March 05, 2013

BNA - The United States Law Week


Reproduced with permission from The United States Law Week, 81 USLW 1223 (March 5, 2013).  Copyright 2013 by The Bureau of National Affairs, Inc. (800-372-1033) <>

Investors Pursuing Fraud Suit Not Required To Prove Materiality to Get Class Certification

Investors relying on the fraud-on-the-market doctrine in bringing securities fraud claims do not have to prove the alleged misrepresentations were material to their investment decision to clear the hurdle of class certification, the U.S. Supreme Court held Feb. 27 (Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, U.S., No. 11-1085, 2/27/13). 

The 6–3 opinion by Justice Ruth Bader Ginsburg said that materiality is determined by an objective standard, and thus is a common question for all the members of the class under Fed. R. Civ. P. 23(b)(3). 

An attorney who filed an amicus brief in support of the defendant company told BNA Feb. 27 the decision maintains the status quo, and will allow ‘‘rampant’’ class filings to continue. But an attorney who regularly represents investors said the opinion underscores ‘‘the principle that Rule 23 is a procedural device designed to allow investors and other groups a way to have their day in court.’’ 

The Connecticut Retirement Plans and Trust Funds sued Amgen Inc. under Section 10(b) of the 1934 Securities Exchange Act and Securities and Exchange Commission Rule 10b-5, invoking the fraud-on-the-market presumption. Under Basic Inc. v. Levinson, 485 U.S. 224 (1998), and Erica P. John Fund Inc. v. Halliburton Co., 79 U.S.L.W. 4416 (U.S. 2011), the premise of the presumption is that the price of a security traded in an efficient market will reflect all publicly available information about a company, and that an investor in the company may be presumed to have relied on that information in purchasing the security. 

To obtain class certification under Rule 23(b)(3), plaintiffs must show numerosity, commonality, typicality, adequacy of representation, and that ‘‘the questions of law or fact common to class members predominate over any questions affecting only individual members, and that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy.’’ 

To prove a claim under Section 10(b) and Rule 10b-5, a plaintiff must prove a material misrepresentation, scienter, a connection between the misrepresentation and the purchase or sale of the security, reliance on the misrepresentation, loss, and loss causation. 

The Connecticut retirement plans alleged that Amgen misrepresented the safety, efficacy, and marketing of its two flagship drugs, and when the truth became known, Amgen’s stock prices fell. 

The district court granted the retirement plans’ request for class certification under Rule 23(b)(3). On appeal, Amgen argued, among other things, that the district court erred by certifying the class without requiring the retirement plans to prove that Amgen’s alleged misrepresentations were material. The appeals court disagreed, and the Supreme Court granted certiorari to settle a circuit split on the issue.

 Rigorous, Not Free-Ranging Analysis

The court noted that a class certification analysis must be ‘‘rigorous,’’ but said that lower courts do not have ‘‘license to engage in free-ranging merits inquiries at the certification stage.’’ At that stage, merits should be addressed only to the extent ‘‘they are relevant to determining whether the Rule 23 prerequisites for class certification are satisfied,’’ it said. 

Amgen argued that materiality is an element of a Rule 10b-5 cause of action, and is an essential predicate for the fraud-on-the-market theory. 

It added that the theory is premised on the understanding that in an efficient market all publicly available information is reflected in the market price. Because immaterial information does not affect market prices, it cannot be relied upon by investors, who presumably relied on the market price’s integrity. It said the fraud-on-the-market theory cannot apply absent a material misrepresentation, and without the fraud-on-the-market theory, reliance cannot be proved through evidence common to the class. Thus, it argued, materiality must be proved before a securities fraud class action can be certified. 

The court disagreed. It said that the key question was not whether materiality is an essential predicate of the fraud-on-the-market theory. ‘‘Instead, the pivotal inquiry is whether proof of materiality is needed to ensure that the questions of law or fact common to the class will ‘predominate over any questions affecting only individual members’ as the litigation progresses.’’

The court explained that materiality requires an objective analysis of the significance of a misrepresentation to reasonable investors, and can be proved through evidence common to the class.

It added that ‘‘there is no risk whatever that a failure of proof on the common question of materiality will result in individual questions predominating.’’ It said that because materiality is an element of a Rule 10b-5 claim, failure to present sufficient evidence of materiality to ward off summary judgment or prevail at trial ‘‘would not cause individual reliance questions to overwhelm the questions common to the class.’’

Other Prerequisites Irrelevant

Amgen argued, however, that under Halliburton, certain prerequisites, like market efficiency and publicity, must be proved in order to invoke the fraud-on-the-market theory. It maintained that if plaintiffs must prove those prerequisites before class certification, they should have to prove materiality too. 

The court explained, ‘‘While the failure of common, classwide proof on issues of market efficiency and publicity leaves open the prospect of individualized proof of reliance, the failure of common proof on the issue of materiality ends the case for the class and for all individuals alleged to compose the class.’’ 

