Key Takeaways  

• The Supreme Court clarified its prior securities class-action decisions in Basic v. Levinson (“Basic”), Erica P. John Fund, Inc. v. Halliburton Co. (“Halliburton II”), and Amgen Inc v. Connecticut Retirement Plans and Trust Funds (“Amgen”) to hold that, when deciding whether a defendant has adequately rebutted the fraud-on-the-market presumption of class-wide reliance, trial courts must consider whether the generic nature of the alleged misstatements shows that they did not impact the price of the defendant’s stock. 
• This ruling is particularly important for cases involving the “inflation-maintenance” theory, where the Court recognized that a sufficient “mismatch” between a generic misstatement and a specific disclosure will usually strengthen a defendant’s efforts to rebut the fraud-on-the-market presumption.  
•  Although the Supreme Court agreed with the Second Circuit that a defendant bears the burden of persuasion to disprove price impact at the class certification stage, the Supreme Court’s description of that burden will likely be much more favorable to defendants in practice.  

Earlier this week, the U.S. Supreme Court clarified an important issue governing motions for class certification in securities fraud litigation:  whether the generic nature of a misrepresentation is relevant to price impact.¹ One of the two key holdings favored defendants:  all nine justices agreed that district courts should consider the generic nature of an alleged misstatement when assessing plaintiffs’ “price impact” allegations, even though such evidence is also relevant to materiality—an issue normally reserved for the merits under Amgen. However, a six-justice majority held that once plaintiffs have stated a prima facie case, defendants bear the burden of persuasion to defeat the application of the fraud-on-the-market presumption. Despite defendants’ apparent loss on this burden issue, however, the Supreme Court’s description of the burden is less onerous than the Second Circuit’s holding was.

Importantly, after reserving any assessment of the validity of the “inflation maintenance” theory, the Supreme Court provided important guidance that should give future defendants the flexibility to overcome the theory. The Court urged lower courts to pay special attention to whether there is a “mismatch between the contents of the misrepresentation and the corrective disclosure.” When a class-action litigation implicates such a “mismatch”—as when a generic alleged misrepresentation is paired with a specific purported corrective disclosure—trial courts should be more hesitant to find that a price drop at the time of the corrective disclosure indicates a price impact at the time of the defendant’s earlier alleged misstatement. We expect that Defendants will rightly seize on this language in future “inflation-maintenance” cases, particularly as cases arising from disclosures concerning COVID-19 preparedness continue to work their way through the lower courts.  

Background on the Case

In 2011, ATRS commenced the litigation as a putative class action in the U.S. District Court for the Southern District of New York against the Company and three of its executives (“Defendants”) alleging violations of Sections 10(b) and 20(a) and Exchange Act Rule 10b-5.  ATRS claimed that public reports concerning the Company’s role in the issuance and marketing of certain collateralized debt obligations (“CDOs”) indicated that the Company had failed to adhere to its public statements about its business practices, which included: 

• “We have extensive procedures and controls that are designed to identify and address conflicts of interest.”  
• Our clients’ interests always come first.  Our experience shows that if we serve our clients well, our own success will follow.”  
• “Integrity and honesty are at the heart of our business.”

Plaintiffs alleged that, when the Company’s role in the marketing of the CDOs became public knowledge, the above statements were revealed to be “false,” causing an initial 13% drop in the price of the Company’s publicly traded shares and subsequent declines on the following two trading days.  

Defendants moved to dismiss the complaint under Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure on the grounds that any purported misstatements were too general to constitute a “material” misrepresentation.  While the District Court agreed that some of the claimed misrepresentations about Defendants’ conflicts policies were not actionable, the Court allowed some of the claims to proceed.² 

The First Class Certification Motion

In response to Plaintiffs’ initial motion for class certification, Defendants argued that Plaintiffs’ allegations failed to satisfy the “predominance” requirement for certification of class seeking money damages. While Defendants recognized that Plaintiffs’ evidence presumptively satisfied the requirements for the fraud-on-the-market presumption set forth in Basic v. Levinson, 485 U.S. 224 (1988), Defendants argued that they had satisfied their burden of rebutting the presumption: Plaintiffs could not point to an increase in the price of the Company’s stock caused by any of the alleged misstatements.  

