On February 27, 2013, the U.S. Supreme Court addressed a long-standing circuit split on the issue of whether, when bringing a securities fraud class action under Section 10(b) of the Securities Exchange Act of 1934, a plaintiff must prove that the defendant's alleged misrepresentations are material at the class certification stage and whether a lack of materiality can be used by the defendant to rebut the "fraud-on-the-market" presumption of reliance.
The "fraud-on-the-market" theory was endorsed by the Supreme Court in Basic Inc. v. Levinson, 485 US 224 (1988), and is based on the premise that "certain well developed markets are efficient processors of public information [and that in] such markets, the market price of shares will reflec[t] all publicly available information." The court also held in Basic that if a market is shown to be efficient, courts may presume that investors who invest in that market "indirectly rely on public, material misrepresentations through their reliance on the integrity of the price set by the market." This presumption, however, can be rebutted by "appropriate evidence." After the Basic decision, a circuit split developed whereby the First, Second, and Fifth Circuits ruled that plaintiffs must prove, and defendants may rebut, materiality before class certification. The Third Circuit developed a modification that did not require that a plaintiff needs to prove materiality prior to class certification, but did allow a defendant to present rebuttal evidence on that issue. By contrast, the Seventh and Ninth Circuits held that courts could not consider materiality at the class certification stage.
According to the plaintiff, the defendant violated §10(b) and Rule 10b-5 by making misrepresentations and misleading omissions regarding the safety, efficacy and marketing of two of its flagship drugs, which resulted in an artificially inflated stock price at the time the plaintiff purchased the stock. Thus, according to the plaintiff, when the truth came to light, the defendant's stock price declined, resulting in financial losses for the plaintiff and others who had purchased the stock during the relevant time period. The district court certified the class and the Ninth Circuit Court of Appeals affirmed. The defendant argued that the District Court erred by failing to require the plaintiff to allege that the misrepresentations and omissions were material, and by refusing to consider the rebuttal evidence it had proffered in opposition to the plaintiff's class-certification motion.
The court began its analysis by noting that the only issue before it was whether the plaintiff satisfied Rule 23(b)(3)'s requirement that "of law or fact common to class members predominate over any questions affecting only individual members." Although the class-certification analysis must be "rigorous," Rule 23 "grants courts no license to engage in free-ranging merits inquiries at the certification stage." Recognizing, as the defendant suggested, that materiality is indisputably an essential predicate of the fraud-on-the-market theory, the court held that the fundamental question was actually whether proof of materiality is needed to ensure the "questions of law or fact common to the class will predominate over any questions affecting only individual members as the litigation progresses." The court held that, first, the question of materiality "is an objective one, involving the significance of an omitted or misrepresented fact to a reasonable investor [and therefore] is a common question for purposes of Rule 23(b)(3)." Second, the court held that there was "no risk whatever that a failure of proof on the common question of materiality will result in individual questions predominating[,]" because the failure of proof on materiality would "end the case for once and for all; no claim would remain in which individual reliance issues could potentially predominate." Thus, the court concluded that the failure to prove materiality "is properly addressed at trial or in a ruling on a summary-judgment motion."
The court rejected the defendant's argument that materiality should be treated no differently than the other fraud-on-the-market prerequisites, including "that the alleged misrepresentations were publicly known ..., that the stock traded in an efficient market, and that the relevant transaction took place between the time the misrepresentations were made and the time the truth was revealed." This was because, unlike materiality, market efficiency and publicity of the alleged misrepresentations "are not indispensable elements of a Rule 10b-5 claim." If class-wide proof failed on those points, individual plaintiffs could attempt to establish reliance through the "traditional" mode by demonstrating personal awareness of the defendant's statement and a relevant transaction based on that specific misrepresentation. A failure of proof on materiality, by contrast, establishes as a matter of law that a plaintiff cannot prevail on the merits of a Rule 10b-5 claim. The defendant also argued that "policy considerations" militated in favor of requiring precertification proof of materiality because certification "can exert substantial pressure on a defendant to settle rather than incur the costs of defendant a class action and run the risk of potentially ruinous liability." The court found that in this sense materiality was no different than other essential elements of a Rule 10b-5 claim, such as loss causation and the falsity or misleading nature of a defendant's alleged statement or omission, and that Congress failed to undo the fraud-on-the-market presumption in either the Private Securities Litigation Reform Act or the Securities Litigation Uniform Standards Act. Finally, the court rejected the defendant's argument that concerns for judicial economy were unwarranted, because "requiring proof of materiality before class certification would ... necessitate a mini-trial on the issue ... at the class certification stage."
Turning to the argument that the District Court erred by failing to consider the rebuttal evidence offered by the defendant, the court quickly dismissed this argument largely for the same reasons discussed above, noting that the rebuttal evidence aimed to prove that the misrepresentations and omissions alleged in the plaintiff's complaint were immaterial. The court once again reiterated that if the alleged misrepresentations and omissions are ultimately found immaterial, the fraud-on-the-market presumption of class-wide reliance would collapse, bringing the litigation to a close. The court recognized that a defendant can rebut the fraud-on-the-market presumption of reliance by demonstrating that "news of the [truth] credibly entered the market and dissipated the effects of [prior] misstatements," but that "proof of that sort is a matter for trial."
Thus, the court's decision eliminates a defendant's ability to challenge the fraud-on-the-market presumption of reliance on materiality grounds at the pre-certification stage. However, it is important to note that both majority and dissenting justices seemed to agree that the court "ha[d] not been asked to revisit Basic's fraud-on-the-market presumption" itself. The concurring opinion of Justice Alito went so far as to state that "[a]s the dissent observes, more recent evidence suggests that the [fraud-on-the-market] presumption may rest on a faulty economic premise," and that "[i]n light of this development, reconsideration of the Basic presumption may be appropriate." Therefore, although the Amgen decision will allow plaintiffs to more easily certify securities fraud class actions going forward, it is possible that the U.S. Supreme Court may be willing to revisit the fraud-on-the-market presumption entirely at a later date.