Tuesday, July 21, 2020

Seventh Circuit provides guidance for price impact analysis at certification stage

By Rodney F. Tonkovic, J.D.

A Seventh Circuit panel has remanded an order granting class certification, while providing guidance on how to approach the issue of price impact. In this interlocutory appeal, the panel read three recent Supreme Court opinions concerning the Basic presumption together and reached the conclusion that the district court was in error when it avoided a price impact defense at the class certification stage as being too closely tied to the merits. The panel then provided guidance for remand about how to analyze the issue without paying attention to the implications for the merits (In re Allstate Corporation Securities Litigation, July 16, 2020, Hamilton, D.).

Loosened underwriting. The case arose out of Allstate Corporation's 2013 announcement of a strategy to attract new customers that involved "softening" its underwriting standards. The complaint claimed that almost from the start, claims spiked as this strategy attracted riskier customers. At the time, Allstate attributed the spike to external factors, such as bad weather, but the company came clean in 2015, the plaintiffs say, revealing that the spike was in fact attributable in part to the new, aggressive growth strategy. For its part, Allstate asserted that the market understood that relaxed underwriting standards can lead to increases in claims, but this was a predictable trade-off, and the company monitored the situation to ensure the strategy led to profitability.

Price impact at class certification. Seeking class certification in the district court, the plaintiffs invoked the Basic presumption to show that common issues of fact predominated. To show reliance, the plaintiffs maintained that Allstate's stock trades in large, efficient, public markets, so any false information could be presumed to have been "baked in" to the market price. Allstate countered that the market knew about its strategy's risks and could not have relied on alleged failures to disclose. The plaintiffs argued that this "truth on the market" defense could not be decided on class certification under Amgen, but Allstate maintained that the argument showed a lack of price impact under Halliburton II. The district court characterized the dispute as merits-based and granted the motion for class certification while declining to decide disputed issues of material facts regarding Allstate's defense that there was no price impact.

The Seventh Circuit then granted an interlocutory appeal to provide guidance on how to apply the Basic presumption. District courts are required to "split some very fine hairs," the panel remarked, because they must evaluate the merits of the case without deciding the merits. To provide guidance, the panel examined three recent Supreme Court decisions that grappled with the application of the Basic presumption to class certification and must be read together: Halliburton I (2011), Amgen (2013), and Halliburton II (2014). As the panel put it, the challenge facing a district court considering class certification is how to: "(a) decide whether reliance can be proven by common evidence without (b) delving too far into the merits of the materiality or falsity of the representations at issue, while still (c) reserving loss causation entirely for the merits phase?"

The panel said that the district court granted class certification after admitting, but not engaging with, evidence that Allstate offered to defeat the Basic presumption. The district court judge concluded that this issue was too closely tied to the merits to be considered upon class certification. The panel remarked that this was understandable, but erroneous under Halliburton II. The price impact issue posed by Allstate's and the plaintiffs' rebuttal may not be deferred for the merits. The panel then undertook to explain how to analyze the issue without paying attention to the implications for the merits—without "thinking about a pink elephant."

Guidance for remand. The first issue at stake on remand is the scope of the evidence that district courts are permitted and required to admit when the fraud-on-the-market theory is invoked. In this case, the district court properly admitted an economist's report offered by Allstate analyzing price impact. This report asserted that Allstate's statements had no price impact and that the implications of its growth strategy were already factored into the stock price. The panel agreed that the finding that a lack of price reaction (the "inflation maintenance theory") after the statements did not resolve the issue of price impact.

At issue then was the report's findings that there was also no movement after the alleged corrective disclosures—in essence, if the price didn't go down, it didn't go up in the first place. But, the court noted, there was in fact a subsequent 10% drop. The panel directed the district court on remand to take into account expert findings on the stock price's response when the alleged fraud is revealed "only as backward-looking, indirect evidence of the core question here—'ex ante price distortion' as a constituent part of transaction causation." The panel acknowledged that the distinction between this argument and a truth-on-the-market defense proscribed by Amgen is quite fine.

The panel saw the question as one of scope and specificity. Allstate claimed that its broad, general statements encompassed any subsequent spikes in claims, while the plaintiffs said that these general representations did not encompass more specific statements that should have been made about risks that were realized. The question at class certification, then, the panel advised, was not the truthfulness of Allstate's representations, but whether they were susceptible of common proof, and the level of specificity of the information that the market would have understood Allstate's stock price to transmit at the time. The panel accordingly vacated the class certification and remanded for the district court to find relevant facts as to whether the plaintiffs may invoke the Basic presumption.

The case is No. 19-1830.