Remedies Spring 2014 “10b-5 Securities Fraud Actions Fraud on the market – presumption of reliance under attack

Prof. George W. Conk Guest lecturer: Wallace Showman, Esq. gconk@law.fordham.edu Room 409 212-636-7446 Adjunct Professor of Law & Senior Fellow Stein Center for Law & Ethics
Fraud on the market - 10 (b)(5) actions 1

Rule 23 Class Actions - Fed. R. Civ. Pro.

(a) Prerequisites. One or more members of a class may sue or be sued as representative parties on behalf of all members only if: (1) the class is so numerous that joinder of all members is impracticable; (2) there are questions of law or fact common to the class; (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class; and (4) the representative parties will fairly and adequately protect the interests of the class.
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The Six Elements of the 10b-5 Action

(1) a material misrepresentation (or

omission)

(2) scienter, i.e., a wrongful state of

mind

(3) a connection with the purchase or

sale of a security
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Elements of the 10b-5 Action

(4) reliance or "transaction

causation"
 

(5) economic loss

(6) "loss causation," i.e., a causal
connection between the material

misrepresentation and the loss
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17 CFR § 240.10b-5

It shall be unlawful for any person, directly or indirectly… (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
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17 CFR § 240.10b-5.

(c) To engage in any act, practice, or

course of business which operates or
would operate as a fraud or deceit

upon any person, in connection with
the purchase or sale of any security.

(Sec. 10; 48 Stat. 891; 15 U.S.C. 78j)

Fraud on the market - 10 (b)(5) actions

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Basic Inc. v. Levinson, 485 U.S. 224 (1988)
Fraud-on-the-market presumption

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Prerequisites for market price incorporation of information
  

(1) misrepresentation publicity

(2) misrepresentation materiality
(3) market efficiency, and

(4) plaintiff traded the shares
between the time the misrepresentations were made and the time the truth was revealed.
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Materiality

"an omitted fact is material if there is

a substantial likelihood that... the
disclosure of the omitted fact would

have been viewed by the reasonable
investor as having significantly

altered the 'total mix' of information
made available.“ Basic
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Reliance

“Reliance provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury.” Basic Falsity, materiality, reliance, damage are the common law elements of fraud
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Basic: we must adapt to modern conditions

The modern securities markets, literally involving millions of shares changing hands daily, differ from the face-to-face transactions contemplated by early fraud cases, and our understanding of Rule 10b5's reliance requirement must encompass these differences
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Fraud on the market - Basic

[I]n an open and developed securities market, the price of a company's stock is determined by the available material information regarding the company and

its business. . . . Misleading statements
will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements. . .
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Rebuttable Presumption of Reliance on the Integrity of the Market Price

Presumptions typically serve to assist courts in managing circumstances in which direct proof, for one reason or another, is rendered difficult. See, e.g., D. Louisell & C. Mueller, Federal Evidence 541-542 (1977).
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Rebuttable Presumption of Reliance on the Integrity of the Market Price

Requiring a plaintiff to show a speculative state of facts, i.e., how he would have acted if omitted material information had been disclosed, ... or if the misrepresentation had not been made... would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market.

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Rebuttable Presumption of Reliance

Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action.
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Rebutting the presumption

Any showing that severs the link between the alleged misrepresentation and either the

price received (or paid) by the
plaintiff, or his decision to trade at a

fair market price, will be sufficient to
rebut the presumption of reliance.
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Markets are imperfect

n28 By accepting this rebuttable

presumption, we do not intend
conclusively to adopt any particular

theory of how quickly and completely
publicly available information is

reflected in market price.

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Three Presumptions - Goldberg & Zipursky

1) Legally cognizable injury is shown by purchase of securities at a market price distorted by the defendant’s misrepresentations 2) Distortion is presumed if a misrepresentation is “material”, disseminated to the public, and securities are sold on an “efficient” market 3) Reliance is presumed but may be rebutted
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Langevoort – Judgment Day

What Basic does, as much as

anything, is create an entitlement to
an undistorted stock price via, as I

have described it, an act of juristic
grace.

