Six former SEC Commissioners
have urged the US Supreme Court to require investors in a private fraud-on-the-market
securities action seeking to obtain class certification to establish by a
preponderance of the evidence that the alleged misrepresentations were material
in that they affected the stock price. In their amicus brief, the former Commissioners asked the Court
to reverse a Ninth
Circuit panel ruling that investor need not prove materiality at the class
certification stage in order to use the fraud-on-the-market presumption of
reliance. The former SEC Commissioners are Aulana Peters, Charles Cox., Philip
Lochner, Stephen Friedman, Joseph Grundfest, and Paul Atkins. The case is set
for oral argument on November 5. Amgen, Inc. v. Connecticut
According
to the former Commissioners, the Ninth Circuit decision strikes at the heart of
the Court’s 1988 ruling in Basic, Inc. v. Levinson, which recognized that in
order to benefit from a presumption of class-wide reliance, a private
securities fraud plaintiff seeking money damages must show at the class
certification stage that the essential predicates to a fraud-on-the-market
theory are met. The crux of the theory is that an efficient market reflects all
public information in the price of a security. Thus, investors purchasing a
stock relying on the integrity of the market price rely on any material
misstatements made to the market because the effect of the misstatement is
incorporated in the stock price.
It
follows that materiality in the form of information that is incorporated into
securities prices is a necessary condition precedent to the very theory that
makes class certification possible. In Basic, the Court recognized that
whenever the link between an alleged misrepresentation and the market price is
severed the presumption of reliance in not applicable and class certification
is improper. In the view of amici, the Ninth Circuit did not follow these
important principles.
The
Ninth Circuit’s misreading the Supreme Court’s Basic decision, and the role of
materiality in the class certification inquiry, has significant implications. Because
securities are almost always settled when a class is certified, reasoned amici,
the materiality and stock price impact of an alleged misstatement will never be
tested unless examined as part of a Rule 23 inquiry. It follows that the
investor’s allegation of reliance will never be tested.
Thus,
in the view of the former SEC Commissioners, the Ninth Circuit ruling unleashes
the in terrorem power of class certification to compel settlement of even
questionable claims without any meaningful inquiry into materiality or price
impact or the properness of presuming
reliance. The Basic decision teaches that these are critical issues that must
be tested at the class certification stage.
Further,
the Ninth Circuit’s expansive interpretation of the fraud-on-the-market doctrine
untethers the class certification determination from even the most cursory
consideration of materiality. The
panel’s decision is therefore contrary to recent Supreme Court admonitions that
the Rule 10b-5 implied right of action is to be narrowly interpreted.
Amici
assured that the position they are advocating would not impair the SEC’s
ability to enforce the federal securities laws. In civil enforcement actions,
the SEC is not required to establish reliance or causation. Thus, the SEC need
not depend on the fraud-on-the-market theory and
need not prove materiality by way of price impact.