Continuing its recent trend of handing down plaintiff-friendly decisions in private securities class actions brought under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and SEC Rule 10b-5 (Rule 10b-5 actions), the U.S. Supreme Court held in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, No. 11-1085, 568 U.S. ___, slip op. (U.S. Feb. 27, 2013), that plaintiffs need not prove materiality as a prerequisite to class certification. Justice Ruth Bader Ginsburg, writing for the majority, resolved a circuit split over whether, at the class certification stage, a plaintiff must prove materiality to satisfy the predominance requirement of Federal Rule of Civil Procedure 23(b)(3), and whether defendants may present evidence rebutting the element of materiality. The Supreme Court held (1) that proof of materiality is not a prerequisite to class certification because Rule 23(b)(3) only requires a showing that questions predominate, not that the question will be answered in the class’ favor, and (2) that the district court did not err in failing to consider Amgen’s rebuttal evidence as to the materiality of the alleged misrepresentations and omissions. Slip op. at 2, 25. (The Court’s opinion is available at http://www.supremecourt.gov/opinions/12pdf/11-1085_9o6b.pdf.)
Plaintiff Connecticut Retirement Plans and Trust Funds (Connecticut Retirement) brought a securities fraud claim against Amgen Inc., a biotechnology company, and several of its officers, for allegedly making material misrepresentations and omissions relating to the safety, efficacy, and marketing of two of Amgen’s flagship drugs. Id. at 6. The district court certified a class of all investors who purchased Amgen stock between the date of the first alleged misrepresentation and the date of the last corrective disclosure, without requiring Connecticut Retirement to prove materiality or allowing Amgen to present evidence rebutting the materiality of the misrepresentations and omissions. Id. at 7. The Ninth Circuit affirmed. In its appeal to the Supreme Court, Amgen argued that the district court and the Ninth Circuit erred in certifying the class because, according to Amgen, materiality was a prerequisite to establish the fraud-on-the-market theory that Connecticut Retirement used at the class certification stage to establish that common questions of reliance predominate over individualized issues of reliance.
In addressing Amgen’s appeal, the Supreme Court confronted the intersection of Rule 23(b)(3)’s class action requirements and the elements necessary to prove a claim for securities fraud under Rule 10b-5. To certify a class for money damages under Rule 23(b)(3), a plaintiff must satisfy Rule 23(a)’s prerequisites of numerosity, commonality, typicality, and adequacy of representation, and also establish that “‘the questions of law or fact common to class members predominate over any questions affecting only individual members.’” Slip. op. at 3. To recover damages in a Rule 10b-5 action, a plaintiff must prove “‘(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation.’” Id. at 3-4 (citation omitted).
The essential element of reliance in a Rule 10b-5 action ensures that there is a proper connection between the defendant’s alleged misrepresentation and the plaintiff’s alleged injury. Id. at 3. Because individualized proof of reliance would be a difficult evidentiary burden for a plaintiff to prove, the Supreme Court in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), adopted the “fraud-on-the-market theory.” Under this theory, “[i]f a market is generally efficient in incorporating publicly available information into a security’s market price, it is reasonable to presume that a particular public, material misrepresentation will be reflected in the security’s price” and, therefore, a court may presume that investors who traded in that security did so in reliance on the misrepresentation. Slip op. at 5. In Amgen, the Court explained that, without this presumption of reliance (which is rebuttable), individualized issues of reliance would “overwhelm questions common to the class.” Id. at 5-6.
Amgen argued that, in order to establish classwide reliance at the class certification stage, a plaintiff must prove the element of materiality as a prerequisite to the fraud-on-the-market theory. The Supreme Court rejected this argument, explaining that, although materiality is an essential element of the fraud-on-the-market theory, the “pivotal” inquiry at the class certification stage 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.” Id. at 10 (emphasis added, quoting Fed. R. Civ. P. 23(b)(3)). The Court answered this question in the negative: First, materiality is judged by an objective standard and can be proved through evidence common to all class members; therefore, the question of materiality is a common question for all class members. Id. at 11. Second, materiality as a common issue predominates over individual issues of reliance because failure of proof on the issue of materiality will end the case for all class members. Id.
Amgen also argued that, because the Court has already held that three other prerequisites for application of the fraud-on-the-market theory – the public nature of the alleged misrepresentations, market efficiency, and the occurrence of the relevant stock transaction between the time of the alleged misrepresentations and the time the truth was revealed – must be proven before a class can be certified, the Court should also require proof of materiality at the class certification stage. Dismissing this argument, the Court explained that the timing of the stock transaction is relevant at the class certification stage because it goes to Rule 23(a)’s typicality and adequacy of representation requirements, not the predominance requirement. Slip op. at 15. Furthermore, unlike materiality, the public nature of the misrepresentations and the efficiency of the market are not indispensable elements of a Rule 10b-5 claim and, therefore, failure of proof on these two issues may result in individualized proof of reliance. Id. at 16-17.
The Court rejected Amgen’s public policy reasons as well. First, Amgen argued that if plaintiffs were not required to prove materiality at the class certification stage, defendants would be more likely to settle once a case was certified. The Court found this argument unpersuasive in part because the Private Securities Litigation Reform Act of 1995 already addressed the issue of settlement pressure and created certain protections including a heightened pleading standard. Slip op. at 18-20. The Court also rebuffed Amgen’s contention that requiring proof of materiality at the class certification stage would conserve judicial resources. Id. at 21. The Court explained that requiring proof of materiality at the class certification stage would have the opposite effect because courts would be forced to conduct mini-trials on the issue of materiality at the class certification stage. Id.
Lastly, the Court held that the district court did not err in failing to consider Amgen’s rebuttal evidence at the class certification stage because the evidence related to whether the alleged misrepresentation and omissions were material, which was solely a merits issue to be decided on summary judgment or at trial. Id. at 24-26.
The Court’s decision in Amgen has serious implications for defendants. In particular, as Amgen asserted in its briefing, the ease of certifying a class based on classwide reliance may cause defendants to settle a case before it reaches the class certification stage so as to avoid the time and expense of a class action lawsuit.