The 10b-5 Daily

In securities class actions, plaintiffs often take a shotgun approach and allege that the defendants made numerous false statements throughout the putative class period.  Whether that helps avoid dismissal, however, is an open question.

In City of Plantation Police Officers Pension Fund v. Meredith Corp., 16 F.4th 553 (8th Cir. 2021), the plaintiffs alleged that Meredith Corp. – during a 19-month class period – made 138 false statements relating to its acquisition and integration of Time, Inc. (the owner of Time, People, Sports Illustrated, and other magazines).  On appeal, the court found that 137 of the 138 statements were not actionable because they “were clearly either (1) statements identified as forward-looking and accompanied by meaningful cautionary statements, (2) corporate puffery, or (3) forward-looking statements that the complaint’s allegations do not imply by strong inference were made with actual knowledge of their falsity.”  But what about that 138th statement?

Meredith’s CEO claimed that the company had “fully integrated [its ]HR, finance, legal and IT functions.”  According to a former Meredith employee, however, at that time the legacy Meredith employees and legacy Time employees were still operating on different finance software systems.  The court found that this was a bit of a closer call, but concluded that nothing in the complaint provided “any insight” into what the CEO actually knew about the integration of the finance departments.  A more plausible inference than fraudulent intent was that the CEO made the statement because he had limited information.

Holding: Dismissal affirmed.

A recent decision by the U.S. Court of Appeals for the Ninth Circuit offers potential lessons for both companies and their securities defense counsel. 

In In re Alphabet, Inc. Sec. Lit., 1 F.4th 687 (9th Cir. 2021), the plaintiffs alleged that Alphabet – Google’s parent company – failed to disclose that a securities glitch in the Google+ social network had left the private data of hundreds of thousands of users exposed to third-party developers and that Google+ was plagued by other security vulnerabilities.  Google discovered these issues in early 2018 and remediated them.  In October 2018, however, the Wall Street Journal published a lengthy story about the Google+ issues and how the company had decided not to tell the public about them during a time when technology companies were under regulatory scrutiny for their handling of customer data.  Google responded with a blog post acknowledging what had happened and announcing that it was shutting down the Google+ social network.  Alphabet’s stock price fell following these disclosures and a securities class action was filed shortly thereafter.

The district court dismissed the case, finding that the plaintiffs failed to adequately plead the existence of material misstatements and scienter.  On appeal, however, the Ninth Circuit reversed the decision as to some of the claims.

Most importantly, the panel considered whether Alphabet’s Form 10-Qs issued in April 2018 and July 2018 were materially misleading.  The risk disclosures incorporated into those filings “warned, among other things, that even unfounded concerns about Alphabet’s ‘practices with regard to the collection, use, disclosure, or security of personal information or other privacy related matters’ could damage the company’s ‘reputation and adversely affect [its] operating results.'”  While some courts have questioned whether risk disclosures can ever form the basis for a securities fraud claim because they are inherently prospective in nature, the Ninth Circuit previously has held that if risk disclosures do not alert the reader that the described risks already have come to fruition they may be actionable. 

Alphabet argued that there was a key factual difference between its case and the Ninth Circuit precedent: by the time the Form 10-Qs were issued, Google already had remediated the problem.  Therefore, the company had no affirmative duty to disclose a problem that no longer existed.  The panel disagreed, finding that because “Google’s business model was based on trust, the material implications of a bug that improperly exposed user data for three years were not eliminated merely by plugging the hole in Google+’s security.”  Moreover, Google also had discovered other security vulnerabilities that led to the decision to shut down the whole platform.  Under these circumstances, the panel held that Google needed to update its risk factors if they wanted to avoid making materially misleading statements.  (The panel also found that the plaintiffs had adequately alleged the defendants’ scienter as to these risk factors.)

In addition, the plaintiffs brought claims under all three subsections of Rule 10b-5.  That is to say, the plaintiffs alleged the defendants (a) made material misstatements under Rule 10b-5(b), and (b) disseminated and approved material misstatements and engaged in a course of conduct to conceal the truth from investors under under Rule 10b-5(a) and Rule 10b-5(c) (often referred to as “scheme liability”).  On appeal, the plaintiffs argued that the district court failed to address their scheme liability claims and therefore erred in dismissing them.  Alphabet countered that the plaintiffs had waived those claims by not raising them in their opposition to Alphabet’s motion to dismiss and, in any event, the scheme liability claims were duplicative of the material misstatement claims.

The panel disagreed.  It noted that Alphabet’s motion to dismiss had not specifically targeted the scheme liability claims, so the plaintiffs could not have waived those claims in its opposition.  Moreover, the scheme liability claims were not merely duplicative.  Under Lorenzo – a 2019 decision by the U.S. Supreme Court – it was possible for the plaintiffs to bring separate “scheme liability” claims even if the underlying conduct involved material misstatements.  Accordingly, the panel reversed the dismissal of all of the plaintiffs’ claims brought under Rule 10b-5(a) and (c).

