August 15, 2023
On August 10, 2023, the Second Circuit decertified Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., a long-pending class action against Goldman Sachs related to a $550 million fine for failing to disclose conflicts of interest tied to investments in various collateralized debt obligation transactions. The decision (Goldman IV) raises important implications about what plaintiffs need to show to obtain class certification in cases where defendants can argue the alleged misrepresentations are “generic” and do not closely match later disclosures that revealed the defendants’ fraud.
To obtain class certification, securities fraud plaintiffs must show that the issue of reliance (i.e., whether a plaintiff relied upon the alleged misrepresentations when buying or selling securities) can be proven on a class-wide basis. To do this, plaintiffs typically rely on the “Basic presumption” established by the Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224 (1988). The idea behind Basic is that stock trading in an efficient market incorporates all public, material information (including material misrepresentations), and that investors rely on the integrity of the market price when they choose to buy or sell that stock. Thus, if plaintiffs can show the market for the security at issue was efficient, there is no need to individually prove reliance—all members of the class effectively relied on the defendants’ material misrepresentations by buying or selling the company’s stock at the prevailing market price, which was impacted by the defendants’ material misrepresentations. Defendants can, however, rebut the Basic presumption by demonstrating by a preponderance of the evidence that the alleged misrepresentations did not actually impact the stock’s price.
There are two ways a misrepresentation can impact a stock’s price: by inflating it, or by maintaining already-existing inflation. In the latter scenario, the back-end price drop when the truth is disclosed can generally be used as a proxy to show there was front-end inflation. But what happens in an inflation-maintenance case when the subject matter of the price-propping misrepresentation and the truth-revealing corrective disclosure don’t quite match up? That’s the question addressed by Goldman IV.
Goldman IV concerns two categories of alleged misrepresentations. The first relate to Goldman’s business principles—statements like “[w]e are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us,” “[o]ur clients’ interests always come first,” and “[i]ntegrity and honesty are at the heart of our business.” The second are lengthier “risk factor” statements from Goldman Sachs’ annual report that address the company’s purportedly “extensive procedures and controls that are designed to identify and address conflicts of interest.” The plaintiffs allege that these statements maintained Goldman Sachs’ already-inflated stock price, and that the SEC’s investigation of Goldman Sachs and the company’s payment of a $550 million fine revealed the truth and caused Goldman’s stock price to fall such that investors lost $13 billion.
The case has a long and tortuous appeal history, involving three prior Second Circuit opinions and a Supreme Court decision in 2021. See Goldman Sachs Grp., Inc. v. Ark. Teacher Ret. Sys., 141 S. Ct. 1951 (2021). Most importantly, the Supreme Court’s 2021 decision was on the very issue addressed by Goldman IV, and explained that the “inference [ ] that the back-end price drop equals front-end inflation [ ] starts to break down” when the earlier misrepresentation is generic and the later corrective disclosure is specific. Thus, 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.” Ultimately, the district court was instructed to “consider all record evidence relevant to price impact and apply the legal standard as supplemented by the Supreme Court.” The district court then re-certified the class, setting up a fourth appeal to the Second Circuit.
This time, the Second Circuit de-certified the class. At its core, the Second Circuit’s decision addresses a simple question: “How generic are the alleged misrepresentations?”
As to the first category of statements, concerning Goldman Sachs’ ethical business principles, the Second Circuit found the district court’s analysis “untenable” because the district court understated the statements’ “genericness.” The Second Circuit found such statements were “separately disseminated to shareholders in separate reports at separate times,” and could not be read in conjunction with the conflicts statements to bolster or strengthen the argument they impacted Goldman Sachs’ stock price, which the Second Circuit found otherwise unconvincing.
Everything thus turned on the conflicts statements. And as to those statements, the Second Circuit found there was an insufficient link between them and the corrective disclosures, because not one of the corrective disclosures expressly identified the conflicts statements, and there was a “considerable gap in specificity” between the two. The proper way for the district court to determine the amount of front-end inflation would have been to “ask what would have happened if the company had spoken truthfully at an equally generic level,” but “instead, the district court allowed the details and severity of the corrective disclosures to do the work of proving front-end price impact.” This was a mistake, because “[u]tilizing a back-end price drop as a proxy for the front-end misrepresentation’s price impact works only if, at the front end, the misrepresentation is propping up the price.”
Going forward, the Court explained, “a searching price impact analysis” must be conducted where (1) there is a considerable gap in genericness between the misrepresentations and corrective disclosures, (2) the corrective disclosures do not directly refer back to the alleged misrepresentations, and (3) the plaintiff claims a company’s generic risk disclosure was misleading by omission.
The Second Circuit directed lower courts to consider indirect evidence of price impact, such as discussions in the market, and to determine whether the specific statements at issue were important to investors in deciding whether to buy or sell stock.
Goldman IV shows that in cases in the Second Circuit where securities fraud plaintiffs are advancing a price-maintenance theory, and where the defendants might argue the alleged misrepresentations are “generic” and not sufficiently tethered to the subsequent corrective disclosures, plaintiffs should marshal as much evidence as they can—econometric and statistical evidence, market commentary, media reports, and more—to solidify their arguments that they are entitled to the Basic presumption and class certification. Because most securities cases do not concern supposedly “generic” alleged misrepresentations, we do not anticipate the decision will have a significant impact on securities cases more broadly.