June 23, 2021

Securities Fraud: SCOTUS Makes Class Certifications A Little Tougher

Earlier this week, the Supreme Court issued its long-awaited decision in Goldman Sachs Group v. Arkansas Teacher Retirement Systems, a securities fraud class action against Goldman Sachs. The litigation arose out of statements Goldman made before the 2008 financial crisis about its commitment to compliance and its ability to identify & prevent conflicts of interest.

A few years later – in the midst of the financial crisis – it came to light that Goldman didn’t fully comply with all laws, didn’t prevent all conflicts of interest, etc. (the bank paid $550 million in 2010 to settle SEC charges related to a subprime mortgage CDO, among other things). Goldman’s stock price dropped, and the lawsuit commenced.

The plaintiffs presented a 10b-5 “fraud on the market” theory that Goldman’s statements about its honesty & integrity had artificially inflated the stock price. Under this theory, anyone who bought shares was defrauded, because they suffered a loss after the truth came to light.

SCOTUS kind of disagreed – but it’s muddy. It’s not the home run that companies and D&O insurers were hoping for, because the Court held that the company has the burden of proof to present evidence that “severs the link” between the statements it made and the price drop. However, companies can offer all sorts of evidence as part of that effort, and lower courts can consider that “generic” statements are less likely to impact price.

In this Twitter thread, Tulane Law prof Ann Lipton predicts the courts may end up coming pretty close to examining the merits of plaintiffs’ “price drop” arguments at the class certification stage. It could get messy in trying to distinguish this type of analysis from the Halliburton I holding of a decade ago, which said that plaintiffs don’t have to prove “loss causation” in order to get class certification.

This Gibson Dunn memo summarizes the issues & the holding in more detail. Here’s an excerpt:

– Today’s decision is the first time the Supreme Court has discussed the “inflation-maintenance” theory of securities fraud, although the Court expressly noted that it was taking no view on the “validity” or “contours” of that theory. Under the inflation-maintenance theory, a misrepresentation causes a stock price to remain inflated by preventing inflation from dissipating from the price. The theory, which has become increasingly common in securities class actions, often depends on an inference that a negative disclosure about the company corrected an earlier misrepresentation, and that a drop in the stock price associated with the disclosure is equal to the amount of inflation maintained by the earlier misrepresentation.

– The Court’s decision suggests important limitations on the theory. The Court explained that the inference 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,” and this occurs “when the earlier misrepresentation is generic . . . and the later corrective disclosure is specific.”

– The decision thus holds that defendants in securities class action suits may rebut the Basic presumption by arguing that the allegedly fraudulent statements are too generic to have impacted the price of the security, even if those arguments overlap with the ultimate merits of the case.

– The Court also clarified that its prior decisions in Basic and Erica P. John Fund, Inc. v. Halliburton Co., 563 U. S. 804, 813 (2011), established that securities-fraud defendants bear the ultimate burden of persuading the court that the Basic presumption does not apply. The Court’s decision thus underscores the importance of defendants offering factual and expert evidence at the class certification stage to rebut the Basic presumption.

We’ll see what happens here, but it sounds like this holding is unlikely to cut the plaintiffs’ bar off at the pass. With the “inflation maintenance” theory still kicking, aspirational statements may continue to land companies in court under the “everything is securities fraud” paradigm. Once you get there, you can claim the statements were “generic” and submit a lot of evidence to show why the class shouldn’t proceed.

For more commentary, see:

– This Dorsey blog

– This Stinson blog

Matt Levine’s column

Liz Dunshee