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 at
class 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