22 June 20217 minute read

In Goldman Sachs decision, Supreme Court expands methods for challenging class certification in securities fraud cases

On Monday, the Supreme Court issued its decision in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System.  The opinion expands the arguments for defendants challenging class certification in securities cases proceeding under the fraud on the market theory, especially when a plaintiff invokes the inflation maintenance theory of fraud.  The majority opinion also holds that defendants have the burden of persuasion to rebut the presumption of reliance at the class certification stage.

The Basic presumption of reliance

Federal Rule of Civil Procedure 23(b)(3) requires a plaintiff seeking class certification to show that questions of law or fact common to class members predominate over questions affecting only individual class members.  Absent a court-developed presumption, class actions asserting claims of securities fraud under Rule 10b-5 would fail this predominance requirement on the element of reliance because determining what information each class member relied upon in making an investment decision would present individualized issues.

In Basic Inc. v. Levinson, the Supreme Court adopted a presumption of reliance based on the fraud-on-the-market theory.  Under Basic, if an alleged misrepresentation is publicly disclosed and securities related to the alleged misrepresentation are traded in an efficient market, the market price of the securities is presumed to incorporate the alleged misrepresentation and investors are presumed to have relied on the integrity of the market price in making their investment decisions.  Unless a defendant “severs the link” between the alleged misrepresentation and the market price, the Basic presumption renders reliance a common issue.

Background to the Supreme Court appeal

In Goldman Sachs, the alleged misrepresentations were generalized public statements that the defendant, a globally recognized financial firm, had procedures to identify and avoid conflicts of interest and placed its clients’ interests first.  The plaintiff alleged these statements were knowingly false and that the alleged fraud was revealed when the Securities and Exchange Commission filed suit alleging conflicts of interest in a specific collateralized debt transaction arranged by one of the defendant’s subsidiaries.  The plaintiff alleged that the firm’s stock price declined after disclosure of that lawsuit, allegedly resulting in significant damages to investors in the parent company’s common stock.

The plaintiffs moved for class certification based on the inflation maintenance theory, under which challenged disclosures are alleged to fraudulently perpetuate artificial inflation in a defendant’s stock price until the alleged truth is revealed and the stock price declines.  Under this theory, the plaintiffs point to the end-of-period stock price decline as evidence that the stock price previously was inflated because of fraud.

In Goldman Sachs, the defendants argued that the Basic presumption was rebutted by evidence that the alleged misrepresentations did not actually have an impact on the stock price.  Under a 2015 Supreme Court decision, Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), defendants are permitted to make such a showing to defeat class certification because evidence of a lack of “price impact” is one way to “sever the link” between an alleged misrepresentation and the market price for securities.  The defendants proffered evidence that conflicts of interest had been disclosed in the past with no effect on the stock price and also that the price decline after the SEC sued reflected only the fact that the government had sued.  The defendants also argued that the generic nature of the alleged misrepresentations meant they could not have had a multibillion-dollar price impact.

Goldman Sachs reached the Supreme Court after four lower court decisions (including two by the Second Circuit) resulted in a class being certified.  By the time the case was decided by the Supreme Court, the issues had been narrowed significantly. 

Courts must consider all relevant evidence — including the contents of relevant disclosures

The majority opinion, written by Justice Amy Coney Barrett and joined in full by four other justices, addressed two questions: first, whether the generic nature of alleged misrepresentations is evidence that must be considered in determining price impact for purposes of class certification; and second, whether defendants bear the burden of persuasion, as well as the burden of production, on the question of price impact at the class certification stage.  The majority ruled for the defendants on the first question and against the defendants on the second one.

On the first question, the Court held:  “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.’”  Based on this holding, the Court remanded with an instruction for 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.”  (Emphasis in original). 

This is a significant holding for securities fraud defendants.  The Court eliminated confusion arising from its decision in Amgen Inc. v. Connecticut Retirement Plans, which held that the materiality of alleged misrepresentations is a question common to all class members that was not appropriate for resolution at the class certification stage.  As a result, lower court decisions refusing to consider price impact evidence based on this confusion are no longer good law.

More generally, however, the Court made clear that the permissible evidence on the question of price impact is far broader than just economic analyses.  It also includes the contents of the alleged misrepresentations and the later allegedly corrective disclosures that purportedly revealed the facts concealed by the previous fraud.  Until now, many courts considering price impact have viewed that issue as one to be resolved through a contest of economic experts and have avoided analysis of the relevant statements, even when offered by securities fraud defendants as evidence that rebuts the presumption of reliance.

While the Court in Goldman Sachs declined to address the validity of the inflation maintenance theory, it recognized that the key inference in such cases – “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.”  In those instances, it is less likely that an allegedly corrective 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.” 

Given this holding, courts considering price impact will be required to compare the contents of both the alleged misrepresentations and the allegedly corrective disclosures when there might be a “mismatch” between those disclosures.  This could dramatically expand the arguments available to securities fraud defendants in challenging price impact in response to a class certification motion.

Burden of persuasion remains with defendants

The Goldman Sachs defendants also argued that the burden of persuasion on price impact at class certification should rest with plaintiffs, not defendants.  The majority disagreed.  The Court concluded that Basic and Halliburton II shifted the burdens of both production and persuasion to the defendants under a preponderance of the evidence standard.  That holding is consistent with previous decisions in the Second and Seventh Circuits, which the Court cited in reaching it. 

In a dissenting opinion, Justice Neil Gorsuch, joined by two other justices, disagreed that Basic and Halliburton II required such an outcome and noted its anomalous implication – that a securities fraud defendant must carry the burden of persuasion on an important element of a plaintiff’s claim of a securities violation.  The majority concluded it was unlikely this allocation of burdens would have a meaningful impact.  Justice Gorsuch disagreed in his dissent. 

The ultimate question is whether the evidence shows “it is more likely than not that the alleged misrepresentations had a price impact.”  The allocation of burden will have the most impact in cases where there is evidence on both sides of that issue.  Only future experience will inform whether those cases are rare or commonplace, but securities fraud plaintiffs undoubtedly will seize upon this holding in contested class certification motions.

Learn more about the implications of this Supreme Court decision by contacting either of the authors or your DLA Piper relationship attorney.