Commercial Litigation and Arbitration

Securities — Required Elements of Proof on Class Certification — Must Plaintiff Prove Materiality? Circuit Split

From Conn. Retirement Plans & Trust Funds v. Amgen, 2011 U.S. App. LEXIS 22540 (9th Cir. Nov. 8, 2011):

To obtain class certification in a 10b-5 securities fraud case, the plaintiff, as required by Federal Rule of Civil Procedure 23(b)(3), must convince the district court that the element of reliance is common to the class. The Supreme Court has held that this can be done in an appropriate case by invoking the "fraud-on-the-market" presumption -- the principle that the market price of a security traded in an efficient market reflects all public information and therefore that a buyer of the security is presumed to have relied on the truthfulness of that information in purchasing the security. Were it not for the fraud-on-the-market presumption, a plaintiff seeking class certification would be required to show the impossible — reliance by each individual prospective class member who bought the stock.

What must a plaintiff do to invoke the fraud-on-the-market presumption in aid of class certification? Today we join the Third and Seventh Circuits in holding that the plaintiff must (1) show that the security in question was traded in an efficient market (a fact conceded here), and (2) show that the alleged misrepresentations were public (a fact not contested here). As for the element of materiality, the plaintiff must plausibly allege — but need not prove at this juncture — that the claimed misrepresentations were material. Proof of materiality, like all other elements of a 10b-5 claim, is a merits issue that abides the trial or motion for summary judgment. Likewise, rebuttal of the fraud-on-the-market presumption, at least by showing that the alleged misrepresentations were not material, is a matter for trial or summary judgment, not a matter to be taken up in a class certification motion.***

B. Elements That Must Be Proved at the Class Certification Stage to Invoke the Fraud-on-the-Market Presumption of Reliance

***As the party seeking class certification, Connecticut Retirement "bears the burden of demonstrating that the requirements of Rules 23(a) and (b) are met." See United Steel, 593 F.3d at 807. And the district court facing a class certification motion is required to conduct "a rigorous analysis" to ensure that the Rule 23 requirements are satisfied. Gen. Tel. Co. of Sw. v. Falcon, 457 U.S. 147, 161, 102 S. Ct. 2364, 72 L. Ed. 2d 740 (1982).

Amgen argues that Connecticut Retirement failed to carry that burden because it did not prove that Amgen's supposedly false statements were material. If those misrepresentations were immaterial, Amgen contends, they by definition would not affect Amgen's stock price in an efficient market, and thus no buyer could claim to have been misled by an artificially inflated stock price. Thus, Amgen concludes, each individual plaintiff would be left to prove reliance at trial individually — making a class proceeding unwieldy.

The problem with that argument is that, because materiality is an element of the merits of their securities fraud claim, the plaintiffs cannot both fail to prove materiality yet still have a viable claim for which they would need to prove reliance individually. See Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341, 125 S. Ct. 1627, 161 L. Ed. 2d 577 (2005). If the misrepresentations turn out to be material, then the fraud-on-the-market presumption makes the reliance issue common to the class, and class treatment is appropriate. But if the misrepresentations turn out to be immaterial, then every plaintiff's claim fails on the merits (materiality being a standalone merits element), and there would be no need for a trial on each plaintiff's individual reliance. Either way, the plaintiffs' claims stand or fall together — the critical question in the Rule 23 inquiry. As the Supreme Court said in Dukes,

"[w]hat matters to class certification . . . is not the raising of common 'questions' -- even in droves -- but, rather the capacity of a classwide proceeding to generate common answers apt to drive the resolution of the litigation. Dissimilarities within the proposed class are what have the potential to impede the generation of common answers."

131 S. Ct. at 2551 (quoting Richard A. Nagareda, Class Certification in the Age of Aggregate Proof, 84 N.Y.U. L. Rev. 97, 132 (2009)).

