Stinson - Corporate & Securities Law Blog

The Supreme Court issued its decision in Goldman Sachs Group, Inc., et al. v. Arkansas Teacher Retirement System, et al. The case analyzes what the Defendants considered were generic statements that did not have a price impact.  The case is important because it addresses when a securities fraud case can be certified as a class action. Once class certification is granted, the settlement value of a case increases.

Plaintiffs alleged that Goldman maintained an artificially inflated stock price by making generic statements about its ability to manage conflicts—for example, “We have extensive procedures and controls that are designed to identify and address conflicts of interest.”  Plaintiffs claimed that Goldman’s generic statements were false or misleading in light of several undisclosed conflicts of interest, and that once the truth about Goldman’s conflicts came out, Goldman’s stock price dropped and shareholders suffered losses.

Here, the Plaintiffs sought to certify a class of Goldman shareholders by invoking the presumption endorsed by the Supreme Court in Basic Inc. v. Levinson.  The Basic presumption is premised on the theory that investors rely on the market price of a company’s security, which in an efficient market incorporates all of the company’s public misrepresentations.

To invoke the Basic presumption, a plaintiff must prove:

  • that the alleged misrepresentation was publicly known;
  • that it was material;
  • that the stock traded in an efficient market; and
  • that the plaintiff traded the stock between the time the misrepresentation was made and when the truth was revealed.

The Basic presumption allows class-action plaintiffs to prove reliance through evidence common to the class. That in turn makes it easier for plaintiffs to establish the predominance requirement of Federal Rule of Civil Procedure 23, which requires that “questions of law or fact common to class members predominate” over individualized issues.

As a result, class-action plaintiffs must prove the Basic prerequisites before class certification—with one exception. In Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, the Supreme Court held that materiality should be left to the merits stage because it does not bear on Rule 23’s predominance requirement.

Satisfying those prerequisites, however, does not guarantee class certification. Defendants may rebut the Basic presumption at class certification by showing that an alleged misrepresentation did not actually affect the market price of the stock. If a misrepresentation had no price impact, then Basic’s fundamental premise “completely collapses, rendering class certification inappropriate.”

On appeal Goldman argued the Second Circuit erred twice:

  • first, by holding that the generic nature of its alleged misrepresentations is irrelevant to the price impact inquiry at the class certification stage; and
  • second, by assigning Goldman the burden of persuasion to prove a lack of price impact.

The Supreme Court noted as to the first question—whether the generic nature of a misrepresentation is relevant to price impact—the parties’ dispute had largely evaporated. Plaintiffs conceded that the generic nature of an alleged misrepresentation often will be important evidence of price impact because, as a rule of thumb, a more-general statement will affect a security’s price less than a more-specific statement on the same question.

The Supreme Court concurred in the parties’ view. The Supreme Court stated in 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.”

The Supreme Court noted the generic nature of a misrepresentation often will be important evidence of a lack of price impact, particularly in cases proceeding under the inflation-maintenance theory. Under that theory, price impact is the amount of price inflation maintained by an alleged misrepresentation—in other words, the amount that the stock’s price would have fallen “without the false statement.” Plaintiffs typically try to prove the amount of inflation indirectly: They point to a negative disclosure about a company and an associated drop in its stock price; allege that the disclosure corrected an earlier misrepresentation; and then claim that the price drop is equal to the amount of inflation maintained by the earlier misrepresentation.

But that final inference, according to the Supreme Court—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. That may occur when the earlier misrepresentation is generic (e.g., “we have faith in our business model”) and the later corrective disclosure is specific (e.g., “our fourth quarter earnings did not meet expectations”). Under those circumstances, 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.

However, the parties did disagree about whether the Second Circuit properly considered the generic nature of Goldman’s alleged misrepresentations. The Supreme Court remanded the case because the Second Circuit’s opinions left the Supreme Court with sufficient doubt on this score.  The Supreme Court directed the Second Circuit to take into account all record evidence relevant to price impact, regardless whether that evidence overlaps with materiality or any other merits issue.

On the second question before the Supreme Court Goldman argued that the Second Circuit erred by requiring Goldman, rather than Plaintiffs, to bear the burden of persuasion on price impact at class certification.  The Supreme Court rejected Goldman’s argument that the Federal Rules of Evidence placed the burden on Plaintiffs, noting that the burden of persuasion under Basic was a settled question.

×