Wednesday, June 13, 2012

Former SEC Commissioners Had Urged Supreme Court to Review Ninth Circuit Ruling on Materialty in Fraud-on-the-Market Case

Five former SEC Commissioners had urged, in an amicus brief,  the Supreme Court to grant certiorari in the Amgen case to resolve the conflict among the federal courts of appeals and to address what the Commissioners called the doctrinal inconsistencies created by the Ninth Circuit’s decision that plaintiffs in a Rule 10b-5 action need not prove materiality to use the fraud-on-the-market doctrine at the class certification stage. The former SEC Commissioners are Joseph Grundfest, Aulana Peters, Philip Lochner, Charles Cox and Paul Atkins. They were joined on the brief by former SEC General Counsel Brian Cartright.

The former SEC officials argued that the Ninth Circuit’s decision strikes at the heart of the Court’s holding in Basic Inc. v. Levinson, 485 U.S. 224 (1988), which recognized that in order to benefit from a presumption of class-wide 
reliance, a securities fraud plaintiff must show at the class certification stage that the essential predicates to the fraud-on-the-market theory have been satisfied. The crux of the fraud-on-the-market theory is that, in an efficient market, all public material information will be reflected in the price of a security. An investor who purchases a security relying on the integrity of its market price relies on any material misrepresentations that have been made to the market. If, however, the value of a security reacts to immaterial information, then by definition the market in that security is not efficient and Basic’s presumption of class-wide reliance does not apply.

In the view of the former Commissioners, materiality is thus a critical component of the very theory that makes class certification of Section 10(b) claims possible. Basic recognized that any showing that severs the link between an alleged misrepresentation and the market price of a security, including a showing that a misrepresentation was immaterial, rebuts the presumption of reliance and makes class certification improper. They contend that the Ninth Circuit failed to follow these important principles when it held that a Section 10(b) plaintiff need not demonstrate materiality in order to obtain class certification.

The Ninth Circuit’s misunderstanding of Basic has significant implications, explained amici, since securities class actions are almost always settled once a class is certified. Thus, alleged misstatement will in practice never be tested beyond the pleading requirements, unless it is tested as part of the Rule 23 inquiry. Plaintiffs’ allegations of reliance therefore will never be tested either. The former Commissioners are concerned that, left standing, the Ninth Circuit’s decision unleashes the considerable in terrorem power of class certification to compel settlement of even questionable claims without any meaningful inquiry into materiality or reliance, even though the Supreme Court in  Basic established that these are critical issues at the class certification stage.