This is no different from what
happens in the common law of fraud.
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Langevoort – Judgment Day

In a face-to-face negotiation between strangers, there is no reason necessarily to assume that what the counterparty is saying is the truth. Yet the law creates a right to rely on sufficiently factual misrepresentations… to promote efficient economic exchange in the face of palpable uncertainty about honesty, by making it safe to assume honesty
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Amgen v. Connecticut Retirement Plans 133 S. Ct. 1184 (2013)

Ginsburg (6-3) Materiality is an essential element of a 10b-5 action common to entire class.

FRCP 23 commonality not threatened by failure of proof on materiality

Alito – Basic’s “flawed economic assumption warrants its reconsideration”
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The attack on Basic
 

   

FOTM is a judge-made rule Materiality essential to class certification Basic‟s economic assumptions flawed Presumption difficult to administer “in terrorem” effect of certification Class cert places materiality determination in jury‟s hands Transaction-specific proofs req‟d
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Amgen 133 S. Ct. 1184 (2013) Materiality of misrepresentation goes to the merits

“[B]ecause materiality is established by evidence common to all plaintiffs...a failure to prove materiality will cause all plaintiffs' individual claims to fail”
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2013 - Amgen majority - Class certification does not require proof of materiality

6-3 split - Ginsburg for 5, Alito concurs, Scalia, Thomas, Kennedy dissent "While [a putative class] certainly

must prove materiality to prevail on
the merits, we hold that such proof is

not a prerequisite to class
certification....
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Thomas: Amgen dissent Materiality must be proven at class certification

Materiality was central to the
development, analysis, and adoption of the fraud-on-the-market theory

both before Basic and in Basic itself.
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Thomas: Amgen dissent Materiality must be proven at class certification

Materiality, therefore, must be demonstrated to prove fraud on the market Until materiality of an alleged misstatement is shown there is no reason to believe that all market participants have relied equally on it.

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Thomas: Amgen dissent Materiality must be proven at class certification

Otherwise individualized questions of
reliance remain.

This history confirms that materiality
must be proved at the time that the

theory is invoked--i.e., at
certification.
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Archdiocese of Milwaukee/ Erica P. John Fund v. Halliburton Co.

 

Halliburton sustained its share price via three misrepresentations * Asbestos liability understated * Cost overrun revenue overestimated * Dresser merger efficiencies knowingly misstated

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Erica P. John Fund v. Halliburton (5th Cir. 2013) – following Amgen

Common question predominance is relevant to class certification Only issues bearing directly on common question predominance and propriety of class resolution should be addressed at class certification Proof of price impact or its absence goes only to the merits.
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Halliburton Co. V. Erica P. John Fund

Cert. granted 11/15/ 2013
 

Questions presented 1. Whether this Court should overrule or substantially modify the holding of

Basic Inc. v. Levinson to the extent
that it recognizes a presumption of

classwide reliance derived from the
fraud-on-the-market theory.
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Halliburton Co. V. Erica P. John Fund

Cert. granted 11/15/ 2013
 

Questions presented 2. Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.
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The Halliburton Attack on Basic

“Implicit in the notion of an efficient market—even a mechanically efficient market as courts understand the securities market to be—is the assumption that the market acts rationally.” Fisher, Does 15 the Efficient Market

Theory Help Us Do Justice in a Time of Madness?, 54 Emory L.J. 843, 898 (2005).
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The Halliburton Attack on Basic

But a “goodly section of academic thought now challenges” this core tenet of Basic, id. at 899, because too many recent events disprove it. E.G. 1998-2001 technology bubble…the market acted irrationally, with stock prices far away from fundamental values

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The Halliburton Attack on Basic

The “economic crisis” of 2008 even

further “undermined „efficient
markets theory.‟ ”

Posner, On the Receipt of the Ronald H. Coase Medal, 12 Am. L. & Econ. Rev. 265, 278 (2010).

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United States as amicus in support of Erica P. John Fund

The Basic presumption reflects the common sense understanding that price reflects available information

It has proven workable.

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United States as amicus in support of Erica P. John Fund

Congress has had many chances to replace the judicially created doctrine and has not done so.
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