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The U.S. Supreme Court Clarifies the Standards and Proof Required to Meet the Reliance Element of a Securities Fraud Claim

On June 21, 2021, the Supreme Court issued an opinion by Justice Barrett on the reliance element of a securities fraud claim.[1]  In a unanimous portion of her opinion (the “Decision”), Justice Barrett held that courts may consider the generic nature of an alleged misrepresentation in determining whether the misrepresentation impacted share price at the class certification stage.  Of potentially greater significance, Justice Barrett also held, over a dissent by Justice Gorsuch (joined by Justices Thomas and Alito), that defendants bear the burden of persuasion by a preponderance of the evidence that an alleged misrepresentation has not had an impact on the price of a security.  This second holding will facilitate the formation of classes under Rule 23 of the Federal Rules of Civil Procedure by making it at least marginally easier for putative classes to demonstrate reliance through evidence common to the class, which in turn will help the class satisfy Rule 23’s predominance requirement.

In this post, we will summarize the Decision, discuss the caselaw interpreting it to date, and offer concluding thoughts on its potential impact on the practice of securities litigation.

Background: Proving Reliance Through the Basic Presumption

The Supreme Court recognizes a private right of action that allows individuals to recover damages for harm they have suffered because of a material misrepresentation or omission made in connection with the purchase or sale of a security.  In order to recover such damages, plaintiffs must prove that they actually relied on the alleged misrepresentation at issue. 

In Basic v. Levinson, 485 U.S. 224 (1988), the Supreme Court made it easier for plaintiffs to demonstrate reliance by holding that plaintiffs can “invoke a rebuttable presumption of reliance based on the fraud-on-the-market theory.”[2]  The premise of this presumption—now known as the Basic presumption—is that “an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction.”[3]  In order to invoke the Basic presumption, plaintiffs must demonstrate “(1) that the alleged misrepresentation was publicly known; (2) that it was material; (3) that the stock traded in an efficient market; and (4) that the plaintiff traded the stock between the time the misrepresentation was made and when the truth was revealed.”[4] 

Demonstrating these prerequisites, however, is not enough to ensure class certification because, as Justice Barrett explains, “defendants may rebut the Basic presumption . . . by showing that an alleged misrepresentation did not actually affect the market price of the stock,” that is, in the parlance of the trade, that the alleged misrepresentation “had no price impact.”[5]  If the alleged misrepresentation had no price impact, then the premise of the fraud-on-the-market theory—that investors relied on the misrepresentation because it was factored into the price they paid for a security—collapses, and class certification will generally be inappropriate as class members will have to prove through individualized evidence that they relied on the misrepresentation.[6]    

Facts and Procedure

The facts of this case are straightforward.  A number of pension funds accused the defendant investment bank (the “Bank”) and three of its former executives of materially misrepresenting the bank’s ability to handle conflicts of interest.  According to plaintiffs, the Bank made false generic statements like “[o]ur clients’ interests always come first” that artificially inflated the Bank’s stock, and when the market learned that the Bank actually had a number of hitherto undisclosed conflicts of interest, its stock price fell to plaintiffs’ detriment.[7]

After the district court rejected the Bank’s motion to dismiss, plaintiffs moved to certify a class and invoked the Basic presumption to show reliance.  The parties then submitted expert evidence on whether the alleged misrepresentation had a price impact.  The district court certified the class and the Bank appealed to the Second Circuit, which vacated the class certification.[8]  On remand, the district court again certified the class after finding that the Bank had failed to establish by a preponderance of the evidence that its alleged misrepresentations had no impact on the price of its stock.  The Second Circuit affirmed, and the Supreme Court granted certiorari to answer two questions: (1) “whether the generic nature of a misrepresentation is relevant to price impact” and (2) which party bore “the burden of persuasion on price impact at class certification.”[9] 

Relevance of Generic Nature of Misrepresentation to Price Impact Analysis

By the time the Decision was issued, the parties had agreed on the proper answer to the first question before the Court: the generic nature of an alleged misrepresentation is relevant to a price impact analysis because “as a rule of thumb, a more-general statement will affect a security’s price less than a more-specific statement on the same question.”[10]  The parties did, however, disagree as to “whether the Second Circuit properly considered the generic nature of the Bank’s alleged misrepresentations.”[11]  Unsure as to whether the Second Circuit had properly considered the generic nature of the Bank’s statements in affirming the district court’s class certification ruling, the Court vacated and remanded to the Second Circuit with instruction to “take into account all record evidence relevant to price impact.”[12]

Who Has the Burden of Persuasion?

Leaning entirely on the Court’s prior opinions in Basic and Haliburton II,[13] the Court held that “the defendant bears the burden of persuasion to prove a lack of price impact” and that “the defendant must carry that burden by a preponderance of the evidence.”[14]  The Court further explained that Federal Rule of Evidence 301—which generally allocates the burden of persuasion to plaintiffs—did not suggest otherwise.  According to the majority, Rule 301 did not restrict the Court’s ability to “change the customary burdens of persuasion,” and, in any event, Basic and Halliburton II had already done so by requiring securities-fraud defendants to “sever the link between a misrepresentation and the price paid by the plaintiff.”[15]   

The majority then proceeded to assure potential defendants that its decision was “unlikely to make much difference on the ground.”[16]  According to the majority, district courts must “assess all the evidence of price impact—direct and indirect—[to] determine whether it is more likely than not that the alleged misrepresentation had a price impact” and “[t]he defendant’s burden of persuasion will have bite only” in the “rare[]” circumstance where the evidence on price impact is in “equipoise.”[17] 

