In a watershed moment for class action securities litigation, last Wednesday the Supreme Court issued its opinion in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, making it easier for plaintiffs to obtain class certification and, in turn, pressure defendants into exorbitant settlements to avoid the costs of class action—and, in many cases, bet-the-company—litigation. The high court ruled that securities-fraud plaintiffs need not prove the materiality of alleged misstatements or omissions at the class-certification stage in order to satisfy Rule 23(b)(3)’s requirement that common questions of law or fact predominate over individual ones.
Reliance by investors on the alleged misrepresentation is an essential element of a securities fraud claim under §10(b) of the Exchange Act and SEC Rule 10b-5. In an earlier landmark case, Basic, Inc. v. Levinson, the Supreme Court recognized the unrealistic burden of proving direct reliance when plaintiff-investors trade on impersonal capital markets. Accordingly, the Supreme Court endorsed the fraud-on-the-market theory of indirect reliance on the integrity of the market, which embraces the notion that our capital markets efficiently digest and incorporate all public information into a stock’s market price. The fraud-on-the-market theory enables plaintiffs to invoke a presumption of reliance on material misrepresentations aired to the public. (Immaterial information, by definition, does not affect market price and thus cannot be relied upon by investors who rely on the market price’s integrity.) Armed with this presumption of reliance, potential class action plaintiffs are able show that common questions of reliance predominate for purposes of Rule 23(b)(3) certification.
In Basic, the Supreme Court also established certain predicates to a plaintiff’s invocation of the presumption of reliance—including materiality. Under Basic, defendants may rebut the presumption of reliance by disproving any of the presumption’s predicate elements (materiality and publicity of the alleged misrepresentation, and efficiency of the market on which the subject security is traded). The Amgen case arrived at the Supreme Court by way of a circuit split over when plaintiffs are required to prove, and when defendants are permitted to rebut, the presumption of reliance.
In Amgen, the plaintiff alleged that Amgen violated §10(b) and Rule 10b-5 through material misrepresentations and omissions regarding the safety, efficacy, and marketing of two of its flagship drugs. The trial court granted plaintiff’s motion to certify a class under Rule 23(b)(3), and, on interlocutory appeal, the Ninth Circuit affirmed, rejecting Amgen’s arguments that the trial court erred by not requiring proof of materiality and by not considering Amgen’s evidence that the alleged misrepresentations were immaterial.
In a divisive 6-3 opinion authored by Justice Ginsburg, the Supreme Court held that because materiality is also an element of a §10(b) and Rule 10b-5 claim on the merits, proof of materiality is not a prerequisite to class certification. The court reasoned that “the plaintiff’s inability to prove materiality would not result in individual questions predominating. Instead, a failure of proof on the issue of materiality would end the case, given that materiality is an essential element of the class members’ securities-fraud claims.” According to the majority, requiring such proof would have courts “put the cart before the horse” and “necessitate a mini-trial on the issue of materiality at the class-certification stage.” For the same reasons, the court held that the defendants were not entitled to submit evidence rebutting the presumption of reliance at the class-certification stage.
Courts (and Congress) have long recognized the “in terrorem” effect of class certification, as it often pressures defendants into what some view as extortionate settlements of frivolous claims. The Supreme Court overcame Amgen’s policy arguments in this regard by noting that Congress chose not to do away with Basic’s presumption of reliance when it enacted the Private Securities Litigation Reform Act of 1995, which simply created heightened pleading standards for securities-fraud claims, a mandatory stay of discovery pending motions to dismiss, and more exacting lead plaintiff requirements.
From the defense perspective, the court’s decision misses the mark, for several reasons. First, as the Supreme Court had recently confirmed in Wal-Mart Stores, Inc. v. Dukes, the class-certification analysis is “rigorous” and “entail[s] some overlap with the merits of the plaintiff’s underlying claim.” Thus, the fact that materiality is not only a predicate to the presumption of reliance that is necessary for Rule 23(b)(3) certification, but also an element of a securities-fraud claim, should not bar an inquiry into proof of materiality (or immateriality) at class certification. Moreover, the Basic court established the rebuttable presumption of reliance—including the predicates to invoking that presumption—in connection with a class-certification ruling. The Amgen opinion is, therefore, arguably a departure from Basic that limits defendants’ ability to dispose of meritless securities-fraud claims in the early stages of litigation.