It would appear that the third time’s the charm, at least for Goldman Sachs in its long-running securities class action related to certain collateralized debt obligation (CDO) transactions. For the past several years, the key issue in the case has been whether Goldman’s alleged misrepresentations about its business principles and potential conflicts of interest had any stock price impact, and therefore could support the presumption of reliance necessary to certify a class. The question has been the subject of two Second Circuit appeals and a Supreme Court decision. Late last week, as part of the third appeal to the Second Circuit, that court finally decided to deny the certification of the class.
As way of background, to certify a class on behalf of all investors who purchased shares during a class period, plaintiffs usually invoke a presumption of reliance created by the Supreme Court in the Basic case. Under the Basic presumption, plaintiffs can establish class-wide reliance by showing (1) that the alleged misrepresentations were publicly known, (2) that they were material, (3) that the stock traded in an efficient market, and (4) that the plaintiff traded the stock between the time that the misrepresentations were made and when the truth was revealed. These requirements are based on the efficient market hypothesis, which, as relevant here, posits that in an efficient market any material statements will impact a stock’s price. If all four elements are met, any investor trading in such a market can be presumed to have relied upon the stock’s price and all material statements (or misstatements) about the stock. Accordingly, the Court has held that the Basic requirements are merely an “indirect proxy for price impact,” which is the true underpinning of the presumption of reliance.
Without the Basic presumption, individualized issues of reliance would normally prevent any attempt to certify a class in a securities fraud class action. Defendants have the ability to rebut the Basic presumption, and defeat class certification, by demonstrating that the alleged misrepresentations did not have a price impact.
Picking up the story at the Supreme Court, in Goldman the Court considered whether defendants can, at least in part, demonstrate a lack of price impact by pointing to the generic nature of the alleged misrepresentations. The Court held that “a court cannot conclude that Rule 23’s requirements are satisfied without considering all evidence relevant to price impact.” That is the true even if the evidence – like the generic nature of the alleged misrepresentations – “is also relevant to a merits question like materiality.” Moreover, the Court noted that an inference of price impact “break[s] down” when “there is a mismatch between the contents of the misrepresentation and the corrective disclosure,” especially where “the earlier misrepresentation is generic . . . and the later corrective disclosure is specific.” This inquiry into the nature of the alleged misrepresentations especially is relevant in cases like Goldman where plaintiffs, invoking the “inflation maintenance theory,” argue that the misrepresentations did not increase the company’s stock price, but instead merely prevented it from falling. The Court concluded that it had some “doubt” as to whether the Second Circuit had “properly considered the generic nature of Goldman’s alleged misrepresentations” and remanded with instructions for the lower court to “take into account all record evidence relevant to price impact.”
Back at the district court level, the court once again found that Goldman had failed to demonstrate that the alleged misrepresentations did not have a stock price impact. In particular, the district court concluded that the Supreme Court’s “mismatch” test was satisfied because the alleged corrective disclosures at issue “implicated” the same subject matter as the misrepresentations. Goldman again appealed the district court’s decision to certify the class.
In Arkansas Teacher Retirement System v. Goldman Sachs Group, 2023 WL 5112157 (2nd Cir. August 10, 2023), the Second Circuit considered whether the district court had adequately applied the Supreme Court’s analytical framework in assessing the evidence of price impact. In a long, and at times convoluted, opinion, the court concluded that Goldman had sufficiently severed the link between the alleged misrepresentations and any price impact. In particular, the court found that the district court’s opinion misapplied the Supreme Court’s framework to the plaintiffs’ inflation-maintenance theory. Having “acknowledged a considerable gap in specificity between the corrective disclosures and alleged misrepresentations,” the district court “should have asked what would have happened if the company has spoken truthfully at an equally generic level.” Instead, the district court determined that the alleged misrepresentations had not been consciously relied upon by investors when they were made, but found that they would have been relied upon had Goldman disclosed the details and severity of its misconduct. The Second Circuit concluded that the district court had “concoct[ed] a highly specific truthful substitute” for the alleged misrepresentations that “look[ed] nothing like the original,” thereby violating the Supreme Court’s guidance that an inference of price impact “breaks down” where the misrepresentations are more generic than the corrective disclosures.
Going forward, the Second Circuit noted that “a searching price impact analysis must be conducted where (1) there is a considerable gap in front-end-back-end genericness . . ., (2) the corrective disclosure does not directly refer . . . to the alleged misstatement, and (3) the plaintiff claims . . . that a company’s generic risk-disclosure was misleading by omission.” The key question is “whether a truthful – but equally generic – substitute for the alleged misrepresentation would have impacted the price.” As to the Goldman case, the Second Circuit concluded that the expert evidence put forward by the parties did not support that conclusion.
Holding: Case remanded with instructions to decertify the class.
Quote of note: “In cases based on the theory plaintiffs press here, a plaintiff cannot (a) identify a specific back-end, price-dropping event, (b) find a front-end disclosure bearing on the same subject, and then (c) assert securities fraud, unless the front-end disclosure is sufficiently detailed in the first place. The central focus, in other words, is ensuring that the front-end disclosure and back-end event stand on equal footing; a mismatch in specificity between the two undercuts a plaintiffs’ theory that investors would have expected more from the front-end disclosure.”
Disclosure: The author of The 10b-5 Daily participated in an amicus brief in support of Goldman filed by the Washington Legal Foundation.
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