(Article from Securities Law Alert, January 2019)
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In Halliburton Co. v. Erica P. John Fund, 573 U.S. 258 (2014), the Supreme Court held that although “plaintiffs need not directly prove price impact to invoke the Basic presumption” of classwide reliance, defendants may “defeat the presumption at the class certification stage through evidence that the misrepresentation did not in fact affect the stock price.” On January 18, 2019, the Middle District of Tennessee found that defendants successfully rebutted the Basic presumption with evidence of lack of price impact. Grae v. Corrections Corp. of Am., 2019 WL 266674 (M.D. Tenn. 2019) (Trauger, J.). The court further held that plaintiffs could not invoke the Affiliated Ute presumption of reliance for omissions because the “core” of plaintiffs’ allegations concerned what the company “said, not what it failed to say.” The court denied plaintiffs’ motion for class certification on the grounds that individual questions of reliance would predominate over common questions.
Plaintiffs Cannot Demonstrate Price Impact Based on the Materialization of a Risk If the Market Was Already Aware of That Risk
At issue in the case before the court were allegations that a private prison operator and its executives failed to disclose quality issues with its contract prisons. On August 11, 2016, the DOJ’s Office of Inspector General issued a report (the “OIG Report”) detailing significant quality concerns with contract prisons, including prisons operated by defendants. The OIG Report had no impact on the company’s stock price. A week later, the Deputy Attorney General issued a memorandum (the “Yates Memorandum”) recommending that the federal government’s Bureau of Prisons (“BOP”) begin “reducing—and ultimately ending—[its] use of privately operated prisons.” Through competing expert analyses, the parties disputed whether the stock price drop following the release of the Yates Memorandum demonstrated that the alleged misrepresentations had any price impact.
At the outset of its analysis, the court emphasized that “the Supreme Court has left little doubt that the court must consider evidence of a lack of price impact as a basis for overcoming the Basic presumption at the class certification stage.” The court found “the presence of the OIG Report complicate[d] the issue of price impact considerably.” The court explained that “[i]f the market learns the truth about an underlying risk to a company prior to the risk’s materializing, then materialization has no concealed truth to reveal.” The court stated that “[t]he value of the company’s shares still might go down—but that reduction in value would be due to the damage done by the materialized risk itself, not the market’s having been in the dark about the risk’s existence or severity.”
The court determined that any investor who read the OIG Report “would have been well-apprised of the fact that there was evidence of significant quality issues with the BOP’s contract prisons, including, specifically,” defendants’ prisons. The court concluded that “[t]here was no concealed truth, then, left for the Yates Memorandum to disclose.” The court found that “[a]ll that the [Yates] Memorandum revealed was the ensuing policy decision.” The court therefore held that plaintiffs could not rely on the stock drop following the Yates Memorandum to demonstrate price impact.
The court acknowledged that defendants’ evidence was “not an ironclad demonstration, beyond a reasonable doubt, that [the company’s] allegedly false or misleading statements and omissions had no price impact.” However, the court found the evidence “enough for [defendants] to prevail with regard to whether the court [could] rely on the Basic presumption to simplify and universalize the issue of reliance.”
Plaintiffs Cannot Invoke the Affiliated Ute Presumption Because the Complaint Alleged Misleading Statements
Plaintiffs alternatively argued that they should be entitled to rely on the presumption of reliance set forth in Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972). The Affiliated Ute Court held that “positive proof of reliance is not a prerequisite for recovery” where plaintiffs’ claims “involv[e] primarily a failure to disclose.” Plaintiffs in Grae contended that their case centered on the company’s “failure to disclose the many deficiencies that led to the erosion of its relationship with the BOP.”
The court explained that “the distinction between misleading statements and misleading disclosures is not always crystal clear, because, in the securities fraud context, it is often what one says that determines whether one has an obligation to disclose.” The court found that “[t]here is . . . a tension between the test for determining whether a defendant had a disclosure obligation and the test for whether to apply Affiliated Ute.” This is because “[t]he disclosure case law looks at statements and omissions together, as complementary parts of a single truth or falsehood.” Application of the Affiliated Ute presumption, on the other hand, “requires the court to pick one or the other—to decide whether a case is ‘primarily’ about statements or about omissions—even if a case may, in a sense, be wholly about both.” The court concluded that “[t]he only way out of this seeming conundrum . . . is to construe the scope of Affiliated Ute narrowly, or, at least, narrowly enough to avoid creating an exception that swallows the rule.”
Here, the court found that the complaint was “replete with allegations of specific false or misleading statements.” The court acknowledged that the company “could have inoculated itself by disclosing more accurate information about the many deficiencies” concerning its contract prisons. However, the court stated that “[s]ome version of that premise . . . is true about every affirmative falsehood—every lie can be corrected by the truth.” The court reasoned that any “version of Affiliated Ute that reached this case would be so broad that it would threaten the viability of reliance as an element of securities fraud altogether” and “would not be consistent with the limited purpose of the rule recognized by the Supreme Court.”
The court emphasized that its ruling should not be read as a determination that defendants were “forthright in their statements about the quality of their facilities.” Rather, defendants had “merely shown that, based on the Supreme Court’s current case law regarding reliance in securities fraud cases, the situation at issue here is one for which reliance must be shown individually, rather than collectively.”