Thursday, November 01, 2012

Financial Economists Urge Supreme Court to Affirm Ninth Circuit Ruling that Materiality Need Not Be Proven at Class Certification Stage

A group of financial economists urged the US Supreme Court to affirm a Ninth Circuit panel ruling that materiality need not be proven at the class certification stage of a private securities fraud action based on the fraud-on-the-market doctrine.  In an amicus brief, the financial economists said that the showing of materiality at the class certification stage is unworkable in practice and inappropriate in principle. Amici also emphasized that the efficient market hypothesis that the Court relied on in Basic, what the financial economists referred to as the semi-strong version of the efficient market hypothesis (SSEMH), remains widely accepted as a  fundamental principle of modern economic theory. For purposes of class certification and the fraud-on-the-market doctrine, posited amici, the critical aspect of the SSEMH is am efficient market’s ability to incorporate public information in the price of the security. A Ninth Circuit panel ruled that the investor need not prove materiality to use the fraud-on-the-market presumption of reliance at the class certification stage. The case is set for oral argument on November 5, 2012. (Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, Dkt. No. 11-1085).

 In Basic, the Supreme Court endorsed the fraud-on-the-market theory under which courts can presume that securities prices in an open and developed market reflect all material public information and that investors rely on the integrity of the market price. These two presumptions allow investors to establish that they relied, indirectly, on alleged on the false statements of corporate managers. Similarly, argued amici, materiality is a common question to class members. In addition, the economic proof will be unitary for all members of the class and will also be identical to any showing required of the plaintiff-investors on the merits.

The economic arguments that the company offers to challenge the SSEMH, namely that markets do not process all forms of information in the same way or at identical speeds, do not go to the legal question of materiality defined by the Court. Amici further expounded that SSEMH was not a simply a theory that the Court found helpful in rendering its ruling in Basic, but was actually central to the Court’s interpretation of the intent of Congress. If economic revisionism is to drive a departure from the formula the Court employed in Basic, said amici, that decision should be made by Congress and not the Court.

Federal courts invoke the fraud-on-the-market theory to answer the narrow question of whether the plaintiff’s claims, particularly reliance, can be established on a common and class-wide bases, said the financial economists, not to establish that a misstatement harmed each member of the class. What the Basic Court presumed was that a purchaser of a security traded in an efficient market relies on all material statements because all of those statements will be included in the stock price. At class certification, explained amici, courts can remain agnostic as to whether the alleged misrepresentations are material because materiality is inherently a common question. Basic presumes that if the misrepresentation is material it will have been incorporated in the stock price and relied upon, in a unitary way, by each class member.

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