conducting the Rule 23 inquiry, courts may consider “merits” questions only to the extent that they are necessary to determine whether the requirements of Rule 23 are satisfied. (Which, incidentally, was a significant statement in and of itself, because although that principle is commonly recited among lower courts, it had never been articulated quite so clearly by the Supreme Court).
Second, she pointed out that materiality itself is gauged by an objective standard, and therefore is common across class members.
Third – and this was the core of the analysis – Justice Ginsburg concluded that if plaintiffs cannot prove materiality, no individualized reliance issues will arise because plaintiffs will necessarily lose their claims on the merits. Thus, there is no situation in which the presence, or absence, of materiality is a deciding factor in whether a fraud-on-the-market case splinters into individualized determinations.
As Justice Ginsburg explained, materiality is both a predicate for the fraud-on-the-market presumption of reliance, and an independent, and necessary, element of a Section 10(b) claim. Therefore, if the misstatement is material, the fraud-on-the-market presumption applies, and reliance is proved commonly; if the statement is immaterial, all investors lose – commonly. Even if, theoretically, a few outlier investors might rely on a false, but immaterial, misstatement, but even if they did, they’d lose their case – commonly – because they would fail to satisfy the element of materiality.
Rule 23 only requires that common questions predominate over individualized ones – not that individualized questions disappear entirely. Because a lack of materiality necessary ends the case for all investors, any individualized questions of reliance – even if they exist – cannot “predominate,” because they will never be tried.
Justice Ginsburg further reasoned that in this respect, materiality differs from, say, proof of market efficiency, or proof that a statement was made publicly, both of which are also predicates to the fraud-on-the-market presumption of reliance, and which must be proved at the class certification stage. If the market was inefficient, for example, there might still be substantial numbers of class members who personally read and relied upon the false statement, and thus still have viable Section 10(b) claims. Plaintiffs would not be entitled to a presumption of reliance across the class, but particular class members might still be able to prove reliance, as well as the other elements of their claims. In such a situation, individualized reliance issues would predominate over common issues. Thus, it is necessary 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 failure of proof would not result in individualized issues predominating, because no individual class member could proceed.
Ultimately, then, because the presence or absence of materiality has no bearing on whether individualized issues predominate in a Section 10(b) class action, the Court held that plaintiffs are not required to prove 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 majority to “conflate” the “doctrinally independent (and distinct) elements of materiality and reliance”; instead, each should have been analyzed separately. He rejected Justice Ginsburg’s view that without materiality, the claims would fail on the merits, because in such a situation, the claims “should never have arrived at the merits at all … [w]ithout materiality, there is no fraud on-the-market presumption, [and] questions of reliance remain individualized.” Perhaps most significantly, he summarized Rule 23(b)(3) as requiring that plaintiffs show “that the elements of the claim are susceptible to classwide proof,” (emphasis added), and faulted the majority for “ignoring at certification whether reliance is susceptible to Rule 23(b)(3) classwide proof simply because one predicate of reliance—materiality—will be resolved, if at all, much later in the litigation on an independent merits element.”
Justice Thomas’s approach to Rule 23, then, is apparently quite extreme. Although the rule itself only requires that common questions “predominate” over individualized ones, he would apparently add the requirement that each element of a claim must be examined separately. Not only would this significantly raise the bar for plaintiffs seeking class certification in a variety of contexts, but it would also entirely reorient courts’ approaches to class certification. Right now, the Rule 23 inquiry is a fairly practical one: courts examine how a case will, realistically, be tried, and try to predict whether any individualized issues are so unwieldy that that they will 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 case in which individualized reliance issues overwhelm common issues when there has been a failure of proof on the element of materiality. Justice Thomas, however, would apparently take the focus off the practical realities of litigation, and instead focus on theoretical differences among class members.
Justice Scalia, it should be noted, dissented as well, but he did not agree with Justice Thomas’s reasoning. Instead, he conceded that if the fraud-on-the-market doctrine were purely a “substantive” method of proving reliance, the majority would be correct. However, he believed that fraud-on-the-market is a hybrid doctrine that contains both procedural and substantive elements, in that that Basic itself held that materiality must be proved at class certification, regardless of what Rule 23 might otherwise require.
Although the reasoning of the Amgen opinions seems rather straightforward, there are several additional wrinkles.
The first is that although Justice Ginsburg’s reasoning is compelling, in fact, it does not entirely hold up on close examination, given the particular facts of the case.
