The Supreme Court released its anxiously awaited decision in Amgen Inc. v. Connecticut Retirement Plans yesterday. On the face of the decision, it was a loss for defendants in that case, and for companies everywhere that are forced to defend themselves against securities class action lawsuits – as the Court found that plaintiffs do not need to establish that allegedly false statements were material to the market before they can gain class certification.
As I have written before (see here and here), the Court had an opportunity in Amgen to make class certification a more meaningful stage in securities class actions, providing defendants with a new tool for stopping unmeritorious cases early in the process. On the surface of the Amgen decision, the Court declined to take that step. For this reason, many of the early reports indicate that the defense bar is concerned about the impact of Amgen. I’m not concerned. At worst, Amgen leaves defendants in most circuits in the same position they were before. The decision leaves open several arguments that will allow defendants to continue to challenge lack of materiality in the early stages of litigation. And, perhaps most significantly, the decision seems to tee up the Court’s re-consideration of the legitimacy and scope of the fraud-on-the-market presumption of reliance that it adopted in Basic v. Levinson.
I explore Amgen’s impact after discussing its majority, concurring, and dissenting opinions.
In a majority opinion authored by Justice Ginsburg, and joined by Chief Justice John Roberts and Justices Breyer, Alito, Sotomayor, and Kagan, the Court concluded that proof of materiality was not necessary to demonstrate, as Rule 23(b)(3) requires, that questions of law or fact common to the class will “predominate over any questions affecting only individual members.” The Court reasoned that this was because: 1) materiality was judged according to an objective standard that could be proven through evidence common to the class, and 2) a failure to prove materiality would not just defeat an attempt to certify a class, it would also defeat all of individual claims, because it is an essential element to a claim under Section 10(b).
Much can be said, and doubtless will be said, in criticism of the majority’s decision. Its chief flaw is its avoidance of the central question through circular reasoning. The materiality of a statement is an essential prerequisite for the application of the fraud-on-the market presumption that the Court developed in Basic v. Levinson, as a device to overcome the need to prove actual, individual reliance on a false or misleading statement – which made securities class actions all but impossible to bring. In Basic, the Court used then-emerging economic theory to create a rebuttable presumption of reliance, based on the assumption that a security traded in an efficient market reflects all public material information, and that traders in that market rely on the market price, and thus on any material misrepresentations that are reflected in the price. The Amgen Court does not dispute that the materiality of a misrepresentation is necessary to create the fraud-on-the-market presumption, nor that the fraud-on-the-market presumption is essential to show under Rule 23 that common questions predominate for the class.
Instead, to avoid the logical conclusion that a showing of materiality was thus necessary to certify the class, the Court reasons backwards: because plaintiffs must also show the materiality of the alleged misstatements in order to prove the underlying merits of a Section 10(b) claim, a finding that there was no materiality would defeat claims for all plaintiffs, whether brought as a class or individually. Therefore, the Court concluded, materiality (or the lack of it) was a “common question,” that should not be decided until summary judgment, or theoretically, trial.
As Justice Thomas writes in his dissent (joined by Justice Scalia (in part) and Justice Kennedy), the majority essentially “reverses” the inquiry. Although class certification is supposed to be decided early in the litigation, and depends upon a showing of materiality to invoke the fraud-on-the-market presumption, the majority effectively says that that portion of the class certification inquiry can be skipped, merely because it is also a question that will be asked at the merits stage. Writes Thomas: “A plaintiff who cannot prove materiality does not simply have a claim that is ‘dead on arrival’ at the merits. . .he has a class that never should have arrived at the merits at all because it failed in Rule 23(b)(3) certification from the outset.”
Despite the flaws of the decision, the Court has spoken, and there is limited usefulness to arguing about whether or not its decision is correct. But lurking under the surface of the opinion are a number of issues that leave ample room for continued litigation over “materiality” issues:
1) The Court affirmed the district court in rejecting Amgen’s effort to offer rebuttal evidence upon class certification that would demonstrate that the misstatement was not material because the truth of the matter had already been disclosed to the market. If this argument is framed as a “truth on the market” defense, alleging that truthful information had already entered the market by other means, then it is traditionally a question that is entertained at the summary judgment stage. On the other hand, in its narrow focus on “materiality,” the Court overlooked that this may also be a question properly raised on a motion to dismiss: if plaintiffs challenge a statement as misleading because it fails to disclose certain information, then the fact that the same information was actually disclosed (in that statement or other statement by the company), negates the existence of a false or misleading statement in the first place. The Amgen decision will not affect defendants’ ability to make this challenge on a motion to dismiss, as an argument not against materiality, but rather against the sufficiency of plaintiffs’ allegations of falsity.
