Supreme Court Holds That Courts Must Consider “All Evidence” Relevant to Price Impact in Securities-Fraud Class Actions

On June 21, 2021, the Supreme Court held in Goldman Sachs Group v. Arkansas Teacher Retirement System that, in an action for securities fraud, courts must consider the generic nature of alleged misstatements when determining whether those statements affected a stock’s price—and thus when determining whether a presumption of reliance is warranted. The Court also held that defendants bear the burden of persuasion when rebutting that presumption. The decision ensures that defendants in securities-fraud class actions have a meaningful opportunity to defeat certification.

Background

Private plaintiffs alleging securities fraud under Section 10(b) of the Securities and Exchange Act of 1934 must establish that they bought or sold a security in “reliance” on a material misstatement. In Basic v. Levinson (1988), the Supreme Court adopted a rebuttable presumption, based on the fraud-on-the-market theory, under which reliance is presumed if the alleged misstatement was public; the security traded in an efficient market; and the plaintiffs traded after the misrepresentation was made but before the truth was revealed. In Halliburton v. Erica P. John Fund (2014) (Halliburton II), the Supreme Court confirmed that defendants could rebut the Basic presumption by showing the “absence of price impact”—that is, that the alleged misstatements had no effect on the price of the security at issue. Parties often litigate whether the Basic presumption applies at the class-certification stage because, without the benefit of the presumption, individualized issues of reliance would usually prevent class certification.

In 2010, shareholders of the Goldman Sachs Group, Inc. brought a putative securities-fraud class action in federal court, alleging that certain general public statements from Goldman’s SEC filings and annual reports—for example, “[o]ur clients’ interests always come first” and “[w]e have extensive procedures and controls that are designed to identify and address conflicts of interests”—were material misstatements. The shareholders moved to certify a class, invoking the Basic presumption.

To demonstrate price impact, the shareholders relied on what is known as the inflation-maintenance theory. Under that theory, plaintiffs claim that a misstatement caused the price of the security artificially to remain inflated by preventing preexisting inflation from dissipating. According to the Goldman shareholders, Goldman’s alleged misstatements caused Goldman’s stock to trade at an artificially inflated level until news of a government enforcement action revealed that the statements were false—thus causing the stock price to drop. In response, Goldman sought to rebut the Basic presumption by showing that the misstatements did not affect the stock price. Goldman pointed to the generic, aspirational nature of the misstatements, as well as extensive expert testimony demonstrating a lack of price impact, to support its argument.

The district court certified the class, and the Second Circuit affirmed in a divided decision. The majority declined to consider the generic nature of the alleged misstatements when deciding whether price impact had been shown. In doing so, the majority relied on the Supreme Court’s decision in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds (2013), which held that a court may not decide the materiality element of a securities-fraud claim at class certification. In the Second Circuit’s view, considering the generic nature of a statement when determining price impact would “smuggle materiality” into the
class-certification inquiry because the generic nature of a statement is also relevant to materiality. Judge Sullivan dissented, faulting the majority for refusing to “consider the nature of the alleged misstatements” when assessing price impact.

The Supreme Court granted review on two questions: first, whether a defendant in a securities class action may rebut the Basic presumption by pointing to the generic nature of the alleged misstatements in showing that the statements had no price impact; and second, whether a defendant seeking to rebut the Basic presumption has the ultimate burden of persuasion or only the initial burden of production. Paul, Weiss represented Goldman at the Supreme Court.

The Supreme Court’s Decision

In an opinion written by Justice Barrett, the Supreme Court unanimously held that a court must consider all evidence relevant to price impact at the class-certification stage, even if that evidence is also relevant to materiality. The Court understood that conclusion to follow from both Halliburton II and other class-certification precedents and did not read Amgen as requiring otherwise. The Court explained that the generic nature of a misrepresentation will often be “important” evidence of price impact because a more general statement is less likely to affect a security’s price than a more specific one. A court must consider that “common sense” reality, the Supreme Court held, when assessing price impact at class certification.

The Court added that the generic nature of a misstatement is “particularly” relevant in inflation-maintenance cases. The critical inference underlying that theory, the Court explained, is that a price drop at one point in time is evidence that the alleged misstatements inflated the price at an earlier point in time. But that inference breaks down, the Court continued, if there is a “mismatch” between the content of a corrective disclosure (which allegedly caused the price drop on the “back end”) and the generic misrepresentations (which allegedly inflated the price on the “front end”). In such a circumstance, the Court concluded, there is less reason to infer price impact.

The Court also held that defendants bear the ultimate burden of persuasion when attempting to rebut the Basic presumption. The Court reasoned that Basic and Halliburton II required defendants to “show” that a misrepresentation did not affect the stock’s price, and the Court interpreted that language to require the defendant to bear the ultimate burden of persuasion and not simply to carry an initial burden of production. Justice Gorsuch, joined by Justices Thomas and Alito, dissented on that issue; they would have followed the general rule that a presumption shifts only the burden of production and not the burden of persuasion.

Because the Court was unsure whether the Second Circuit properly considered the generic nature of the alleged misstatements, the Court vacated the judgment below and remanded for further consideration. Justice Sotomayor dissented from that remedial holding; in her view, the Second Circuit properly considered the generic nature of the alleged misstatements.

Implications

The Court’s decision in Goldman should ensure that defendants in securities-fraud class actions have a meaningful opportunity to rebut the Basic presumption by showing a lack of price impact. Though Halliburton II reaffirmed that defendants must have such an opportunity, the practical reality is that defendants have been able to show a lack of price impact in only a few isolated cases. The decision in Goldman should help ensure that the Basic presumption remains a rebuttable one.

To begin with, the decision in Goldman reaffirms that courts must consider all evidence relevant to price impact at class certification, even if that evidence overlaps with materiality. That holding clears up any lingering confusion from Amgen, which had caused some courts (like the Second Circuit here) to disregard evidence probative of price impact on the ground that the evidence was also relevant to materiality.

The decision in Goldman also offers a roadmap to defendants seeking to rebut the inflation-maintenance theory. The Court noted that a defendant can rebut that theory by showing a “mismatch” between the content of the misrepresentation and the corrective disclosure. Demonstrating such a mismatch—for example, where the front-end statement is far more generic than the back-end correction, or when the two statements address different subjects entirely—will likely aid defendants in countering increasingly inventive invocations of the inflation-maintenance theory. Indeed, in Blackberry Limited v. Pearlstein, another
price-impact case currently pending in the Second Circuit, defendants have already attempted to rely on Goldman to defeat the inflation-maintenance theory. Defendants may similarly rely on Goldman to argue—even at the pleading stage—that a “mismatch” between an alleged misrepresentation and a corrective disclosure severs the causal link between the alleged fraud and plaintiffs’ damages, negating the essential element of loss causation.

Finally, the Supreme Court clarified that defendants bear the ultimate burden of persuasion, not just the initial burden of production, when seeking to rebut the Basic presumption. But that aspect of the decision is unlikely to have significant effect in most cases. As the Court explained, the burden of persuasion has “bite” only when the evidence is in “equipoise.”

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