A plaintiff seeking certification of a class must meet the requirements for class cohesion set out in Federal Rule of Civil Procedure 23(b)(3), said the Commission, which requires that common questions of law or fact predominate over issues specific to individual class members. In securities fraud cases, that inquiry often focuses on whether the element of reliance can be established through proof common to the plaintiff class.
To establish reliance, the investor in this case invoked the fraud-on-the-market presumption. Under that presumption, when a company makes public material misstatements in an efficient market, the misstatements are reflected in the stock’s price, and it is presumed that the investor relies on the misstatements when he or she buys stock at the market price. The application of Rule 23(b)(3) in this case turns on whether a failure to establish materiality at the class certification stage creates a significant risk that individualized reliance inquiries will prove necessary as the case proceeds.
In its brief, the SEC contended that a class plaintiff invoking the fraud-on-the-market presumption need not prove materiality to establish that common issues predominate. A plaintiff must demonstrate that the market is efficient and that the company’s statements were public. If a class was certified without inquiry into those factors, and the court subsequently determined that the market was not efficient or that the statements were not public, the reliance element of the plaintiffs’ claims would depend on proof specific to individual class members, causing individual issues to predominate.
A failure to demonstrate materiality at the class certification stage creates no similar risk, asserted the SEC. Because materiality is determined under a reasonable investor standard, it can be proved or disproved through evidence common to the class. And if the company’s statements are ultimately found not to be material, judgment can be entered for the company on that basis without the need for individualized reliance inquiries.
Thus, there is no basis for requiring this merits showing at class certification, continued amicus, because the class stands or falls together on the element of materiality. Failure to prove materiality does not show that individual issues predominate, said the Commission, it shows that the whole class loses on the merits. Thus, while a plaintiff must prove materiality to successfully establish fraud-on-the-market reliance at summary judgment or at trial, it need not do so at class certification.
The SEC also maintained that class certification is not the appropriate time to litigate a truth-on-the-market defense. Such a defense is a means of disproving materiality by showing that, in light of neutralizing disclosures, reasonable investors would not have regarded particular false statements as significant to their investment decisions. At summary judgment or at trial, the company’s truth-on-the-market defense can be adjudicated based on proof that is common to all class members. And if the defense is successful, judgment can be entered for the company on the merits without the need for further inquiry into individual plaintiffs’ reliance.
Further, the SEC said that the company’s policy concerns about abusive class actions do not justify supplementing the requirements of Rule 23. Congress sought to combat abusive securities fraud actions by enacting legislation that heightened pleading standards and altered how securities fraud class actions are litigated, reasoned the Commission, and the panel appropriately declined to use Rule 23 to test the merits of the plaintiff’s claim.
Similarly, the government found no merit in the company’s contention that the Ninth Circuit panel contravened the Supreme Court’s recent Wal-Mart decision by taking account of the fact that materiality is an element of the merits claim. The court of appeals did not rely on any rigid view of the sort specifically disapproved in Wal-Mart, said the SEC, that merits issues are categorically irrelevant to the class-certification decision. In the SEC’s view, Wal-Mart confirms that the focus at class certification must be on compliance with Rule 23 and not on the plaintiff’s prospects for ultimate success.
Rather, the panel carefully explained how the status of materiality as a separate merits element bears on the Rule 23(b)(3) inquiry. That approach was fully consistent with the Supreme Court’s admonition that lower courts, in deciding whether class certification is appropriate, must address merits issues to the extent necessary to ensure that Rule 23’s requirements are satisfied.
Indeed, continued amicus, the panel cogently explained why materiality differs for these purposes from market efficiency and public disclosure, which must be proved atclass certification. The court explained that, whereas a failure of proof on materiality allows judgment to be entered against all class members, a failure of proof on market efficiency or public disclosure leaves open the possibility that some class members may have meritorious claims so long as they can establish individualized reliance