On August 10, 2023, the Second Circuit Court of Appeals granted an emphatic victory to Goldman Sachs, Inc. in its long-running battle to snuff a securities fraud class action arising from conflicts of interest related to collateralized debt obligations (CDOs) when the Court ordered the investor class decertified in its third ruling on the issue.[1]
The underlying class action arose in the wake of an enforcement action by the U.S. Securities and Exchange Commission (SEC) against Goldman Sachs and an employee alleging securities fraud in the marketing and sale of the Abacus 2007 AC-1 CDO and the extensive media coverage of the charges.[2] The investigation and reporting ultimately revealed that Goldman Sachs surreptitiously allowed hedge fund Paulson & Co. to select Abacus’ assets, and then misrepresented Paulson’s short interest in the CDO,[4] leading to a $550 million settlement with the SEC.[3]
The purported investor class alleges damages of more than $13 billion due to the ensuing declines in Goldman Sachs’ stock price during the class period,[5] shown below:
Chart: Bloomberg L.P.
The issue before the Court of Appeals here was the District Court’s application of the Supreme Court’s recent guidance[6] on the long-standing use of the “fraud-on-the-market” theory, the principle that “stock trading on theoretically efficient markets like the New York Stock Exchange or Nasdaq incorporates all public, material information, including material misrepresentations, into its share price”[7] first reviewed in Basic Inc. v. Levinson.[8]
Specifically, the Supreme Court in Goldman ruled that, at the class certification stage, “class-action plaintiffs must prove [certain] Basic prerequisites before class certification,” which includes demonstrating an impact on share price of the revealed false or misleading statements, subject to defendants’ efforts to rebut such a showing.[9]
Reviewing the District Court’s most recent grant of class certification based on the reasoning that “Defendants have failed to establish a lack of price impact by a preponderance of the evidence,”[10] the Second Circuit focused on the Supreme Court’s explanation regarding the fraud-on-the-market theory when a plaintiff alleges a specific disclosure that corrects a generic prior statement:
[The] inference—that the back-end price drop equals front-end inflation—starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure. … [I]t is less likely that [a] specific disclosure actually corrected [a] generic misrepresentation, which means that there is less reason to infer front-end price inflation.”[11]
Despite recognizing the high “abuse of discretion” standard for appellate review,[12] the Second Circuit concluded that the District Court clearly erred in both: (1) “assessing the generic nature of business principles statements”[13]; and (2) its “application of the inflation-maintenance theory.”[14]
The Second Circuit determined that the defendants “managed to sever the link between back-end price drop and front-end misrepresentation,”[15] by among other things, introducing wide-ranging expert analyses of:
“880 analyst reports published during the Class Period (both before and after the filing of the Abacus Complaint), none of which reference the conflicts disclosure,”[16]
an event study that analyzed “36 dates—all prior to the corrective disclosure dates—on which media outlets discussed … Goldman's ability to manage conflicts of interest,”[17] and
“a group of 117 enforcement events bearing similar qualities, whose announcements to the market resulted in significant drops in those companies’ stock prices” purporting to show that “the price drop in April 2010 was caused entirely by the news of the enforcement action itself, rather than the revelation of Goldman's client conflicts.”[18]
Ruling that “[t]he district court clearly erred in concluding otherwise, and therefore abused its discretion in certifying the shareholder class,” the panel majority, in response to Judge Sullivan’s concurrence, also predicted that “Someday the Supreme Court will revisit the issue.”[19]
In light of the Second Circuit’s unambiguous remand “with instructions to decertify the class,”[20] the Supreme Court may be afforded that opportunity shortly. Plaintiffs have until November 8, 2023 to petition the Supreme Court for a writ of certiorari to review the ruling.[21]
The case is Arkansas Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., Dkt. No. 22-00484 (2d Cir. Mar. 9, 2022).
***
[1] Arkansas Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., No. 22-484, — F.4th —, 2023 WL 5112157, at *2 (2d Cir. Aug. 10, 2023) (“ATRS III”).
[2] In re Goldman Sachs Grp., Inc. Sec. Litig., 2015 WL 5613150 (S.D.N.Y. Sep 24, 2015).
[3] See, e.g., SEC Press Release 2010-123, Goldman Sachs to Pay Record $550 Million to Settle SEC Charges Related to Subprime Mortgage CDO (July 15, 2010),available at https://www.sec.gov/news/press/2010/2010-123.htm.
[4] ATRS III at *4-5.
[5] Id. at *5.
[6] Goldman Sachs Grp., Inc. v. Arkansas Tchr. Ret. Sys., — U.S. —, 141 S. Ct. 1951, 210 L. Ed. 2d 347 (2021) (“Goldman”).
[7] ATRS III at *6 (citing in Basic Inc. v. Levinson, 485 U.S. 224 at 246 (1988)).
[8] 485 U.S. 224 at 250 (1988).
[9] Goldman, 141 S. Ct. at 1959.
[10] In re Goldman Sachs Grp., Inc. Sec. Litig., 579 F. Supp. 3d 520, 538 (S.D.N.Y. 2021), rev'd sub nom. Arkansas Tchr. Ret. Sys. v. Goldman Sachs Grp., Inc., No. 22-484, 2023 WL 5112157 (2d Cir. Aug. 10, 2023).
[11] Goldman, 141 S. Ct. at 1961.
[12] ATRS III at *11.
[13] ATRS III at *13.
[14] ATRS III at *16.
[15] ATRS III at *24.
[16] Id.
[17] Id. at *7.
[18] Id.
[19] Id. at *24.
[20] Id.
[21] 28 U.S.C. §§ 1254, 2101(c).
