In late March, the U.S. Supreme Court heard oral argument in a case that could redefine the “fraud on the market” presumption—a presumption crucial to investor’s ability to prove reliance on a class-wide basis. While early commentary foreshadowed a potential blockbuster decision altering the class certification landscape, statements by several Justices at oral argument signal a far more modest result is likely. As Tulane law professor Ann M. Lipton commented, while the appeal came “in like a lion,” it appears slated to go “out like a lamb.”
The case, Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System, stems from the financial crisis of 2008. Goldman marketed and sold synthetic collateralized debt obligations while, allegedly, failing to disclose that Goldman or its major clients were heavily betting against the products. The plaintiff alleges that Goldman’s statements about adhering to high ethical standards when managing conflicts of interests were false and misleading when made, which caused the price for Goldman’s stock to be artificial inflated. The decade-old case has seen several twists and turns, including two trips to the Second Circuit Court of Appeals revolving around whether plaintiffs are entitled to presume reliance on the alleged misrepresentations or whether defendants have successfully rebutted the presumption of reliance.
By way of brief background: typically, fraud claims require proof of reliance, which if needed on an investor-by-investor basis would raise a host of individual issues that would prevent class certification in securities class actions. The fraud on the market theory established by the Supreme Court in Basic v. Levinson provides another option. Under this theory, reliance is presumed when a stock trades in an efficient market. In Halliburton II, the Supreme Court held that a defendant must have an opportunity to rebut the Basic presumption at the class certification stage by showing that the statements at issue did not affect the stock price. But, in its prior Amgen decision, the Court cautioned against delving into materiality at the class certification stage. This intersection of materiality and rebuttal evidence has proven a hurdle to defendants. In fact, since 2014’s Halliburton II decision, defendants successfully refuted price impact in only five cases.
Goldman hopes to reverse that trend. In fighting against class certification, Goldman attempted to rebut the presumption by relying on expert testimony that the alleged misrepresentations were too generic to have affected the company’s stock price. Further, Goldman argued that on 36 occasions during the class period, there were public reports about Goldman’s purported conflicts of interests and that those stories had no material effect on Goldman’s stock price.
Initially, the district court refused to consider Goldman’s expert evidence, citing the Supreme Court’s Amgen decision that courts should not consider materiality arguments when deciding a motion for class certification. The Second Circuit disagreed and directed the district court to consider Goldman’s expert evidence. On remand, the district court held an evidentiary hearing and again certified the class. This time, the Second Circuit affirmed, holding that the district court did not abuse its discretion, either in weighing the expert testimony or in rejecting Goldman’s argument that the challenged statements were too generic as a matter of law to have had a price impact.
The Supreme Court accepted Goldman’s appeal to address: (i) whether a defendant may rebut the presumption of class-wide reliance by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality; and (ii) whether a defendant seeking to rebut the presumption has only a burden of production or also the ultimate burden of persuasion. Goldman maintains that the alleged actionable statements are far too generic to impact its stock price and that the “inflation maintenance” theory—that an alleged misstatement can have actionable “price impact” by maintaining a previously inflated stock price—effectively lowers the bar to such a degree that it makes the fraud on the market presumption essentially irrebuttable.
The lead-up to the Goldman argument generated a great deal of interest, amicus filings, and legal news coverage. This was driven by both the importance of the fraud on the market presumption to class certification, as well as because this will be the first securities class action that the Court considers since the passing of Justice Ruth Bader Ginsburg, who repeatedly sided with investors in prior decisions addressing the Basic presumption. Thus, many eyes are on her successor, Justice Amy Coney Barrett, who could now play a pivotal role in the decision.
But any predictions of a dramatic shift by the new Court were quickly brushed aside at oral argument, where several Justices commented that the case and arguments merited a narrower decision. For example, Justice Breyer commented, “This seems like an area that, the more that I read about it, the less that we write about, the better.” In addition, Justice Barrett noted that both parties “moved to the middle” on their arguments, which significantly narrowed the issues in dispute. For example, while Goldman originally argued that the generic statements were not actionable as a matter of law, through briefing and oral argument it shifted its position to argue that the generic nature of the statements was merely a relevant factor to be considered, which the investors did not dispute.
Based on these comments, from different ends of the ideological spectrum, commentators are expecting a narrow decision, likely focused on the evidentiary burden a defendant must bear to rebut the presumption. The Court appears unlikely to broadly revisit Basic as a whole, or the “price maintenance” theory, but it is possible the Court will clarify its prior decisions on the line between materiality (Amgen) and rebutting the fraud on the market presumption (Halliburton II). A ruling is expected by summer.