Benjamin P. Chapple
On February 27, 2013, the United States Supreme Court, in Amgen, Inc. v. Connecticut Retirement Plans and Trust Funds, a 6-3 decision, concluded that proof of materiality is not a prerequisite to certification of a securities-fraud action that alleges violations of §10(b) or Rule 10b–5. Below is a summary of the Court’s decision.
In all private securities-fraud actions brought under §10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b–5, the plaintiff must prove, inter alia, that it relied on a misrepresentation or omission of material fact that was made by the defendant. In Basic v. Levinson, the United States Supreme Court concluded “requiring proof of direct evidence ‘would place an unnecessarily unrealistic burden on [a] plaintiff who has traded on an impersonal market.'” Slip Op. at 1 (quoting Basic). In order to facilitate the certification of securities-fraud class actions, the Court in Basic fashioned the fraud-on-the-market (“FOTM”) theory. The premise of this theory is that the price of a security that is traded in an efficient market will reflect all publicly available information about a company; therefore, one who purchases a security that trades in an efficient market will be presumed to have relied on that information in purchasing the security. Additionally, “because immaterial information, by definition, does not affect the market price, it cannot be relied upon indirectly by investors who, as the [FOTM] theory presumes, rely on the market price’s integrity.” Slip Op. at 10. As a result, the FOTM theory is inapplicable absent a showing that the misrepresentation or omission was in fact material.
Invoking the FOTM theory, Connecticut Retirement Plans and Trust Funds (“Plaintiff”) sought certification of a securities-fraud class action under Federal Rule of Civil Procedure 23(b)(3) against biotechnology company Amgen Inc. and several of its officers (collectively, “Amgen”). The Plaintiff claims that Amgen violated §10(b) and Rule 10b–5 when it made material misrepresentations and misleading omissions regarding the safety, efficacy, and marketing of two of Amgen’s flagship drugs. As a result of these alleged misrepresentations and omissions, the Plaintiff contends that the price of Amgen’s stock was artificially inflated, until “the truth came to light” and the Plaintiff, among others, suffered financial losses. The district court certified the class, and the Court of Appeals for the Ninth Circuit affirmed. Amgen appealed, and the Supreme Court granted certiorari and heard oral argument on November 5, 2013. The Court issued a 6-3 opinion, with Justices Thomas, Scalia, and Kennedy dissenting.
Because Amgen conceded (1) the efficiency of the market for the securities at issue, (2) the public character of the allegedly fraudulent statements on which the Plaintiff’s complaint is based, and (3) that the Plaintiff satisfied all of the class-action prerequisites stated in Rule 23(a), the issue presented to the Court concerned the requirement stated in Rule 23(b)(3) that “the questions of law or fact common to class members predominate over any questions affecting only individual members.” Put differently, as the Court stated, “the pivotal inquiry in this case is whether proof of materiality is needed to ensure that the questions of law or fact common to the class ‘will predominate over any questions affecting only individual members’ as the litigation progresses.” Amgen claimed that to meet the predominance requirement, the Plaintiff must do more than “plausibly plead that Amgen’s alleged misrepresentations and misleading omissions materially affected Amgen’s stock price.” According to Amgen, certification must be denied unless the Plaintiff proves materiality, because immaterial misrepresentations or omissions, by definition, would have no impact on Amgen’s stock price in an efficient market. To this end, Amgen claimed the key question in this case was whether materiality is an essential predicate of the FOTM theory.
Although agreeing with Amgen that “materiality is an essential predicate” of the FOTM theory, the Court explained that the “pivotal inquiry” in this case is whether proof of materiality is needed to ensure that the questions of law or fact common to the class will “predominate over any questions affecting only individual members” as the litigation progresses. Slip Op. at 10 (citing Fed. R. Civ. P. 23(b)(3)). The Court answered this question in the negative for two reasons; thereby holding that proof of materiality is not a prerequisite to class certification. First, because the question of materiality is judged according to an objective standard, viewing the significance of an omitted or misrepresented fact from the purview of a reasonable investor, materiality can be proved through evidence common to the class. As a result, the Court concluded, materiality is a common question for Rule 23(b)(3). Slip Op. at 11 (quoting Basic, where the Court listed “materiality” as one of the questions common to the Basic class members). Second, because materiality is an essential element of a Rule 10b–5 claim, if the Plaintiff fails to present sufficient evidence of materiality, individual reliance questions will not overwhelm the questions common to the class. Instead, the Court concluded, if the Plaintiff failed to establish materiality, whether upon summary-judgment or at trial, it “would end the case for one and for all; no claim would remain in which individual reliance issues could potentially predominate.” Id.
As is usual with most recent decisions from the United States Supreme Court, the conclusion that proof of materiality is not a prerequisite to class certification was not unanimous. However, before turning to the dissenting views of Justices Thomas, Kennedy, and Scalia, attention should be paid to Justice Alito’s concurring opinion. Although brief, Justice Alito explains: “As the dissent observes, more recent evidence suggests that the [FOTM] presumption may rest on a faulty economic promise. In light of this development, reconsideration of the Basic presumption may be appropriate.” Alito, J. Concurring Op. at 1.
Justice Thomas dissented, with Justice Kennedy joining fully, and Scalia joining only in part. Justice Thomas explained:
Without demonstrating materiality at certification, plaintiffs cannot establish Basic‘s fraud-on-the-market presumption. Without proof of fraud on the market, plaintiffs cannot show the otherwise individualized questions of reliance will predominate, as required by Rule 23(b)(3). And without satisfying Rule 23(b)(3), class certification is improper. Fraud on the market is thus a condition precedent to class certification, without which individualized claims of reliance will defeat certification.
Moreover, Justice Thomas stated that the majority opinion “transform[ed] the predicate certification inquiry into a novel either-or inquiry occurring much later on the merits.” To this end, he explained:
According to the [majority], either (1) plaintiffs will prove materiality on the merits, thus demonstrating ex post that common questions predominated at class certification, or (2) they will fail to prove materiality, at which point they will learn ex post that certification was inappropriate because reliance was not, in fact, a common question. In the [majority’s] second scenario, fraud on the market was never established, reliance for each class member was inherently individualized, and Rule 23(b)(3) in fact should have barred certification long ago. The [majority] suggests that the problem created by the second scenario is excusable because the plaintiffs will lose anyway on alternative grounds, and the case will be over. But nothing in logic or precedent justifies ignoring at certification whether reliance is susceptible to Rule 23(b)(3) classwide proof simply because one predicate of reliance—materiality—will be resolved, if at all, much later in the litigation on an independent merits element.
In addition to joining in Justice Thomas’s dissent, Justice Scalia also wrote a separate dissenting opinion, which in part stated that he views the FOTM theory as governing not only the question of whether class certification is proper, but also the question of substantive liability. But see Thomas, J. Dissenting Op. at 11 (“The result [of the majority’s error] is that [it] effectively equates §10(b) materiality with fraud-on-the-market materiality and elides reliance as a §10(b) element.”). In accord with Justice Thomas’s dissenting opinion, Justice Scalia wrote that, in his view, “it makes no sense to ‘presume reliance’ on the misrepresentation merely because the plaintiff relied on the market price, unless the alleged misrepresentation would likely have affected the market price—that is, unless it was material.” Scalia, J. Dissenting Op. at 2. Finally, recognizing the practical import of the majority’s decision, Justice Scalia explained how “[c]ertification of the class is often, if not usually, the prelude to a substantial settlement by the defendant because the costs and risks of litigating further are so high.”