Yesterday, the Supreme Court issued its highly anticipated ruling in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System, holding that the generic nature of an alleged misrepresentation may be important evidence of price impact to rebut the Basic presumption of reliance and thus should be considered at class certification.
The decision provides defendants facing securities fraud class actions – particularly so-called “inflation maintenance” cases – with an important tool to defeat class certification.
The Basic presumption, price impact, and generic statements
Securities fraud requires a plaintiff to show reliance to prevail on her claim. In private securities fraud actions, however, plaintiffs frequently invoke the “Basic presumption,” stemming from the Supreme Court’s decision in Basic Inc. v. Levinson.
The presumption follows from the theory that a security’s market price reflects all available information about the security, including any statements made by the issuing company. Accordingly, a plaintiff in a private securities fraud action need not prove individual reliance. Instead, she can invoke the presumption by proving that: (1) the alleged misrepresentation was publicly made; (2) the misrepresentation was material; (3) the stock traded in an efficient market; and (4) the plaintiff traded in the stock between the time when the misrepresentation was made and the truth revealed.
This “fraud on the market” tool is a powerful one for securities fraud plaintiffs bringing class action suits. Ordinarily, reliance would be impossible to prove on a classwide basis given the inherently individualized question of what information a plaintiff relied on when purchasing a security; the Basic presumption allows plaintiffs to avoid having to show individual, investor-by-investor reliance.
The presumption is rebuttable. For example, it can be overcome by showing that an alleged misrepresentation did not actually affect the market price of the stock. Absent “price impact,” the Basic presumption collapses.
But overcoming the presumption has proven uniquely difficult in securities fraud class actions because courts traditionally hold that an inquiry into whether the misrepresentation was “material”—an element of the Basic presumption—must be reserved for the merits phase of the case and cannot be evaluated at class certification. Because “materiality” and “price impact” are closely intertwined—a statement that is immaterial has no price impact—defendants have had a hard time convincing courts to consider evidence that an alleged misrepresentation did not impact stock price at class certification.
Goldman Sachs Group arose from this backdrop and followed a similar pattern. Plaintiffs alleged that Goldman Sachs made misrepresentations regarding an alleged conflict-of-interest related to the sale of collateralized debt obligations. The alleged misrepresentations consisted of statements in Goldman Sachs’s SEC filings regarding its commitment to integrity and its clients. Plaintiffs alleged that when the misrepresentations were revealed to be false, Goldman Sachs’s stock price dropped accordingly. In other words, Plaintiffs alleged the misrepresentations kept Goldman Sachs’s stock price artificially inflated and that the subsequent stock price drop demonstrated the impact of these statements – a theory of “inflation maintenance” that has become increasingly prevalent in securities fraud class actions.
At class certification, Goldman Sachs offered substantial evidence, including expert evidence, that the alleged misrepresentations were too generic to have affected its stock price. The district court nevertheless certified a class of investors and the Second Circuit affirmed, but did not make clear whether it accounted for the generic nature of Goldman Sachs’ statements in determining that class certification was appropriate.
The Supreme Court’s ruling bolsters defense arguments at class certification that courts must scrutinize whether the statements at issue are too generic to impact a security’s price
The Supreme Court vacated the Second Circuit’s judgment and remanded for further proceedings. Justice Amy Coney Barrett’s majority opinion solidifies the argument 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.”
Importantly, the Supreme Court held, “the Second Circuit must take into account all record evidence relevant to price impact, regardless whether that evidence overlaps with materiality [another element of securities fraud] or any other merits issue.”
The Court recognized that materiality and price impact are overlapping concepts, but drew on In Re Allstate, Comcast, and Walmart to conclude the court can consider evidence regarding price impact even though it also touches on materiality. Thus, if a defendant can prove by a preponderance of the evidence at class certification that the alleged misrepresentation had no impact on stock price, then the Basic presumption is rebutted and a class cannot be certified.
The Goldman Sachs decision thus adds an important new arrow into defendants’ quiver at class certification in securities fraud cases. Where a defendant can show that an alleged misrepresentation was so generic that it had no impact on stock price, the Basic presumption can be rebutted at class certification. Defendants may introduce evidence showing lack of price impact, and plaintiffs can no longer argue that the court should refrain from considering this evidence because the closely related question of whether a statement is material is off-limits until the merits phase of the case. The result may be denial of certification in a broad range of cases premised on generic statements in “inflation maintenance” cases, saving defendants hundreds of thousands of dollars in merits discovery and avoiding the “hydraulic pressure” to settle that usually accompanies a grant of class certification.
What other securities violations might plaintiffs assert based on generic statements?
Plaintiffs asserting securities fraud based on generic statements may not be entirely out of luck, however. For example, there have recently been a host of derivative lawsuits filed by investors alleging false and misleading statements under Section 14(a) of the Securities and Exchange Act, where those statements were related to the company’s commitment to diversity and inclusion. These statements include representations like:
- “Amid this age of digital transformation, we believe inclusion, diversity, and collaboration make us more innovative, more agile, and ultimately more successful. This commitment starts at the top.”
- “Diversity, inclusion, collaboration, and technology are fundamental to who we are, how we create the best teams, and how we will succeed in this age of digital transformation.”
- “We further innovation and accelerate progress by fostering a diverse workforce.”
- “We’re measuring and tracking our progress to ensure that our programs and policies around inclusion and diversity are having a tangible effect.”
Compare these statements to those that form the basis for Plaintiff’s 10(b) claims in Goldman Sachs Group, as noted by Justice Barrett:
- “We have extensive procedures and controls that are designed to identify and address conflicts of interest.”
- “Our clients’ interests always come first.”
- “Integrity and honesty are at the heart of our business.”
Although most all of the diversity and inclusion cases are in their early stages, there is clear overlap in the character of those statements and the ones at issue in Goldman Sachs. Whether the increased scrutiny on generic statements in the 10(b) context leads plaintiffs to assert other causes of action—securities-related or not—remains to be seen.