The United States Supreme Court has taken a keen interest in the securities arena this current term, agreeing to hear at least three cases (of only approximately 70 in total). This week, the Supreme Court announced decisions in two securities cases – one involving class certification in private actions, and the other involving the statute of limitations for enforcement claims by the Securities & Exchange Commission. The Supreme Court also recently agreed to hear another case seeking to impose further restrictions on securities class actions.
Materiality at the Class Certification Stage
Amgen Inc. v. Connecticut Retirement Plans & Trust Funds addressed the standard for class certification in securities actions. Last term, in Wal-Mart Stores, Inc. v. Dukes, the Supreme Court indicated that the underlying merits of a case may be considered at the class certification stage. Now in Amgen, the Supreme Court refused to extend that reasoning to securities class actions involving the fraud-on-the-market theory of reliance.
At the trial level, the named plaintiffs alleged that common issues predominated among the proposed class because of the fraud-on-the-market presumption of reliance on public, material misrepresentations. The defendants countered that the presumption depends on the materiality of the alleged misrepresentations and, therefore, the court must take up the issue of materiality at the class certification stage. In its opinion issued this week, the Supreme Court rejected the defendants' attempt to accelerate materiality to the class certification stage because materiality is evaluated under an objective standard common to the class, and is an essential element of a securities fraud claim common to the class.
The Court also rejected the defendants' policy arguments to curtail the "strike suit" nature of securities fraud class actions. The Court relied on what Congress had (and had not) already done to address these concerns in the Private Securities Litigation Reform Act of 1995 (PSLRA). Of particular note, Congress rejected overt attempts to undo the fraud-on-the-market presumption when drafting the PSLRA. The Court saw no reason "for the judiciary to make its own further adjustments" when Congress already had legislated in response to these very concerns. Indeed, by espousing private securities actions as "an essential supplement to criminal prosecutions and civil enforcement actions," the Court insinuated that it would not independently contribute to the wave of restrictions on securities fraud class actions.
Limitations on Regulatory Enforcement Actions
Gabelli v. Securities & Exchange Commission, another case decided this week, interpreted the five-year time period in which the Securities & Exchange Commission (SEC) can seek civil penalties in enforcement actions.
Under a catch-all limitations period, SEC enforcement actions seeking civil penalties must be “commenced within five years from the date when the claim first accrued[.]” 28 U.S.C. § 2462. In the underlying case, the SEC filed an enforcement action more than five years after the wrongdoing, but within five years of when the wrongdoing was apparently discovered by the SEC. The question was thus whether accrual under Section 2462 occurs upon the occurrence of the wrongdoing or, as in other fraud contexts, its discovery. In an unanimous ruling, the Supreme Court refused to graft the discovery rule onto Section 2462, and held that "the five-year clock begins to tick when the fraud is complete."
The key distinction driving the opinion is that the SEC is a "prosecutor seeking penalties," not an injured victim itself. First, the Court found that the discovery rule, as an exception to statutes of limitations, exists primarily to protect victims that would have no reason to suspect fraud. On the other hand, the SEC has a "central mission" to root out fraud and "has many legal tools at hand to aid in that pursuit." Second, the different types of relief warrant different time limits. Whereas a private fraud victim seeks compensation, the SEC seeks penalties that intend to punish and publicly label defendants as wrongdoers. Third, there are practical difficulties in applying the discovery rule to regulators, including the definition of the relevant actor, judgment calls on agency resource constraints, and invocation of special evidentiary privileges.
The Court's ruling could have ramifications far beyond the securities context, given the fact that Section 2462 applies to other agencies. Any time a government agency seeks fines, penalties or forfeiture in its enforcement (as opposed to victim) capacity, absent another statutory mandate, the agency must take action within five years of the act itself regardless of its discoverability.
The "Connection" Requirement for Class Action Preemption
Chadbourne & Parke v. Troice, Willis of Colorado v. Troice, and Proskauer Rose v. Troice are consolidated cases that will address the Securities Litigation Uniform Standards Act (SLUSA), which was enacted in 1998 to curb the increase in filing of class action securities cases in state court to avoid the strictures of the PSLRA. Specifically, SLUSA precludes any "covered class action" based on state law that alleged a misrepresentation or omission of material fact "in connection with" the purchase or sale of a "covered security." The federal circuit courts had split in their interpretation of the "connection" requirement in this provision. Just last month, the Supreme Court granted certiorari in these consolidated cases to resolve this conflict.
In the underlying cases, the Fifth Circuit addressed whether the actions were precluded under SLUSA as ones alleging fraud "in connection with" a covered security. The court noted the split among at least six circuit courts, which have adopted standards ranging from fraud allegations that “necessarily involve” (Second Circuit), “depend on” (Sixth Circuit), "more than but for" (Seventh Circuit), "relate to" (Eighth Circuit), are “more than tangentially related to" (Ninth Circuit) or “are induced by” (Eleventh Circuit), transactions in covered securities. The Fifth Circuit sided with the Ninth Circuit's "tangentially related" test, applied that test to the specific facts, held that there was no preclusion under SLUSA, and remanded the actions to state court.
The Supreme Court has agreed to resolve this wide conflict among the circuit courts. Although the ultimate determination of "connection" is heavily fact-specific and the circuit conflict may be largely semantic, at least the Supreme Court is expected to clarify what standard is to be applied for SLUSA preemption.