The Supreme Court’s decision in the Amgen securities case will have a profound impact on the future of securities class action litigation. If the Court affirms the Ninth Circuit’s decision, it will eliminate an important event: a determination of whether the alleged false or misleading statements materially impacted the price of the company’s stock sufficient to invoke the “fraud-on-the-market” presumption of reliance. That would mean, absent settlement, that the vast majority of all securities class actions that survive a motion to dismiss will remain alive until at least summary judgment, even those that are doomed to fail because the challenged statements were not, in fact, material. If the Court reverses the Ninth Circuit, many future securities class actions will involve a meaningful class certification process. That would yield several important strategic and economic consequences. Argument is scheduled for November 5, 2012.
Before getting to my prediction and a discussion of the consequences of the Court’s ruling, following is a brief overview of the law and practice surrounding the issue the Court will decide.
Reliance is an essential element of a Section 10(b) claim. Absent some way to harmonize individual issues of reliance, however, class treatment of a securities class action is not possible; individual issues would overwhelm common ones, precluding certification under Federal Rule of Civil Procedure 23(b)(3). In Basic v. Levinson, the Supreme Court provided a solution: a rebuttable presumption of reliance based on the “fraud-on-the-market” theory, which provides that a security traded on an efficient market reflects all public material information. Purchasers (or sellers) rely on the integrity of the market price, and thus on a material misrepresentation. Decisions following Basic have established three conditions to its application: market efficiency, a public misrepresentation, and a purchase (or sale) between the misrepresentation and the disclosure of the “truth.” At issue in Amgen is whether the materiality of an alleged misrepresentation is also a condition to the presumption’s application.
Over the years, defendants have argued that, absent a showing by plaintiffs that the challenged statements were material, or upon a showing by defendants that they were not, the presumption is not applicable or has been rebutted. And, in a twist on such arguments, defendants sometimes argued that the absence of loss causation rebutted the presumption. This argument was accepted by the Fifth Circuit in Oscar Private Equity Investments v. Allegiance Telecom, Inc. But Oscar rested on shaky analytic grounds, and indeed the Supreme Court in Halliburton unanimously rejected loss causation as a condition of the presumption of reliance.
In Halliburton, the defendants did not dispute that proof of loss causation is not required for the presumption of reliance to apply. Instead, they argued to the Supreme Court that, although the Fifth Circuit ruled on loss-causation grounds, it really ruled that the absence of loss causation means that the challenged statements were not material, and a lack of materiality defeats the application of the presumption.
A few years earlier, my colleagues and I made a similar argument in one of our cases. We argued a lack of materiality, supported by expert opinion, and, relying directly on Basic, further argued that proof of materiality is no different than proof of market efficiency; plaintiffs have to prove both for the presumption to apply. We cited Oscar, and argued that the Fifth Circuit was really getting at the lack of materiality that was evidenced by the absence of loss causation; if the stock price did not go down materially upon the disclosure of the truth, the challenged statements could not have been material. It was, and is, an analytically sound argument, even though the court rejected it.
In Halliburton, the Supreme Court rejected the argument too: “Whatever Halliburton thinks the Court of Appeals meant to say, what it said was loss causation: “[EPJ Fund] was required to prove loss causation, i.e., that the corrected truth of the former falsehoods actually caused the stock price to fall and resulted in the losses.” . . . . We take the Court of Appeals at its word. Based on those words, the decision below cannot stand.”
But the Supreme Court explicitly left the door open for the argument that plaintiffs must prove materiality for the presumption of reliance to apply. The Supreme Court granted certiorari in Amgen to review the Ninth Circuit’s decision that plaintiffs are not required to prove materiality for the presumption to apply, and that the district court is not required to allow defendants to present evidence rebutting the applicability of the presumption before certifying a class based on the presumption. Amgen is represented by Shepard Mullin, including my good friend John Stigi, and Wilmer Hale. The plaintiffs are represented by Labaton Sucharow and Kellogg, Huber, Hansen, Todd, Evans & Figel. The parties’ briefs are linked here.
I, of course, am not a Supreme Court Justice. I have never even met one. But I will take a stab at predicting the outcome: Amgen will win. There are many technical legal reasons for my opinion.* The core reason, though, is practical: the Court will find that there is little or no harm in requiring plaintiffs to prove materiality at the class certification stage and for defendants to be able to demonstrate a lack of materiality. If the plaintiffs cannot prove materiality, then the district court will have ended claims that ultimately will fail, before the expenditure of millions of additional dollars in attorneys’ fees and hundreds of hours of wasted time by the court and directors and officers of the defendant company. If the plaintiffs can prove materiality, then the class is properly certified (assuming market efficiency, etc.) and everyone will have a better basis on which to assess the value of the case for settlement purposes when the time to discuss settlement arrives. This practical reason is supported by ample Supreme Court precedent proscribing the limits of securities class actions because of the “danger of vexatiousness” they present.
The plaintiffs in Amgen argue that adjudication of materiality at the class certification stage will have two principal “adverse effects.” One is that it would be unfair to adjudicate materiality before merits discovery is complete, since materiality may turn on internal company information that will not have been produced before the class-certification motion. In a great many cases, however, whether a misrepresentation was material will turn on public information or expert analysis based on public information – for example: did the misrepresentations materially impact the stock price? Was the information that made the challenged statement allegedly misleading actually omitted (the issue in Amgen)? Future plaintiffs will still be free to argue that materiality can’t be adjudicated without certain information, and the court will either agree or not on a case-specific basis.
Another of plaintiffs’ claimed “adverse effects” is that, because the court’s determination of non-materiality at class certification would not preclude later litigation of materiality in non-class actions, numerous individual actions would ensue in different courts around the country. But (even assuming the lack of preclusion) it seems highly unlikely that whatever individual actions are filed would be scattered instead of transferred to one court or otherwise coordinated. And, of course, rarely would an individual plaintiff be able to prove materiality after the lead plaintiff in the failed securities class action could not do so.
If the Court does rule in Amgen’s favor, the sky will not fall, and securities class actions will not go away. They will, though, be reformed for the better. Currently, there is no meaningful adjudication of the appropriateness of a securities class action between the denial of a motion to dismiss and summary judgment. Those two stages are separated by years and many millions of dollars in fees of attorneys and experts. A meaningful class-certification procedure will result in significant savings of money and judicial and management time in cases that are not proper securities class actions.
Requiring proof of materiality as a condition to class certification will change various strategic considerations. For example, in cases presenting a significant materiality issue, there will be an inclination, especially on plaintiffs’ part, to discuss settlement early instead of waiting until the facts and expert opinions on other issues have been developed. The procedure will also have economic ramifications. For example, class certification will involve the expenditure of significant attorney and expert fees early on in the case – though the majority of those fees should simply shift from the typical expert phase to class certification, thus reducing fees later on.
* Amgen also makes a strong economic argument: materiality is relevant to the market-efficiency inquiry because modern economic research shows that whether a market is efficiently processing information depends on the type of specific information at issue. Amgen argues that “[a] court cannot reliably conclude, based on [standard efficiency tests] alone, that the theory will in fact apply to a particular case. Market efficiency and materiality are both essential predicates, and often are intertwined, when determining whether a presumption of class-wide reliance is appropriate. The misrepresentation at issue must have been material, and the market must have been efficient as to that misrepresentation . . . .”