Justice Gorsuch’s Dissent

Justice Gorsuch dissented from the Court’s resolution of the burden of persuasion question.  Writing for Justices Thomas and Alito, he argued that Basic and Halliburton II did not require—or even support—the Court’s holding.  He further argued that the law—as exemplified by Title VII—generally shifts burdens of production, not persuasion, to defendants.  Furthermore, he criticized the majority’s efforts to minimize the significance of its own holding, writing that “[t]he whole reason we allocate the burden of persuasion is to resolve close cases by providing a tie breaker where the burden does make a difference.”[18] 

Subsequent Caselaw

Federal courts have not yet had the opportunity to grapple with the Decision’s holdings in depth.  To the extent the Decision has played a role in a court’s analysis, it generally supports, rather than inhibits, class certification.  In the Decision itself, the Second Circuit subsequently remanded the case on the grounds that it was “unclear whether the district court considered the generic nature of the Bank’s alleged misrepresentations.”[19]  Following that, the district court again certified the class, finding that there was a “comfortable” “gap in genericness between the alleged misstatements and subsequent corrective disclosures” such that the Bank had failed to demonstrate “a complete lack of price impact attributable to the alleged misstatements.”[20] 

In September 2021, another district court in the Southern District relied on the Decision’s allocation of the burden of persuasion to conclude that defendants had failed to rebut the Basic presumption.  In that case, plaintiffs argued that defendant, a global pharmaceutical and medical products company that sells textured breast implants, materially downplayed the risk of recall of its implants due to a growing concern that the use of breast implants was associated with a higher risk of developing certain types of cancer.[21]  At the class certification stage, defendants argued that the alleged misrepresentations had no price impact but did not dispute that the misrepresentations were in certain key financial disclosures and that the factors informing market efficiency favored the purported class.  The district court relied on the Decision’s burden-of-persuasion holding to rule that the defendants failed to carry their burden of persuasion and ultimately certified the class.[22]      

In October 2021, a district court in the Central District of California also relied on the Decision to certify a class.  In that case, the plaintiffs alleged that officials at Mattel, Inc. identified material misrepresentations in certain tax-related disclosures in its 2017 financial statements.  Following a whistleblower-led investigation, Mattel filed a Form 8-K amending its 2017 financial data.  The plaintiffs claimed damages based on their purchases of Mattel stock between mid-2017 and mid-2019.[23]  The defendants opposed class certification, arguing that investors did not assess Mattel’s value based on the alleged tax-related misrepresentations.  In certifying a class, the district court distinguished the specificity of the alleged misrepresentations in Mattel from the generic nature of the alleged misrepresentations.  The court also relied on the Decision’s instruction to “assess all the evidence of price impact—direct and indirect.”[24] 

Takeaways and Concluding Thoughts

The Decision will not revolutionize securities litigation.  It does, however, clarify two points.  First, all probative evidence on price impact must be considered at the class certification stage, including whether an alleged misrepresentation was generic or specific.  The more specific a misrepresentation, the more likely it is to impact the price of a security, triggering reliance under the fraud-on-the-market theory.  Second, when defendants endeavor to defeat the Basic presumption, they bear the burden of persuading the court by a preponderance of the evidence that their alleged misrepresentation or omission had no impact on the price of their security.  The exact import of this second holding will depend on whether Justice Barrett is right that the burden of persuasion will rarely be outcome determinative.  Regardless, the Decision will help plaintiffs by making it at least a little easier for them to prove reliance, typically an important hurdle to class certification.

[2] Id. at 1958. 

[3] Id. (quoting Erica P. John Fund, Inc. v. Halliburton Co., 586 U.S. 804, 813 (2011)). 

[4] Id.

[5] Id. at 1959 (internal quotation marks omitted). 

[6] See id. at 1958–59 (explaining that the Basic presumption is uniquely helpful to plaintiffs in securities-fraud class actions as “individualized issues of reliance ordinarily . . . defeat predominance” for class certification purposes).

[7] Id. at 1959–60.

[8] As Justice Barrett explained: “[t]he Second Circuit held that [the Bank bore] the burden of persuasion to prove a lack of price impact by a preponderance of the evidence.  But it concluded that the District Court erred by holding the Bank to a higher burden of proof and by refusing to consider some of Goldman’s price impact evidence.”  Id. at 1960. 

[9] Id. at 1960, 1962.

[10] Id. at 1960 (internal quotation marks omitted). 

[11] Id. at 1961. 

[12] Id.  Justice Sotomayor dissented as to this narrow issue, arguing that the Second Circuit had already properly considered the generic nature of the Bank’s statements.  Id. at 1963–65 (Sotomayor, J., concurring in part and dissenting in part).   

[13] Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014).

[14] Id. at 1963. 

[15] Id. at 1962 (alteration and internal quotation marks omitted).

[16] Id. at 1963. 

[17] Id.

[18] Id. at 1970 (Gorsuch, J., concurring in part and dissenting in part). 

[19] 11 F.4th 138, 143 (2d Cir. 2021).

[20] No. 10-CV-3461, 2021 WL 5826285, at *15 (Dec. 8, 2021).

[21] See In re Allergan PLC Sec. Litig., No. 18-CV-12089, 2021 WL 4077942, at *2–3 (S.D.N.Y. Sept. 8, 2021).

[22] Id. at *12–14, *17.

[23] See In re Mattel, Inc. Sec. Litig., No. 19-CV-10860, 2021 WL 1259405, at *2–4 (C.D. Cal. Jan. 26, 2021).

[24] See In re Mattel, Inc. Sec. Litig., No. 19-CV-10860, 2021 WL 4704578, at *5–6 (C.D. Cal. Oct. 6, 2021).