US Supreme Court clarifies standards for rebutting price impact in securities class actions

Yesterday the Supreme Court issued its long-awaited decision in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System, holding that Rule 10b-5 claims premised on generic statements regarding a company's internal policies may be less susceptible to class certification than claims based on more specific alleged misstatements. No. 16-250, 2021 WL 2519035 (June 21, 2021). The opinion also clarified that defendants bear the burden of disproving price impact at the class certification stage by a preponderance of the evidence, but emphasized that the allocation of the burden should "rarely" be dispositive in deciding whether a class should be certified.¹ While the decision does not reflect a significant change in substantive law, it should nonetheless provide defendants additional support for opposing class certification, particularly in "event driven" cases that are often premised on generalized statements that companies have adequate policies or procedures to prevent the type of adverse regulatory or environmental "event" that ultimately causes the stock price to decline. Because these types of claims have proliferated in recent years, companies and litigation counsel should carefully study this opinion in crafting arguments against class certification for these types of claims.

Background

In 2011, a group of shareholders filed a securities class action against The Goldman Sachs Group, Inc. and three former executives (collectively, "Goldman") in the United Stated District Court for the Southern District of New York alleging violations of Section 10(b) and Rule 10b-5.² Plaintiffs alleged that generalized statements about Goldman's ability to manage conflicts of interest—including a statement that "[w]e have extensive procedures and controls that are designed to identify and address conflicts of interest"—were purportedly shown to be false when a government enforcement action pertaining to alleged conflicts of interest was later announced, which was followed by a stock price decline.³

Goldman initially moved to dismiss the case on the grounds that the alleged misrepresentations and omissions were immaterial as a matter of law.⁴ The District Court denied the motion to dismiss, and the case moved into the class certification stage.⁵ To certify a damages class under Federal Rule of Civil Procedure Rule 23(b)(3), the plaintiff must satisfy the predominance requirement, which provides that "the questions of law or fact common to the class members predominate over any questions affecting only individual members."

To satisfy this requirement, the plaintiffs invoked the "fraud-on-the-market" presumption from Basic Inc. v. Levinson, 485 U.S. 224 (1988), which provides that investors are allowed to rely on the market price of a company's security, which in an efficient market will reflect all of the company's public statements, including misrepresentations. Establishing a presumption of reliance is critical for plaintiffs, as otherwise individualized reliance issues would predominate over common issues and defeat class certification. To successfully invoke the Basic presumption, the plaintiffs must show that: (1) the alleged misrepresentation was publicly known; (2) it was material; (3) the stock traded in an efficient market; and (4) the plaintiff traded the stock between the time when the misrepresentation was made and when the truth was revealed. Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 268 (2014) (Halliburton II). While class members are generally not required to prove materiality at the class certification stage, the other three elements must be satisfied. See Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 568 U. S. 455, 462 (2013) (holding that materiality should be left to the merits stage because it does not bear on Rule 23's predominance requirements).

Goldman attempted to rebut the Basic presumption with evidence that the alleged misstatements had no impact on the stock price.⁶ Goldman argued that the statements were too generic to affect the stock price and that it could not be inferred from the subsequent stock price decline after the announcement of the SEC enforcement action that the earlier generic statements inflated the stock price. In making this argument, Goldman relied on the Supreme Court's decision in Halliburton II, which held that a defendant may rebut the Basic presumption by presenting evidence that the alleged misrepresentation did not affect the price of the relevant security—i.e., by showing a lack of price impact. A defendant can rebut the presumption with "[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by [a] plaintiff, or his decision to trade at a fair market price."⁷ Of particular relevance here, if a defendant "show[s] that the misrepresentation in fact did not lead to a distortion in price," it breaks the "causal connection" by eliminating "the basis for finding that the fraud had been transmitted through [the] market price."⁸

Despite Goldman's evidence that the generalized "policies and procedures" statements at issue in the litigation had no impact on the stock price, the District Court initially certified the class, reasoning that the evidence did not "conclusively" prove a "complete lack" of price impact.⁹ After the Second Circuit vacated the District Court's initial certification order, the District Court again certified the proposed class, and the Second Circuit this time affirmed, holding that the absence of stock price movement when the "generic" statements were made does not preclude plaintiffs from relying on an "inflation price maintenance" theory—i.e., the argument that the alleged misstatements maintained existing inflation in the price (even though there was no additional increase in price when the statements were made) that was later allegedly dissipated when the enforcement action was announced.¹⁰ In reaching this conclusion, the Second Circuit held that Goldman's proposed test for assessing price impact of "generic" disclosures was an attempt to "smuggl[e] materiality into Rule 23," which, as held in Amgen, was a merits question that does not impact the predominance requirement.¹¹ The court also held that defendants carried a "heavy burden"¹² and could rebut the Basic presumption only by showing that the "entire price decline on the corrective-disclosure dates was due to something other than [their] alleged misstatements."¹³ Judge Sullivan dissented, noting that under the majority's approach, "the Basic presumption is truly irrebuttable and class certification is all but a certainty in every case."¹⁴