By contrast, the elements of the fraud-on-the-market presumption — whether the securities market was efficient and whether the defendant's purported falsehoods were public — are not elements of the merits of a securities fraud claim. See Dura Pharms., 544 U.S. at 341-42. Thus, if the plaintiffs failed to prove those elements, they could not use the fraud-on-the-market presumption, but their claims would not be dead on arrival; they could seek to prove reliance individually. That scenario, however, would be inappropriate for a class proceeding. Accordingly, the district court was correct to require Connecticut Retirement to prove at the class certification stage that the market for Amgen's stock was efficient and that Amgen's supposed misstatements were public. (Because those elements were uncontested, we need not decide the applicable standard of proof for proving those elements at the class certification stage.)

The Seventh Circuit, recently faced with this same issue, held that proving materiality is not a precondition to invoking the fraud-on-the-market presumption at the class certification stage:

Defendants say that, before certifying a class, a court must determine whether false statements materially affected the price. But whether statements were false, or whether the effects were large enough to be called material, are questions on the merits. Although we concluded in [a prior case] that a court may take a peek at the merits before certifying a class, [we] insisted that this peek be limited to those aspects of the merits that affect the decisions essential under Rule 23. If something about "the merits" also shows that individual questions predominate over common ones, then certification may be inappropriate. Falsehood and materiality affect investors alike, however. It is possible to certify a class under Rule 23(b)(3) even though all statements turn out to have only trivial effects on stock prices. Certification is appropriate, but the class will lose on the merits.

Schleicher v. Wendt, 618 F.3d 679, 685 (7th Cir. 2010). The Third Circuit agrees. See In re DVI, Inc. Sec. Litig., 639 F.3d 623, 631 (3d Cir. 2011) ("To invoke the fraud-on-the-market presumption of reliance, plaintiffs must show they traded shares in an efficient market, and the misrepresentation at issue became public.") (citations omitted).

The three circuits that require a plaintiff to prove materiality at the class certification stage do so on the apparent rationale that a footnote in Basic Inc. v. Levinson, 485 U.S. 224, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988), compels it. See id. at 248 n.27 ("The Court of Appeals held that in order to invoke the presumption, a plaintiff must allege and prove . . . that the misrepresentations were material . . . ."); see also In re Salomon Analyst Metromedia Litig., 544 F.3d 474, 481 (2d Cir. 2008) ("The Basic Court thereby set forth a test of general applicability that where a defendant has (1) publicly made (2) a material misrepresentation (3) about stock traded on an impersonal, well-developed (i.e., efficient) market, investors' reliance on those misrepresentations may be presumed.") (citing Basic, 485 U.S. at 248 n.27); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261, 264 (5th Cir. 2007) ("The Supreme Court in Basic adopted this presumption of reliance . . . . Reliance is presumed if the plaintiffs can show that '(1) the defendant made public material misrepresentations . . . .'") (citation omitted), abrogated on other grounds by Erica P. John Fund, 131 S. Ct. at 2183, 2186; In re PolyMedica Corp. Sec. Litig., 432 F.3d 1, 8 n.11 (1st Cir. 2005) (noting in a dictum that to invoke fraud-on-the-market presumption at class certification stage, plaintiff must prove materiality) (quoting Basic, 485 U.S. at 248 n.27).

But as the Seventh Circuit pointed out, those circuits misread the Basic footnote: "All note 27 [in Basic] does . . . is state that the court of appeals deemed materiality essential; the Justices did not adopt it as a precondition to class certification." See Schleicher, 618 F.3d at 687; see also Basic, 485 U.S. at 248 n.27. That reading of Basic also enjoys support from the Supreme Court's more recent formulations of the presumption in Erica P. John Fund and Dukes, which require the plaintiff to show that the stock was traded in an efficient market but do not mention materiality as a requirement. See Erica P. John Fund v. Halliburton, 131 S. Ct. 2179, 2185, 180 L. Ed. 2d 24 (2011); Dukes, 131 S. Ct. at 2552 n.6. ***

In sum, because proof of materiality is not necessary to ensure that the question of reliance is common among all prospective class members' securities fraud claims, we hold that plaintiffs need not prove materiality to avail themselves of the fraud-on-the-market presumption of reliance at the class certification stage. They need only allege materiality with sufficient plausibility to withstand a 12(b)(6) motion. See Ashcroft v. Iqbal, 556 U.S. 662, 129 S. Ct. 1937, 1949-50, 173 L. Ed. 2d 868 (2009).

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