Tuesday, January 16, 2018

Defendant still has burden of persuasion when rebutting Basic presumption of reliance

By Mark S. Nelson, J.D.

The Second Circuit reiterated that a securities fraud defendant bears the burden of persuasion with respect to rebuttal of a plaintiff’s invocation of the Supreme Court’s Basic fraud-on-the-market presumption of reliance. The case arose out of Goldman Sachs Group, Inc.’s alleged failure to disclose conflicts it had regarding collateralized debt obligations involving funds investing in subprime mortgages. The panel followed the holding of a different Second Circuit panel that had previously explained that a securities fraud defendant can rebut the reliance presumption by showing by a preponderance of the evidence that there was no price impact. As a result, the district court’s opinion in the Goldman Sachs case was vacated and remanded for further proceedings, including an evidentiary hearing or other oral argument, both of which the panel encouraged the lower court to pursue (Arkansas Teachers Retirement System v. Goldman Sachs Group, Inc., January 12, 2018, Wesley, R.).

Who has which burden? Plaintiffs, public pensions and others, had alleged that Goldman Sachs misled investors about the role that one of its hedge fund clients played in selecting assets for Abacus 2007 AC-1, a CDO transaction. Goldman Sachs allegedly let the client, which had a short position in the fund, choose particularly risky subprime mortgage assets in the hope that the fund would perform poorly. The plaintiffs also alleged similar conflicts on Goldman Sachs’s part in three other CDO transactions involving subprime mortgages.

The district court had certified the class of Goldman Sachs investors who bought the firm’s common shares between February 2006 and June 2010. On appeal, there was no dispute that most of the requirements for class certification had been satisfied, nor was there any dispute over plaintiffs’ invocation of the Basic presumption and that the plaintiffs’ claims were brought after the alleged misrepresentation yet before the truth about the CDOs was revealed. The parties did dispute the allocation of burdens regarding the rebuttal of price impact.

According to Goldman Sachs, the district court imposed too high a burden on the firm. The Supreme Court in Halliburton II reaffirmed the Basic v. Levinson presumption of reliance, commonly known as the fraud-on-the-market theory, which posits that a company’s share price, when its shares are traded in an efficient market, will take into account all public information. But the justices also held that a securities fraud defendant can rebut this presumption by showing the lack of a price impact. The Second Circuit noted that the absence of a price impact in the Goldman Sachs case could undermine the plaintiffs’ assertion of predominance under Federal Rule of Civil Procedure 23(b)(3).

Goldman Sachs had argued that Federal Rule of Evidence (FRE) 301 puts the burden of persuasion on the plaintiffs. FRE 301 provides that unless a federal law or the FREs state otherwise, a defendant in a civil case has the burden of production, but the burden of persuasion remains with the party that had it originally. Goldman Sachs also relied on language from Basic that the firm said suggests that “[a]ny showing” (emphasis in original) breaking the connection between share price and an alleged misrepresentation would rebut the Basic presumption. According to Goldman Sachs, because the plaintiffs must prove predominance and reliance, they also must also bear the burden of persuasion.

But the Second Circuit said Goldman Sachs’s price impact rebuttal must instead comport with circuit precedent placing the burden of persuasion on securities defendants. In Waggoner, decided last November, a different three-judge panel concluded that the same Basic text cited by Goldman Sachs regarding “any showing” is more consistent with a burden of persuasion than it is with a burden of production. Said the Waggoner panel: “… the Court requires defendants to do more than merely produce evidence that might result in a favorable outcome; they must demonstrate that the misrepresentations did not affect the stock’s price by a preponderance of the evidence” (emphasis in original).

Moreover, the panel in the Goldman Sachs case observed that the Waggoner panel also had countered the FRE 301 theory. According to the Waggoner panel, the Basic presumption has roots in federal securities laws and, thus, satisfies FRE 301’s “federal statute” exception. Still, the case would have to be vacated and remanded because it was unclear to the Second Circuit panel which burden the trial judge had imposed on Goldman Sachs. The district court spoke of “conclusive” proof while also mentioning the Waggoner standard via footnote.

Truth-on-the-market. The Second Circuit, however, noted one error in the district court’s class certification. The district court appeared to view certain evidence presented by Goldman Sachs as being a truth-on-the-market defense. That theory posits that investors could not have relied on misstatements because those misstatements were already known to the market. The panel instead concluded that truth-on-the-market was not offered by Goldman Sachs as defense, but rather offered as evidence that prior revelations about conflicts resulted in no decline in the firm’s share price.

The case is No. 16-250.

No comments: