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(Article from Securities Law Alert, January 2018) 

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On January 12, 2018, the Second Circuit vacated class certification in a securities fraud action in which defendants attempted to rebut the Basic presumption with price impact evidence.[1] Arkansas Teachers Ret. Sys. v. Goldman Sachs Grp., 2018 WL 385215 (2d Cir. 2018) (Wesley, J.) (Arkansas Teachers II). The Second Circuit found the district court may have imposed a higher burden than the “preponderance of the evidence” standard it recently adopted in Waggoner v. Barclays, 875 F.3d 79 (2d Cir. 2017).[2] The Second Circuit further ruled that the district court “erred in declining to consider” defendants’ price impact evidence at the class certification stage.

To Rebut the Basic Presumption at the Class Certification Stage, Defendants Must Only Demonstrate a Lack of Price Impact by a Preponderance of the Evidence

In the decision below, the district court found defendants’ proffered evidence of price impact insufficient to rebut the Basic presumption because defendants did “not provide conclusive evidence that no link exists between the price decline and the misrepresentation.” In re Goldman Sachs Grp. Sec. Litig., 2015 WL 5613150 (S.D.N.Y. 2015) (Arkansas Teachers I). Defendants argued on appeal that the district court “imposed an impermissibly high evidentiary burden by requiring them to rebut the Basic presumption with conclusive proof of a lack of price impact.” Arkansas Teachers II, 2018 WL 385215.

After the district court issued its decision, the Second Circuit in Waggoner held that defendants must “do more than merely produce evidence that might result in a favorable outcome.” Waggoner, 875 F.3d 79. The Waggoner court ruled that “defendants seeking to rebut the Basic presumption must demonstrate a lack of price impact by a preponderance of the evidence at the class certification stage rather than merely meet a burden of production.”

In Arkansas Teachers II, the Second Circuit found it “unclear …whether the [district] court required more of defendants than a preponderance of the evidence.” 2018 WL 385215. The Second Circuit therefore vacated the district court’s decision and remanded for the court “to reconsider defendants’ evidence in light of the [Waggoner] standard.”

Courts Must Consider Price Impact Evidence at the Class Certification Stage

During the class certification proceedings, defendants produced evidence that there was no decline in the price of the company’s stock on more than thirty dates when news sources reported the company’s alleged conflicts of interest in the transactions at issue. The Second Circuit found the district court erroneously “construed this evidence as ‘an inappropriate truth on the market defense’ or as evidence of the statements’ lack of materiality, neither of which the court thought it could consider at the class certification stage.” Id. (quoting Arkansas Teachers I, 2015 WL 5613150). The district court did not hold an evidentiary hearing or an oral argument to address defendants’ price impact evidence.

On appeal, the Second Circuit explained that “[t]he ‘truth on the market’ defense attacks the timing of the plaintiffs’ purchase of shares” on the theory that “the market was already aware of the truth regarding defendants’ misrepresentations at the time the class members purchased their shares.” Here, it was “undisputed that plaintiffs purchased their shares after the misstatements were made but before the truth was revealed.” The Second Circuit found that “defendants did not present a ‘truth on the market’ defense” but instead presented evidence that alleged “conflicts of interest ‘did not actually affect the stock’s market price.’” Id. (quoting Halliburton Co. v. Erica P. John Fund, 134 S. Ct. 2398 (2014)).

The Second Circuit also distinguished price impact from materiality. The court observed that while “price impact touches on materiality, which is not an appropriate consideration at the class certification stage, it ‘differs from materiality in a crucial respect.’” Id. (quoting Halliburton, 134 S. Ct. 2398). The court explained that “[w]hether a misrepresentation was reflected in the market price at the time of the transaction—whether it had price impact—‘is Basic’s fundamental premise. It … has everything to do with the issue of predominance at the class certification stage.’” Id. (quoting Halliburton, 134 S. Ct. 2398). The Second Circuit emphasized that if an alleged misrepresentation did not affect the stock price, there would be no basis for plaintiffs to assert that they indirectly relied on that misrepresentation through the market price.

The Second Circuit instructed the district court to consider defendants’ price impact evidence on remand, and “encourage[d] the court to hold any evidentiary hearing or oral argument it deems appropriate under the circumstances.”