Ann Lipton has been a practicing securities litigator for
several years. Beginning this fall, she
will be joining Duke
Law School
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 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.”
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