The Supreme Court decision

After granting certiorari and hearing oral argument, the Supreme Court ruled on Monday that (1) "[t]he generic nature of a misrepresentation often will be important evidence of a lack of price impact";¹⁵ and (2) while the defendant bears the burden of persuasion to prove a lack of price impact by a preponderance of the evidence at the class certification stage, the allocation of the burden to defendants should only be outcome-determinative in rare situations when the evidence for and against price impact are "in perfect equipoise."¹⁶

Generic nature of a misrepresentation

The plaintiffs conceded, and the Supreme Court agreed, that the generic nature of an alleged misstatement will often be "important" evidence of a lack of price impact because, "as a rule of thumb, 'a more-general statement will affect a security's price less than a more specific statement on the same question,'" and there is more likely to be a "mismatch between the contents of the misrepresentation and the corrective disclosure."¹⁷ As a result, the fact that the stock price falls when an unfavorable event is announced—i.e., an announcement of disappointing earnings—may be less likely to support an inference that a more generalized prior statement (e.g., a statement that the company has "faith in our business model") itself impacted the stock price.¹⁸ In reaching this conclusion, the Court emphasized that when assessing price impact at class certification, courts should consider all probative evidence.¹⁹ Because it was not clear if the Second Circuit majority had appropriately considered the generic nature of the alleged misstatements as part of the price impact analysis, the Supreme Court remanded the case to the Second Circuit for further consideration on whether Goldman's specific statements impacted the stock price.²⁰

Defendant's burden of persuasion

On the question of burden of persuasion, the Supreme Court concluded that Basic and Halliburton II previously assigned the burden of persuasion to defendants.²¹ Specifically, Basic requires that the defendant "show that the misrepresentation in fact did not lead to a distortion of price" by making "[a]ny showing that severs the link between the alleged misrepresentation and . . . the price received (or paid) by the plaintiff." 485 U. S., at 248 (emphasis added). Similarly, Halliburton II requires a "showing . . . that the particular misrepresentation at issue did not affect the stock's market price." 573 U. S., at 279 (emphasis added). The Supreme Court concluded that "[t]hese references to a defendant's 'showing'" in the Basic and Halliburton II opinions "require a defendant to do more than produce some evidence relevant to price impact; the defendant must 'in fact' 'seve[r] the link' between a misrepresentation and the price paid by the plaintiff."²²

Concurrence and dissent

Justice Sotomayor concurred in part and dissented in part, agreeing with the majority's substantive holdings regarding the importance of generic statements as evidence of lack of price impact and the defendant bearing the burden of persuasion, but disagreeing with the majority's view that it was unclear whether the Second Circuit properly considered the generic nature of the alleged misstatements.²³ In her view, the Second Circuit's opinion correctly addressed the issue and should be affirmed.²⁴ Justice Gorsuch, joined by Justice Thomas and Justice Alito, also concurred in part and dissented in part, agreeing with the majority's resolution of importance of generic statements as evidence of lack of price impact, but disagreeing with its conclusion that the defendants bear the burden of persuasion in rebutting price impact.²⁵

Takeaways

While the Goldman Sachs Group decision does not significantly change the substantive law governing class certification in securities cases, and despite the defendants failing to succeed on their burden-of-proof argument, the Supreme Court's opinion could nonetheless lead more district courts to find in favor of defendants on price impact at the class certification stage. The Supreme Court made clear that the generic nature of an alleged misrepresentation can be "important" evidence that there is no price impact, that all evidence relevant to price impact should be considered (even if it arguably overlaps with materiality), and that the allocation of the burden of proof to defendants should "rarely" affect the outcome except in cases where the evidence is in "perfect equipoise."²⁶ By emphasizing these principles, the opinion may help overcome future judicial reluctance to accepting defendants' price impact arguments at the class certification stage. Because many "event-driven" securities class actions are based on similar theories that generalized "policies and procedures" statements are rendered false by later revelations of regulatory noncompliance or other adverse "events," this opinion could be particularly significant as more event-driven suits move into the class certification phase.