The District Court disagreed, holding that Defendants failed to “provide conclusive evidence that no link exists between the price decline and the alleged misrepresentations.”³ On appeal, the U.S. Court of Appeals for the Second Circuit vacated and remanded, holding that the District Court imposed an inappropriately high standard for rebuttal of the Basic presumption because “conclusive” evidence is not required and the District Court should have instead considered “whether defendants established by a preponderance of the evidence that the [alleged] misrepresentation[s] did not in fact affect the market price of [the] stock.”⁴   

The Second Class Certification Motion

On remand, the District Court again granted Plaintiffs’ motion for class certification. The Court held that Plaintiffs had established a proper application of Basic under the “inflation maintenance” theory, pursuant to which a plaintiff may establish “price impact” by pointing to a statement that does not increase the price of a security but which nonetheless maintains an already inflated security price.⁵

On appeal, the Second Circuit held that the District Court had correctly applied the preponderance of the evidence standard when it rejected Defendants’ Basic rebuttal evidence. With respect to Defendants’ argument that the “generic” character of the alleged misrepresentations rebutted the application of the Basic presumption, the Second Circuit held that it impermissibly raised an argument about the “materiality” of the alleged misstatements, which is an issue generally reserved for the merits phase of litigation.⁶ Judge Sullivan authored a forceful dissent, noting that adopting the District Court’s and the Second Circuit majority’s analysis would render “the Basic presumption . . . truly irrebuttable and class certification . . . all but a certainty in every case.” ⁷

Supreme Court Proceedings

On December 11, 2020, the Supreme Court granted Defendants’ petition for a writ of certiorari on its two questions:

1. “Whether a defendant in a securities class action may rebut the [Basic presumption] by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even thought that evidence is also relevant to the substantive element of materiality; and
2. “Whether a defendant seeking to rebut the Basic presumption has only a burden of production or also the ultimate burden of persuasion.”

Each of the parties received significant amicus support, and the United States filed a brief that favored Defendants’ position on the first question, but Plaintiffs’ position on the second.  The Court heard oral argument on March 29, 2021.  

The Supreme Court Gave Courts Flexibility to Consider the Generic Nature of a Defendant’s Alleged Misstatement

In a majority opinion authored by Justice Barrett, vacating the Second Circuit’s holding and remanding, the Court unanimously determined that district courts may consider the generic nature of a defendant’s misstatement as indicating that the statement had no price impact.  Justice Barrett explained, “[i]n assessing price impact at class certification, courts should be open to all probative evidence on that question—qualitative as well as quantitative—aided by a good dose of common sense.”⁸ All nine members of the Court also agreed that such comprehensive consideration is particularly appropriate in the context of “inflation-maintenance” theory cases. In such cases, the Second Circuit had previously instructed courts to measure the front-end inflation of an alleged misstatement by referring almost exclusively to the back-end price impact of a purportedly corrective disclosure. The Second Circuit said, “if a court finds a disclosure caused a reduction in a defendant’s share price, it can infer that the price was inflated by the amount of the reduction.”⁹   

As Justice Barrett wrote, this inference that the “back-end price drop equals front-end inflation” can break down “when there is a mismatch between the contents of the misrepresentation and the corrective disclosures.”¹⁰ When such a mismatch occurs, “it is less likely that the specific disclosure actually corrected the generic misrepresentation, which means that there is less reason to infer front-end price inflation—that is, price impact—from the back-end price drop.”¹¹   

Given this ruling and the considerable change in positions of the parties between the certiorari petition briefing and oral argument on the merits, eight of the nine justices agreed that the best course of action was to vacate the decision below and remand for further consideration.¹² In particular, the Court noted that there was “sufficient doubt” to warrant a remand because it was not clear that the Second Circuit majority in the decision below had assumed that it could consider the generic nature of the alleged misstatements.¹³ Only Justice Sotomayor would have concluded that the Second Circuit’s reasoning was consistent with the Court’s and affirmed the Second Circuit’s decision.¹⁴   

The Supreme Court Confirmed—But Lightened—Defendants’ Burden of Persuasion

With respect to the second question certified, whether the plaintiff or a defendant bears the ultimate burden of persuasion on the application of the Basic presumption when a defendant has offered facially sufficient rebuttal evidence, six of the nine justices held that Rule 301 does not apply and that the Second Circuit correctly placed the burden of proving a lack of price impact on the defendants. The Court also observed that, as a practical matter, it “is unlikely to make much difference on the ground” because the “defendant’s burden of persuasion will have bite only when the court finds that the evidence [submitted by competing experts] is in equipoise—a situation that should rarely arise.”¹⁵   

The majority’s opinion nominally ruled against Defendants on the burden issue, but the Supreme Court’s description of that burden may prove much less onerous for defendants than the Second Circuit’s now-vacated standard. The Second Circuit had not only held that the defendants bore the burden of persuasion to disprove price impact, but also described that burden in an inflation-maintenance case as requiring defendants to “show by a preponderance of the evidence that the entire price decline on the corrective-disclosure dates was due to something other than the corrective disclosures.”¹⁶   

