On January 12, 2018, the United States Court of Appeals for the Second Circuit vacated a district court order certifying a securities fraud class action brought by purchasers of common stock in The Goldman Sachs Group, Inc. (“Goldman” or the “Company”).  Arkansas Teachers Ret. Sys. v. Goldman Sachs, No. 16-250 (Jan. 12, 2018).  The district court certified the class, ruling that defendants failed to rebut the presumption of reliance first articulated in Basic Inc. v. Levinson, 485 U.S. 224 (1988) because defendants did not “conclusively” prove a “complete absence of price impact.”  On appeal, the Second Circuit ruled that, consistent with its precedent, defendants seeking to rebut the Basic presumption of reliance must do so by a preponderance of the evidence.  Because it was unclear if the district court applied a more demanding standard than preponderance of the evidence, the Second Circuit vacated the district court’s decision and remanded it to consider the defendants’ evidence under the proper standard.

In a consolidated class action complaint, plaintiffs alleged that the Company and several directors made material misstatements about their efforts to avoid conflicts of interest in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)-5 promulgated thereunder.  Plaintiffs claimed that the statements about efforts to avoid conflicts of interest were false and misleading because the Company allegedly acted in direct conflict with the interests of its client in at least four collateralized debt obligations (“CDO”) transactions involving subprime mortgages.  Plaintiffs alleged that news of government enforcement actions against the Company related to the CDOs revealed the falsity of defendants’ statements and caused the Company’s share price to decline.  Specifically, plaintiffs claimed that through these news reports the market learned for the first time that the Company had allegedly created “clear conflicts of interest with its own clients” by “intentionally packaging and selling securities that were designed to fail, while at the same time reaping billions for itself or its favored client by taking massive short positions” in the same transactions. 

In support of its motion for class certification, plaintiffs argued that they satisfied Rule 23(b)(3) because common issues of law or fact predominated over issues affecting only individual members of the class.  To establish the predominance requirement with respect to the element of reliance, plaintiffs argued that, under Basic, they were entitled to a presumption that all class members relied on defendants’ misstatements in choosing to buy the Company’s stock.  Defendants attempted to rebut the Basic presumption by presenting evidence in the form of declarations and sworn affidavits that the Company’s stock experienced no price increase on the dates the alleged misstatements were made, and no price decrease on 34 occasions when the press reported the Company’s alleged conflicts of interest in the CDOs.  The district court rejected defendants’ arguments and certified the class.  In so holding, the district court ruled that defendants failed to rebut the Basic presumption because they “did not provide conclusive evidence that no link exists between the price decline [of the Company’s stock] and the misrepresentations.”

In vacating the district court order and remanding for further consideration, the Second Circuit relied on its 2017 decision in Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017) in which the Court held that, in seeking to rebut the Basic presumption of reliance, defendants have the burden of persuasion and must rebut the presumption by a preponderance of the evidence.  Although the district court acknowledged the Barclays standard in a footnote, it ruled that defendants failed to rebut the Basic presumption because they did not “conclusively” prove a “complete absence of price impact.”  Because it was unclear whether the district court required more of defendants than a preponderance of the evidence, the Second Circuit vacated the district court’s order and remanded it for reconsideration of defendants’ evidence in light of the Barclays standard.

Finally, the Second Circuit provided guidance to the district court on how to consider defendants’ evidence on remand.  The Second Circuit noted that the district court had improperly construed defendants’ evidence as “an inappropriate truth on the market defense,” or as evidence of the statements’ lack of materiality, neither of which the district court thought it could consider at the class certification stage.  The Second Circuit stated that the district court’s view of defendants’ evidence was erroneous and that, on remand, the district court should evaluate the evidence to determine whether defendants established by a preponderance of the evidence that the misrepresentations did not in fact affect the market price of the Company’ stock