In an ordinary dispute over materiality, the defendant might argue 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 to matter much to investors. But in this case, defendant Amgen’s materiality argument was different. Amgen was pursuing what is known as the truth-on-the-market corollary to the fraud-on-the-market doctrine. Simply put, this corollary holds that if the truth behind a false statement is sufficiently well-known among traders, a false statement will have no effect on stock prices. The principle is that if the truth is sufficiently well-known, the false statement – which, standing alone, might have influenced stock prices – becomes immaterial in light of other available information.
(This corollary is therefore merely a twist on one of the rebuttals to the fraud-the-market presumption noted in Basic, i.e., that stock prices were not influenced because major traders did not believe the lie.)
In this case, Amgen argued that the “truth” behind any allegedly false statements had been published in the Federal Register and was known to market analysts.
Justice Ginsburg’s logic regarding the relevance of materiality to class certification does not apply as neatly when truth-on-the-market is on the table. If, say, the false statement is immaterial in its own right – the CEO lies about the color tie he wore to a business meeting – then any investor who tries to bring a case individually will necessarily lose on the element of materiality. But if a false statement is, standing alone, material, and only immaterial in light of some other statement made available in some other source, there remains a theoretical possibility that the individual investor – who heard the former statement but not the latter – might still have a claim. Or, to put it another way, perhaps materiality is not always a common question, in that there may be a “space” between whether a truth is sufficiently well-known among sophisticated traders that it counteracts the effects of a false statement on stock prices, while being sufficiently hidden from ordinary investors such that they might reasonably rely on the false statement, unaware of the truth.
There is no definitive answer to this question, which is made more complicated by the fact that materiality itself is evaluated based on the “total mix of information made available” – which only begs the question what counts as “information made available” in situations where some information has only been published in sources not usually consulted by ordinary investors (like, say, the Federal Register). But neither the majority nor the dissents addressed this issue, apparently because of the way Amgen chose to litigate the case. Rather than emphasize its truth-on-the-market defense specifically, it chose to pursue a general rule that all materiality disputes must be resolved at the class certification phase, leaving no room for arguments about the special qualities of truth-on-the-market.
The second interesting aspect of Amgen is Justice Ginsburg’s subtle dig at the Supreme Court’s earlier decision in Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541 (2011). Dukes considered the requirements for proving commonality under Rule 23(a). Although the Rule itself requires only that plaintiffs prove the existence of “questions of law or fact common to the class,” the Dukes majority interpreted the rule to require that plaintiffs show that a class action can generate common answers to those common questions. Justice Ginsburg dissented, arguing, inter alia, that the rule itself is explicitly limited to common questions.
In Amgen, Justice Ginsburg carried on the fight, repeatedly emphasizing that Rule 23(b)(3)’s requires only a predominance of common “questions” – with the word “questions” italicized several times. Nowhere did Justice Ginsburg discuss the need for common “answers.” And, surprisingly, her opinion was joined by two members of the Dukes majority, who were apparently unwilling to fight over the verbiage – Chief Justice Roberts and Justice Alito.
But these are mere sidebars when compared to the real significance of Amgen, which is what it portends for the fraud-on-the-market doctrine more generally. As part of its argument, Amgen and its amici challenged the empirical aspects of Basic, insisting that as a factual matter, all material information is not necessarily impounded into the price of a stock. They contended that more recent research shows that markets can be imperfectly efficient, absorbing some information quickly 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 that the Amgen case did not present the proper vehicle to revisit Basic, but four went further and invited such challenges in the future. Justice Alito wrote a separate concurrence to state that it might be appropriate to reconsider Basic in light of new economic developments; Justice Thomas’s dissent – 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 and class actions generally. Section 10(b) actions are among the largest and most common types of class actions today, and such class actions are the primary mechanism by which investors seek and recover damages for securities fraud. Moreover, in 1995 and again in 1998, Congress revamped the laws governing private securities actions in the Private Securities Litigation Act and Securities Litigation Uniform Standards Act, but made no change to the fraud-on-the-market presumption (despite proposals that it should be legislatively overruled). Indeed, both statutes explicitly rest on the assumption that plaintiffs will continue to bring their claims as class actions, something that would be if not impossible, then considerably less probable, in the absence of the fraud-on-the-market presumption. This legislation, however, apparently leaves at least Justice Thomas unmoved; although Justice Ginsburg pointed out in her majority opinion that Congress left Basic intact after passing the PSLRA, Justice Thomas answered in dissent that “The Court retains discretion over the contours of Basic unless and until Congress sees fit to alter them.”