Holding: Reversed in part, affirmed in part, judgment vacated, remanding for further proceedings.

Notes:  (1) Companies headquartered in the Ninth Circuit will need to think carefully about the scope of their disclosures.  Merely by disclosing the risk of data security issues, Alphabet apparently also was required to disclose any material data security issues that had arisen in the past and were already resolved.  The panel’s view of a company’s duty of disclosure arguably goes well beyond what other courts have found Section 10(b) and Rule 10b-5 to require.

(2) Securities defense counsel are now on notice that they must separately and specifically address scheme liability claims in the motion to dismiss or risk the court finding that they were unopposed.

(3) The defendants moved for rehearing or rehearing en banc, which was denied on July 23, 2021.  Then, last week, the defendants filed a motion to stay mandate pending the filing of a petition for writ of certiorari to the U.S. Supreme Court.  Stay tuned.

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.

On Monday, the U.S. Supreme Court heard oral argument in the Goldman Sachs v. Arkansas case, which addresses issues related to class certification in securities cases.

To certify a class on behalf of all investors who purchased shares during the 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.

Defendants have the ability to rebut the Basic presumption, and defeat class certification, by demonstrating that the alleged misrepresentations did not have any price impact.  The questions presented in Goldman are whether defendants can do so by pointing to the generic nature of the alleged misrepresentations and whether a defendant seeking to rebut the Basic presumption has only a burden of production or also the ultimate burden of persuasion.

At oral argument, the Court appeared peeved that the first question might not be much of a question at all.  Chief Justice Roberts asked petitioners (Goldman) whether there was “any daylight on the substantive question between the [parties] concerning the generic statements?”  And, indeed, both sides (as well as the government as amicus) agreed that the generic nature of the misstatements could be evidence of a lack of price impact.  As a result, the argument focused on two sub-issues: (a) does the court have to rely solely on experts in assessing the existence of price impact, and (b) did the Second Circuit’s decision below really fail to take the generic nature of the alleged misstatements into account.

As to whether courts need to rely solely on experts, the justices appeared sympathetic to petitioners’ argument that the court also could apply its own judgment.  Justice Breyer, in particular, noted that “Take the statement for what it’s worth. Listen to the experts, and don’t check your . . . common sense at the door. That’s what judges do. So why are we hearing that issue?”  Similarly, Justice Barrett wondered whether all that was now on the table was a “ruling on that very, very narrow issue, saying, sure, judges can also consider their common sense.”  And, indeed, both the government and the respondents argued that courts could rely on common sense in determining price impact, although respondents suggested that “the more there is expert testimony . . . the more the judge ought to be evaluating the experts” and not relying on his or her own view of “how economic markets work.”

There did appear to be a genuine disagreement, however, on whether the Second Circuit really had held that the generic nature of the alleged misstatements could not be considered.  Justice Sotomayor appeared to agree with the government and respondents that the Second Circuit’s opinion below contained some ambiguity on that point and suggested that the best approach might be to affirm the decision while clarifying the correct law.  Meanwhile, petitioners and respondents debated whether, if the Court were to decide that the correct legal standard had not been applied, the Second Circuit’s decision should be reversed (petitioners) or merely vacated and remanded with further instructions (respondents).  This issue, as the government pointed out, is meaningful to the parties, but does not impact the Court’s formulation of the law.

Finally, on the second question presented, only two justices indicated that they might support petitioners’ argument that plaintiffs should bear the burden of persuasion as to price impact given that they bear the overall burden of persuasion as to class certification.  Justice Gorsuch expressed concern that “the plaintiff might be able to do nothing and just rest on the presumption that there’s a price impact in the face of direct evidence that there wasn’t.”  Similarly, Justice Alito questioned how a judge is supposed to deal with a situation where the plaintiffs were not required to provide evidence of price impact.  On the other hand, respondents correctly pointed out that every court of appeals that has addressed the issue, including the Seventh Circuit in a decision joined by then-Circuit Judge Barrett, has found that defendants bear the burden of persuasion in rebutting the Basic presumption.  Moreover, after persistent questioning from Justice Gorsuch, respondents conceded that if plaintiffs choose to rely entirely on the presumption in the face of direct evidence of no price impact a court “absolutely can find that the defendants prevail.”

Overall, it would appear that the Court is headed for a narrow decision (a) clarifying that courts can and should take the generic nature of the alleged misstatements into account when assessing price impact, and (b) holding that defendants have the burden of persuasion in rebutting the Basic presumption of reliance.  But whether that decision, which is expected by June, will come in the form of an affirmance, reversal, or vacatur is far from clear.

Disclosure: The author of The 10b-5 Daily assisted the Washington Legal Foundation in the submission of an amicus brief in support of the petitioners.