(Article from Securities Law Alert, June/July 2021)
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On June 21, 2021, in Goldman Sachs Group v. Arkansas Teacher Retirement System, 2021 WL 2519035 (2021) (Barrett, J.), the Supreme Court vacated the Second Circuit’s class certification affirmance in a securities fraud class action brought under Section 10(b).[1] The Court unanimously held that a court must consider all probative evidence, including the nature of the alleged misrepresentations, in assessing price impact at the class certification stage. An eight-justice majority of the Court further held that it was not clear that the Second Circuit properly considered the generic nature of the alleged misrepresentations at issue and for that reason vacated and remanded back to the Second Circuit. The Court directed the Second Circuit on remand to reassess the district court’s price impact determination, taking into account “all record evidence relevant to price impact, regardless [of] whether that evidence overlaps with materiality or any other merits issue.” A six-justice majority of the Court also held that a defendant seeking to overcome the Basic presumption bears the burden of persuasion to prove a lack of price impact, which must be carried by a preponderance of the evidence.
Background
Plaintiff stockholders commenced this securities fraud class action against a bank and certain of its executives alleging that defendants made misstatements about its ability to manage conflicts of interest, such as “[w]e have extensive procedures and controls that are designed to identify and address conflicts of interest.” Plaintiffs relied on a stock price inflation-maintenance theory asserting that the alleged misrepresentations caused the bank’s stock price to remain inflated until the truth regarding certain conflicts of interest was revealed and the bank’s stock price fell. Plaintiffs sought to certify a class of stockholders by invoking the rebuttable presumption of reliance established in Basic v. Levinson, 485 U.S. 224 (1988). Defendants sought to defeat class certification by rebutting the Basic presumption with evidence that their alleged misrepresentations had no stock price impact. Both parties submitted expert testimony on the issue of price impact. The district court determined that defendants failed to carry their burden of proving a lack of price impact and certified the class, and the Second Circuit affirmed.
The Nature of the Alleged Misrepresentations Is Relevant to Price Impact
Before the Court, defendants argued that the Second Circuit erred in holding that the generic nature of their alleged misrepresentations was irrelevant to the price impact inquiry. The Court held that a court must consider all probative evidence, including the nature of the alleged misrepresentations, in assessing price impact at the class certification stage and observed that the “generic nature of a misrepresentation often will be important evidence of a lack of price impact, particularly in cases proceeding under the inflation-maintenance theory.” In assessing price impact at the class certification stage, the Court stated that courts “should be open to all probative evidence on that question—qualitative as well as quantitative—aided by a good dose of common sense.”
The Court explained that under the inflation-maintenance theory, price impact is the amount of price inflation maintained by an alleged misrepresentation. The Court reasoned that when the alleged misrepresentation is generic and the back-end corrective disclosure is specific, the argument that the back-end price drop equals front-end inflation starts to “break down” and it is less likely that the disclosure corrected the alleged misrepresentation, meaning that there is less reason to infer price impact.
Defendant Bears the Burden of Persuasion to Prove a Lack of Price Impact
Defendants also argued that the Second Circuit erred by assigning defendants the burden of persuasion to prove a lack of price impact. The Court stated that “the best reading of our precedents . . . is that the defendant bears the burden of persuasion to prove a lack of price impact” and that defendants must do so by a preponderance of the evidence. Quoting Basic, the Court stated that the presumption of reliance may be rebutted if defendants make “any showing that severs the link” between the alleged misrepresentation and the price paid (or received) by the plaintiff. The Court noted that the allocation of the burden of persuasion should rarely be outcome determinative as “the defendant’s burden of persuasion will have bite only when the court finds the evidence in equipoise—a situation that should rarely arise.”
Justices Sotomayor and Gorsuch Write Dissents
Justice Sotomayor dissented from the court’s decision to vacate and remand because she believed that the Second Circuit properly considered the generic nature of the alleged misrepresentations. Justice Gorsuch, joined by Justices Thomas and Alito, dissented from the Court’s burden of persuasion holding, stating that the Court has never placed the burden of persuasion on the defendant in this area and it “is incumbent on the plaintiff to prove reliance, not the defendant to disprove it.”
[1] Simpson Thacher filed an amici curiae brief on behalf of the Securities Industry and Financial Markets Association, the U.S. Chamber of Commerce, the Bank Policy Institute, the American Bankers Association, and the American Property Casualty Insurance Association in support of defendants-appellants.