Opinion analysis: Plaintiffs need not establish materiality to obtain certification of securities class actions

In an unsurprising decision, the Court declined to raise the bar for the certification of securities class actions by requiring plaintiffs to establish the materiality of alleged misstatements to invoke the fraud-on-the-market theory in support of class certification.  Instead, it remains sufficient for plaintiffs to simply plead materiality, and establish the traditional requirements of Rule 23 at the certification stage.

 

On Wednesday, the Supreme Court affirmed the Ninth Circuit’s decision, holding that (1) plaintiffs need not establish materiality at the class certification stage even when relying on the fraud-on-the-market theory of reliance; and (2) defendants are not entitled to present evidence of an absence of materiality at the class certification stage to defeat certification.

In so ruling, the Court emphasized that the presence or absence of materiality was to be determined on an objective basis and was an issue common to all potential class members.  Justice Ginsburg wrote for the majority: “As to materiality, therefore, the class is entirely cohesive: It will prevail or fall in unison.  In no event will the individual circumstances of particular class members bear on the inquiry.”

Rule 23 requires for certification of a class action for money damages under Rule 23(b)(3) a plaintiff to demonstrate numerosity, commonality, typicality, adequacy of representation, and that “questions of law or fact common to class members predominate over any questions affecting only individual members, and that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy.”  Reliance on a material misrepresentation or omission is a required element for a private securities fraud claim under Section10(b) and Rule 10b-5 and is often established by invoking the rebuttable presumption of reliance by plaintiffs under the fraud-on-the-market theory, which presumes that an efficient market will rely on material misrepresentations aired to the general public.

The respondent in this case, Connecticut Retirement, brought securities fraud claims in federal district court against Amgen based on allegations that Amgen publicly made material misrepresentations regarding some of its key products; when the truth was revealed, Amgen’s stock price declined and investors that had purchased at artificially inflated prices based on the misinformation suffered damages.  Amgen admitted in its Answer that the statements had been made publicly and that Amgen stock traded in an efficient market.  The district court granted Connecticut Retirement’s motion for class certification, and Amgen appealed to the Ninth Circuit on two grounds:  first, the district court’s failure to require Connecticut Retirement to prove the materiality of the misstatements prior to certification; and, second, the district court’s refusal to consider evidence from Amgen during the class certification process that, in Amgen’s view, affirmatively established an absence of materiality of the alleged misstatements.

The Ninth Circuit affirmed the certification order and the Court granted Amgen’s petition for certiorari to resolve a conflict among the courts of apepals. Both the Ninth and Seventh Circuits held that materiality need not be established at the certification stage.  While the Third Circuit had agreed that a class plaintiff need not establish materiality at the certification stage, it had held that a defendant may present rebuttal evidence on the issue.  Meanwhile, the Second Circuit adopted the most defendant-friendly standard, requiring plaintiffs to establish materiality to obtain class certification of a securities action and with defendants having the right to present evidence rebutting materiality prior to certification.

In an opinion by Justice Ginsburg, the Court summarized Amgen’s position that “certification must be denied unless Connecticut Retirement proves materiality, for immaterial misrepresentations or omissions, by definition, would have no impact on Amgen’s stock price in an efficient market.”  The Court rejected this argument for two independent reasons.  First, because materiality is an objective inquiry under the federal securities laws, the question of the materiality is one common to all class members.  “Rule 23(b)(3) requires a showing that questions common to the class predominate, not that those questions will be answered, on the merits, in favor of the class.”  Second, “there is no risk whatever that a failure of proof on the common question of materiality will result in individual questions predominating.”  This is true because “materiality is an essential element of a Rule 10b-5 claim” and, accordingly, “the failure of proof on the element of materiality would end the case for one and all; no claim would remain in which individual reliance issues could potentially predominate.”

The majority also rejected Amgen’s policy arguments that materiality should be required prior to class certification because certification can exert “substantial pressure” to settle even meritless claims, and that requiring proof of materiality prior to certification would conserve judicial resources.  It found these arguments unpersuasive because Congress enacted the Private Securities Litigation Reform Act and chose other methods to address the possibility of plaintiffs extracting extortionate settlements of frivolous securities class claims; moreover, the court observed, adopting Amgen’s argument “would necessitate a mini-trial on the issue of materiality at the class certification stage.”  The Court concluded that Amgen need not be permitted to offer rebuttal evidence on the issue of materiality prior to certification because “the potential immateriality of Amgen’s alleged misrepresentations and omissions is no barrier to finding that common questions predominate.”

Justice Thomas authored the principal dissent, which Justice Kennedy joined in full and Justice Scalia joined in part.  He emphasized that materiality remains an essential requirement for invocation of the fraud-on-the-market theory presumption of reliance and that absent materiality “plaintiffs cannot establish Basic’s fraud-on-the-market presumption.  Without proof of fraud on the market, plaintiffs cannot show that otherwise individualized questions of reliance will predominate, as required by Rule 23(b)(3).”  Writing separately in dissent, Justice Scalia addressed the proper role of the fraud-on-the-market presumption and argued that a demonstration of materiality is necessary for both substantive recovery and for class certification.  He concluded with a flourish: “Today’s holding does not merely accept what some consider the regrettable consequences of the four-Justice opinion in Basic, it expands those consequences from the arguably regrettable to the unquestionably disastrous.”

In addition to resolving the circuit split regarding materiality and easing the burden on securities plaintiffs seeking certification within the Second Circuit, Wednesday’s opinion also provides a preview of a potentially much more significant battle to come.  Both the majority and dissenting opinions noted that the overarching issue of the continuing viability of the crucial fraud-on-the-market presumption itself was not before the Court.  Justice Alito wrote a separate concurrence to emphasize the point, noting that “more recent evidence suggests that the presumption may rest on a faulty economic premise” and that “in light of this development, reconsideration of the Basic presumption may be appropriate.” Together with Justice Scalia’s observation that the presumption was “invented” by a four-Justice majority in Basic and Justice Thomas’s critique of the presumption in the dissent, Justice Alito’s concurrence seems to indicate it that the Court may return to it sooner rather than later.