The court also rejected Amgen’s argument that policy considerations favor requiring proof of materiality.  Congress has looked at the policies specifically noted by Amgen, and rejected calls to undo the fraud-on-the-market theory endorsed in Basic, it said. 

Justice Samuel A. Alito Jr. concurred, because Amgen did not seek to revisit the fraud-on-the-market presumption.  But he suggested that ‘‘reconsideration of the Basic presumption may be appropriate.’’ 

Dissenting, Justice Antonin Scalia argued, ‘‘The fraud-on-the-market theory approved by Basic envisions a demonstration of materiality not just for substantive recovery, but for certification.’’ 

Justice Clarence Thomas, joined by Scalia and Justice Anthony M. Kennedy, also dissented, arguing, ‘‘Without demonstrating materiality at certification, plaintiffs cannot establish Basic’s fraud-on-the-market presumption.’’ He added that without proof of fraud on the market, it cannot be shown that otherwise individualized questions of reliance will predominate, and that without satisfying Rule 23(b)(3), ‘‘class certification is improper.’’ He said that fraud on the market is a ‘‘condition precedent to class certification, without which individualized questions of reliance will defeat certification.’’

Security Fraud, Class Actions Go Hand-in-Hand

Richard A. Samp, Washington Legal Foundation, Washington, D.C., who filed an amicus brief supporting Amgen, told BNA Feb. 27 that the reality is that most securities fraud cases are filed as class actions, ‘‘and the only way for them to proceed as class actions is by invoking the fraud-on-the-market theory.’’ He said that ‘‘a win for Amgen would have made it much more difficult for plaintiffs to get their classes certified’’ in these cases. 

According to Samp, the decision maintains the status quo, and will allow ‘‘rampant’’ class filings to continue. 

Daniel S. Sommers, Cohen Milstein Sellers & Toll PLLC, Washington, D.C., who handles securities fraud cases for investors, told BNA Feb. 27 that there is no data to support the conclusion that the opinion will increase the number of class actions filed, or that it will be the catalyst for more settlements. 

Sommers said that the ‘‘opinion is good news for investors’’ because it ‘‘strongly rejected Amgen’s attempt to impose on investors a requirement to prove allegedly false statements were material at the class certification stage.’’ He said that the Supreme Court ‘‘took a common sense approach that is rooted in the plain text of Rule 23, concluding that because materiality is an issue common to all class members, there is no possibility of a court being confronted with individualized issues that would preclude use of the class action device.’’ 

Samp said that under the opinion a plaintiff need not prove materiality in order to win class certification. He added that ‘‘once there is a decision on certification, virtually all securities fraud cases come to an end; they never go to trial.’’ He said that at that point the defendants usually decide to settle, because ‘‘the costs of pretrial discovery generally dwarf the amount that they must pay to settle most cases.’’ 

As a result of this opinion, ‘‘it will be quite easy to win class certification in virtually every securities fraud case,’’ Samp said. Furthermore, because there will not be a trial, the plaintiffs will never have to prove materiality, he said.  The court said that the existence of an efficient market is the number one criterion for getting certification, Samp noted. ‘‘But every widely traded public company trades in an efficient market,’’ he said. He therefore envisions a scenario where a plaintiff’s attorney files suit the day after a stock drops by 5 percent or following a disappointing earnings report, and then scours the company’s records from the previous six months to find an ‘‘arguably misleading’’ statement. The attorney can then claim that the earnings statement revealed the misstatement to be misleading and caused the stock to drop, he said. ‘‘Because (per today’s decision) the materiality of the arguably misleading statement is irrelevant to the class certification decision, he will get class certification and then force a settlement,’’ Samp said.

But Sommers noted that the Supreme Court ‘‘gave no weight to Amgen’s policy arguments that failing to require proof of materiality at the class certification stage will somehow lead to defendants being unfairly pressured into paying large settlements to investors.’’ 

He added that the court ‘‘reiterated its long-held view that private securities litigation is a vital supplement to governmental enforcement of the federal securities laws and that the court should not make policy-based decisions that would undermine that important goal.’’

Fraud-on-the-Market Theory Should Survive

Samp said that there appears to be some sentiment on the court to jettison the fraud-on-the-market theory, but he doubts that will ever happen. He explained that securities fraud suits ‘‘have proven to be a reasonably effective means of compensating shareholders who have been injured by fraudulent corporate executives.’’ Without the fraud-on-the-market theory, it would be difficult for those suits to be maintained, he said. 

According to Samp, Amgen provided a great opportunity for the court ‘‘to reform the system—getting rid of the more frivolous suits (a category into which the Amgen case definitely falls) while still allowing recovery in the more substantial cases.’’ He added, ‘‘The court missed a golden opportunity for reform.’’

Seth P. Waxman, Wilmer Cutler Pickering Hale and Dorr, Washington, D.C., argued for Amgen. David C. Frederick, Kellogg, Huber, Hansen, Todd, Evans & Figel, Washington, D.C., argued for Connecticut Retirement.  Assistant to the Solicitor General Melissa Arbus Sherry argued for the United States as amicus curiae.