The Second Opinion: The U.S. Supreme Court Questions Fraud-on-the-Market
The recent U.S. Supreme Court ruling in the Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, No. 11-1085, 2013 WL 691001 (Feb. 27, 2013) (“Amgen”) securities fraud class action is an important milestone in the evolution of the defences to securities disclosure class actions in the U.S., and potentially in Canada. The Court addressed two questions relevant to public issuers: the necessity for plaintiff investors to prove that alleged misrepresentations to the market by companies are material, and that they were relied upon.
The Amgen decision
In this case, an investor brought a securities fraud class action against Amgen, alleging that it had misrepresented the safety of two of its products, and thereby artificially inflated its share price.
In the U.S., investors must prove that they relied on a material misrepresentation or omission in a company’s public disclosure to prove their private securities fraud claim under Securities Exchange Act of 1934 and the SEC’s Rule 10b-5.
Amgen defended the plaintiff’s motion to certify the lawsuit as a class action with two arguments that came to be considered by the Supreme Court (the lower court decisions in Amgen were extensively discussed by my colleague, Elder C. Marques in a previous post). Specifically, Amgen argued that certification should be denied because:
- the plaintiff should be required to prove at the certification motion that the alleged misrepresentation was material; and
- the plaintiff should be required to prove at the motion that the question of whether every investor in the proposed class relied upon the misrepresentation in making their purchase was a common one.
Although Amgen was unsuccessful in defeating certification with these arguments, the dissents issued by the Court support a continued debate about these defences. This debate points to potential changes in the law favourable to public issuers facing class actions in the U.S. and which are relevant to the development of securities class action law in Canada as well.
As to materiality, Justice Ginsburg, writing for the majority at the Supreme Court, rejected the argument that investors must prove materiality at the certification motion. She concluded that because materiality is an objective inquiry under federal securities laws, the plaintiff was only required to show that the issue was one common to all class members in order to justify certification; proof was not needed until trial: “Rule 23(b)(3) requires a showing that questions common to the class predominate, not that those questions will be answered, on the merits, in favor of the class.”
However, Justice Thomas authored a dissent which Justice Kennedy joined, with Justice Scalia supporting it in part. He emphasized that materiality remains an essential requirement of the fraud-on-the-market theory presumption of reliance, and that absent materiality “plaintiffs cannot establish Basic’s fraud-on-the-market presumption”.
Reliance and Fraud-on-the-market
As to reliance, the U.S. Supreme Court established, 25 years ago in Basic Inc. v. Levinson, 485 U.S. 224 (1988) (“Basic”), the “fraud-on-the-market” presumption in favour of investors. That doctrine assumes that investors who buy securities rely on a company’s alleged misstatements – even where they do not read them - because those misstatements are, in an “efficient market”, rapidly incorporated into and thus reflected in the price of the securities. The majority in Basic held that this was a reasonable presumption because it relieved plaintiffs from an “unnecessarily unrealistic evidentiary burden”.
Critics have since contended that this presumption is flawed and that different kinds of information about a company are incorporated into the market at different rates. In addition, critics have observed that many trades are not based on the value of a company, but on speculation and increasingly, on powerful algorithms. The theory, however, remains ubiquitous in U.S. securities cases and is rarely challenged by defendants because of the difficulty involved in proving a market is not efficient.
Indeed, Amgen did not challenge the plaintiff’s use of the theory and for that reason Justice Ginsburg, despite acknowledging serious questions about the theory's continued relevance, concluded that this case was “a poor vehicle” for revisiting fraud-on-the-market, and rejected this defence to certification.
Four other justices were more critical. In a concurring statement, Justice Alito warned that the fraud-on-the-market presumption “may rest on a faulty economic premise." In separate dissenting opinion, Justices Thomas and Kennedy called it "questionable", and Justice Scalia criticized the presumption for having been "invented by the court” in Basic and concluded that:
Today’s holding does not merely accept what some consider the regrettable consequences of the four-Justice opinion in Basic, it expands those consequences from the arguably regrettable to the unquestionably disastrous.
If this presumption is indeed revisited in future cases, it could dramatically change the landscape of U.S. federal securities class actions.
Implications for Canada
Both of these aspects of the Amgen decision are of interest to Canadian public issuers. Although U.S. court decisions are not binding on Canadian courts, the similarities in our public markets and common law and statutory securities class actions does give some weight to the views of the U.S. Supreme Court on common questions of law.
As to materiality, Canadian plaintiff investors, at certification, must lead “some evidence” in support of the critical aspects of their cases, and so in some cases they file economic evidence in respect of materiality. Further, under certain statutory causes of action, a plaintiff must present some evidence as to the merits of their case to be allowed to proceed. Any debate in the U.S. courts as to the nature and quality of the economic evidence to being presented at certification could impact the standards set by Canadian courts at certification.
The more active debate in Canada centres on reliance. At common law, investors were required to show individual reliance on an alleged misrepresentation, which made certification of a lawsuit on behalf of a class of investors difficult. Attempts by plaintiffs to introduce the U.S. fraud-on-the-market presumption were rejected in Canada by several lower courts, although no appellate court has specifically addressed the issue. Provincial governments reacted by introducing statutory disclosure causes of action for investors which, in both prospectus and secondary market cases, permit investors to sue without proof of reliance on the alleged misrepresentation.
Nevertheless, investors have recently argued in common law class actions that in an efficient market, reliance can be “inferred as a question of fact” (a theory which defendants argued was indistinguishable from the rejected “fraud-on-the-market” theory). Canadian courts have, however, allowed that argument to survive at certification, leaving the determination as to its viability for some future trial (see, for instance, Silver v. IMAX, 2009 CanLII 72334 (ON SC) at paras. 65-75; aff'd 2011 ONSC 1035 (CanLII), but see Dobbie v. Arctic Glacier Income Fund, 2012 ONSC 773 (CanLII), paras. 33-37)
Clearly any weakening or outright rejection of the fraud-on-the-market principle in the U.S. could have a significant effect on this open question in Canadian securities class actions.
After Amgen, it can be expected that U.S. public issuers may continue to assert the materiality requirement at certification, and will certainly be seeking to overturn courts’ continued application of the fraud-on-the-market doctrine (indeed, the U.S. Supreme Court has all but invited lower courts to send an appropriate case their way.) These developments in the landscape of U.S. securities class actions continue to bear close scrutiny for Canadian investors and public issuers alike over the next few years.
Amgen fraud-on-the-market Securities Exchange Act U.S. securities class actions US Court of Appeals for the Ninth Circuit US Supreme Court