Argument preview: Materiality required for class certification in fraud-on-the-market cases?

Securities plaintiffs must demonstrate reliance on a material misrepresentation in order to prove a violation of Section 10(b) of the Securities Exchange Act and SEC Rule 10-b.  However, the Supreme Court has recognized that if each putative securities class member had to establish the element of reliance on an individual basis, no securities action would proceed on a class basis because individual issues regarding reliance would routinely and necessarily overwhelm common issues.

To address this issue, the Court has also recognized for putative securities class actions the “fraud-on-the-market” theory, which posits that, where securities trade in an efficient market, all public material information is reflected in the price of an individual security.  In cases where the fraud-on-the-market theory applies, class members benefit from a rebuttable presumption of reliance in proving their claims.

Next week the Court will hear oral argument in Amgen v. Connecticut Retirement Plans and Trust Funds (2011).  The case has its origins in a putative class action alleging misstatements by Amgen regarding the safety of two Amgen products.  Connecticut Retirement moved for class certification and invoked the fraud-on-the-market theory in support by demonstrating that Amgen’s stock traded in an efficient market and that the alleged misstatements had been publicly disseminated.  Amgen responded that plaintiffs had failed to provide any evidence of materiality as should be necessary for application of the fraud-on-the-market theory; it also offered its own evidence of lack of materiality in an attempt to rebut any presumption of reliance.  The district court rejected Amgen’s arguments and granted class certification.  On appeal, the Ninth Circuit affirmed the district court’s order certifying the class.  It held that securities plaintiffs seeking class certification are not required to establish materiality in actions relying on the fraud-on-the-market theory of reliance, nor are courts required to give defendants the opportunity to rebut application of the theory prior to class certification.

Amgen filed a petition for certiorari, which the Court granted in June 2012.

Merits Briefing

Amgen makes three primary arguments for reversal of the decision below.  First, it notes that the Court’s seminal decision in Basic Inc. v. Levinson endorsed a rebuttable presumption of reliance based on application of the fraud-on-the-market theory.  Without materiality, there is no basis for application of the fraud-on-the-market theory and, accordingly, no basis for a presumption of reliance.  In such a circumstance, class-wide issues would not predominate.  Second, Amgen argues that because the fraud-on-the-market theory creates only a rebuttable presumption of reliance, defendants should have the right to challenge materiality and rebut the presumption at the class certification stage.  Third and finally, Amgen points out the enormous pressure on defendants to settle certified class actions generally, and securities class actions specifically, and argues as a matter of policy that this reality further supports a rule permitting defendants to challenge materiality at the class certification stage.

Connecticut Retirement responds that materiality need not be established for certification of securities class actions because the materiality is a merits question common to all class members and application of the fraud-on-the-market theory does not require a showing of materiality.  In so arguing, Connecticut Retirement contends that absence of materiality does not serve to disprove commonality or predominance of common issues but, rather, serves only to undermine the viability of the securities claims on the merits.  Thus, it argues, such challenges should be made on summary judgment or at trial, not as part of the class certification process.  Connecticut Retirement concludes that denying class certification based on lack of materiality would serve little practical purpose because a materiality determination as part of the class certification process would not preclude claims by individual plaintiffs, and both plaintiffs and defendants would be harmed by the inefficiencies of not having the materiality issue decided on the merits on a class-wide basis.

The United States weighs in

The United States filed a brief in support of Connecticut Retirement which offers a thorough defense of the decision below and emphasizes the difference between the procedural elements for class certification under Rule 23 and the substantive elements of a securities fraud claim.  In particular, the United States argues that to invoke the fraud-on-the-market presumption, a securities plaintiff need only establish that an efficient market exists and that the challenged misstatement was public.  Materiality need not be demonstrated at the class certification stage.  “Because materiality is determined under a ‘reasonable investor’ standard, it can be proved or disproved through evidence common to the class.  And if [Amgen’s] statements are ultimately found not to be material, judgment can be entered for [it] on that basis, without the need for individualized reliance inquiries.”

The United States also argues that the class certification stage is not the appropriate time for courts to consider efforts by defendants to rebut the application of the fraud-on-the-market theory.  Instead, it contends, because that theory goes to the substantive element of reliance, Connecticut Retirement is correct that the proper time for such challenges is at summary judgment or trial.

Potential significance

A ruling in favor of Amgen, and a holding that plaintiffs must demonstrate materiality to invoke the fraud-on-the-market presumption, would likely have several significant impacts on securities class actions.  First, the process of class certification would become more complicated and costly as expert witnesses battle over the materiality of alleged misstatements, in addition to the relatively straightforward inquiry of whether a security traded in a an efficient market and the simpler still issue of whether an alleged misstatement was disseminated publicly.  Second, it is fair to assume that at least some of these challenges based on failure to establish materiality would lead to a decrease in the number of securities actions certified.  Finally, although fewer securities class actions would actually be certified, the ones that are certified would become even more perilous for defendants than those certified under the existing interpretation of Rule 23.