Although the Second Circuit did not expressly say so, this standard was tantamount to requiring defendants in inflation-maintenance cases to disprove loss causation at the class certification stage. Such a requirement would be contrary to the Supreme Court’s prior decisions in Halliburton, in which the Court ruled that: (1) plaintiffs need not prove loss causation in order to certify a class, (2) “loss causation is a familiar and distinct concept in securities law; it is not price impact,” and (3) defendants may defeat class certification by disproving price impact.¹⁷   

By vacating the Second Circuit’s decision, the Supreme Court maintained the defendants’ burden while making that burden somewhat easier to meet. Unlike the Second Circuit, the Supreme Court did not say that the defendant must disprove price impact solely by disaggregating the causes of the price decrease associated with a corrective disclosure.  Instead, Justice Barrett said that “[t]he defendant must ‘in fact’ ‘seve[r] the link’ between a misrepresentation and the price paid by the plaintiff.”¹⁸ The Court further explained that “[t]he district court’s task is simply to assess all the evidence of price impact—direct and indirect—and determine whether it is more likely than not that the alleged misrepresentations had a price impact.”¹⁹ The Supreme Court’s description of the defendant’s burden therefore takes the focus off the impact of a purported corrective disclosure and places the focus on the impact of the defendants’ alleged misstatement. This represents a significant victory for defendants in inflation-maintenance cases, who are no longer held to the extremely difficult burden of proving that none of a back-end price decrease relates to information discussed in a front-end misstatement.

Justice Gorsuch’s Decision Concurring in Part and Dissenting in Part

In an opinion joined by Justices Thomas and Alito, Justice Gorsuch would have given Defendants a total victory and held that, once a defendant meets its initial burden of production to show a lack of price impact, the plaintiff must bear the ultimate burden of persuasion to establish that the Basic presumption applies. In Justice Gorsuch’s view, nothing in Basic or the Court’s subsequent decisions required the Court to deviate from Rule 301’s “normal order of operations” for the allocation of burdens for evidentiary presumptions in civil cases.²⁰ Justice Gorsuch also aggressively criticized the majority’s comment that the burden will “rarely” be significant, writing that: “The whole reason we allocate the burden of persuasion is to resolve close cases by providing a tie breaker where the burden does make a difference.”²¹  

Conclusion

The Court’s key holding that lower courts must consider all potentially relevant evidence on a motion for class certification, regardless of whether particular facts typically relate to the merits, is likely to be an important tool for defendants in securities class actions. In particular, defendants in litigation concerning generic disclosures about business ethics or environmental, social and governance issues on an “inflation-maintenance” theory should carefully consider whether there may have been a “mismatch” between the alleged misrepresentation and the alleged “corrective disclosure,” as the Justices unanimously agreed that, holding all else equal, defendants are more likely to succeed in their efforts to rebut the Basic presumption.

Footnotes

1) Goldman Sachs Grp., Inc. v. Arkansas Teacher Ret. Sys., No. 20-222, U.S. 2021 WL 2519035 (U.S. June 21, 2021).  

2) Richman v. Goldman Sachs Grp., Inc., 868 F. Supp. 2d 261, 276, 280 (S.D.N.Y. 2012).   

3) In re Goldman Sachs Grp., Inc. Sec. Litig., No. 10-cv-03461, 2015 WL 5613150, at *7 (S.D.N.Y. Sept. 24, 2015).   

4) ATRS v. Goldman Sachs Grp., Inc., 879 F.3d 474, 486 (2d Cir. 2018) (emphasis added).   

5) See In re Goldman Sachs Grp., Inc. Secs. Litig., No. 10-cv-03461, 2018 WL 3854757, at *4 (S.D.N.Y. Aug. 14, 2018); see also In re Vivendi, S.A. Sec. Litig., 838 F.3d 223, 257 (2d Cir. 2016).   

6) ATRS v. Goldman Sachs Grp., Inc., 955 F.3d 254, 267 (2d Cir. 2020).  

7) 955 F.3d at 278 (Sullivan, J., dissenting).   

8) Goldman Sachs Grp., Inc. v. ATRS, 2021 WL 2519035, at *5 (quotations omitted, emphasis in original).   

9) 955 F.3d at 265. 

10) 2021 WL 2519035, at *6.   

11) Id.   

12) Id. at *6.   

13) Id.   

14) 2021 WL 2519035, at *8 (Sotomayor, J., concurring in part and dissenting in part).   

15) 2021 WL 2519035, at *7.   

16) 955 F.3d at 271 (emphasis added).

17) Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804, 813, 814 (2011); Halliburton II, 573 U.S. 258, 279 (2014).  

18) 2021 WL 2519035, at *7 (second alteration in original).   

19) Id.   

20) 2021 WL 2519035, at *11 (Gorsuch, J., concurring in part and dissenting in part).   

21) Id. at *13.