2) Because Amgen conceded that the market for its stock was “efficient,” the Court avoided more searching examination of what this term means, and how the efficiency of a market – an undisputed prerequisite to the application of the fraud-on-the-market presumption at the class certification stage – can be challenged. In footnote 6, the Court noted that Amgen had advanced an argument founded on modern economic research tending to show that market efficiency was not a “binary, yes or no question.” Rather, the efficiency of a market in absorbing information depends upon the type of information – a market might be able to readily process easily digestible information like public merger announcements, while the same market could be slow to respond to potentially important technical or scientific disclosures in an SEC filing. The Court sidestepped the issues raised by this argument, by saying that it did not impact the “materiality” question.
But the argument does raise the question of how efficiency should be defined, and whether the efficiency of a market may depend on the type of statement in question and/or its price impact. The Court thus left the door open to question on class certification whether a statement was “efficiently” absorbed into, and thus reflected by, the market price. This argument is a close cousin to materiality, with one important distinction: I can imagine a circumstance in which a court could find that a public statement was not absorbed into, or reflected by the market price, and that the fraud-on-the-market presumption should not apply – but that, regardless, the statement was still “material,” in that a reasonable investor would find it significant. In such an instance, the certification of a class would properly be defeated, but the ultimate question of materiality would be left open for an independent determination on the merits should an individual investor bring suit. Such a circumstance would break the circle upon which the Court based its holding in Amgen.
3) Perhaps the most striking part of the decision was Justice Alito’s one paragraph concurrence, which baldly called for a reconsideration of the fraud-on-the-market presumption created in Basic. Alito concurred with the majority, but only with the understanding that Amgen had not asked for Basic to be revisited. Alito thus signaled that he agreed with Thomas’s contention in footnote 4 of the dissent that the Basic decision was “questionable.” The majority, in turn, did not come to the defense of Basic, but simply noted with apparent relief (in footnote 2) that even Justice Thomas had acknowledged that the Court had not been asked to revisit that issue. Considered together, these three opinions put out a welcome mat for the right case challenging Basic’s fraud-on-the-market presumption, with four votes already supporting the view that the decision was “questionable,” and the other five failing to come to its defense. When, and if, Basic is reconsidered, the result could have a much larger impact on the future of class actions than would have been felt by any decision on the “materiality” questions raised in Amgen.
In summary, my first take on the Amgen decision is that far from settling the question of what plaintiffs must prove to gain class certification, it has merely opened the doors wider for continued litigation on the matter. I predict that these issues are going to continue to be challenged, and that another case on class certification will be before the Court within the next few years. After considering class-certification issues in Halliburton in 2011, and now in Amgen, the Court seems destined at long last to reach the ultimate question – the legitimacy and scope of the fraud-on-the-market presumption.
That doesn’t mean that Amgen will be forgotten – in addition to leaving behind a number of crumbs to feed continued litigation of “materiality” questions, the majority seemed to signal a shift away from its historic narrow construction of the securities laws based on the Court’s observation in Blue Chip Stamps v. Manor Drug Stores that “litigation under Rule 10b-5 presents a danger of vexatiousness different in degree and in kind from that which accompanies litigation in general.” 421 U.S. 723, 739 (1975). Here, the Court flatly rejected Amgen’s argument based upon the public policy interest of containing that “vexatiousness.” Amgen argued that if materiality was not addressed in class certification, it was likely not to be ever addressed at all, because after class certification, plaintiffs are able to bring substantial pressure to bear on defendants to get them to settle before the merits phase – even on frivolous claims. But the Court contended that Congress had already taken steps, through the Reform Act, to curb the “‘extraction’ of ‘extortionate settlements’” of frivolous claims,” and, in doing so, had consciously decided not to challenge the fraud-on-the-market presumption. And while continuing to recognize the potential for abuse, the Court nonetheless chose to emphasize the possibility that securities class actions also serve an important public policy purpose, by supplementing the criminal prosecutions and civil enforcement actions brought by the DOJ and the SEC. As the debate over the “materiality” question continues to play out, this passage may prove to be the most enduring takeaway from Amgen – and the one most likely to haunt us in plaintiffs’ briefs in the coming years.