The U.S. Supreme Court has issued a decision in the Goldman Sachs v. Arkansas case. As predicted, it is a narrow opinion (a) clarifying that courts can and should take the generic nature of the alleged misstatements into account when assessing price impact for purposes of class certification, and (b) holding that defendants have the burden of persuasion in rebutting the Basic presumption of reliance. The majority opinion was authored by Justice Barrett. It is a 8-1 decision on the issue of taking the generic nature of the alleged misstatements into account (with Justice Sotomayor dissenting only as to whether a remand of the case was necessary) and a 6-3 decision on the issue of the burden of persuasion (with Justices Gorsuch, Thomas, and Alito concluding in dissent that defendants should have only a burden of production).
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 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.
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.” The inquiry into the nature of the alleged misrepresentations is especially relevant in cases like Goldman where the plaintiffs, invoking the “inflation maintenance theory,” argued that the misrepresentations did not increase Goldman’s stock price, but instead merely prevented it from falling. The Court found 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.”
While Goldman won a clear victory on that issue, it was not as fortunate on the question of the burden of persuasion. The Court noted that under applicable law, it has “the authority to assign defendants the burden of persuasion to prove a lack of price impact.” Accordingly, the only question was whether the Court had already done so in its previous decisions addressing the Basic presumption. The Court found that the “best reading” of its precedents is “that the defendant bears the burden of persuasion to prove a lack of price impact.” In any event, the Court noted, “the allocation of the burden is unlikely to make much difference on the ground” because the district court’s task is “to determine whether it is more likely than not that the alleged misrepresentations had a price impact.” Unless the district court finds that the evidence is in “equipoise,” a situation the Court stated “should rarely arise,” there is no negative impact on defendants from having this burden.
Holding: Judgment vacated and case remanded for further proceedings consistent with the opinion.
Additional notes on the decision:
(1) There arguably is a circuit split on the issue of whether the inflation maintenance theory is legally cognizable under the federal securities laws and the Court’s prior decisions. In Goldman, the Court stated that it was not expressing any “view on [the theory’s] validity or its contours.” As a result, that issue remains one for a future case.
(2) Justice Gorsuch, in a vigorous dissent (joined by Justices Thomas and Alito) on the issue of the burden of persuasion, stated that the “hard truth is that in the 30-plus years since Basic this Court has never (before) suggested that plaintiffs are relieved from carrying the burden of persuasion on any aspect of their own causes of action.” Addressing the majority’s insistence that shifting the burden of persuasion would have little practical effect, Justice Gorsuch noted that the “whole reason we allocate the burden of persuasion is to resolve close cases by providing a tie breaker where the burden does make a difference.” The fact that close cases may be uncommon “is no justification for indifference about how the law resolves them.”
Disclaimer: The author of The 10b-5 Daily assisted with the submission of an amicus brief by the Washington Legal Foundation in support of the petitioner.