On December 11, 2020, the Supreme Court granted the petition of Goldman Sachs Group, Inc. (“Goldman”) for certiorari in Arkansas Teacher Retirement System v. Goldman Sachs Group, Inc., 955 F.3d 254 (2d Cir. 2020), a securities class action asserting that Goldman made certain misstatements in violation of Section 10(b) of the 1934 Securities Exchange Act and Rule 10b-5(b), which caused the value of Goldman’s publicly-traded shares to decline. The Supreme Court will consider two important issues: First, whether a court may consider the nature of the alleged misstatements themselves in determining whether, at the class certification stage, a defendant has rebutted the presumption of classwide reliance; and second, which party has the burden of persuasion on the issue.
On April 7, 2020, the Second Circuit issued the underlying opinion on appeal, which was its second in the action. In Ark. Teachers Ret. Sys. v. Goldman Sachs Grp., Inc. (ATRS I), 879 F.3d 474 (2d Cir. 2018), the Second Circuit initially reversed and remanded the District Court’s opinion granting class certification for failing properly to apply the “preponderance of the evidence” standard in assessing whether Goldman successfully rebutted the presumption, set out in Basic v. Levinson, 485 U.S. 224 (1988), that “shareholders relied on Goldman’s allegedly material misstatements in choosing to purchase its stock at the market price.” Ark. Teacher, 955 F.3d at 254. On remand, the District Court again held that “Goldman failed to rebut the Basic presumption by a preponderance of the evidence” and so “certified the class once more.” Id. at 258. The Second Circuit affirmed the District Court again, and the Supreme Court granted Goldman’s petition for certiorari.
The Court’s decision could potentially expand the ability of securities class action defendants to narrow the plaintiff class at the certification stage, where reducing the class period or class size can have a significant impact on the potential damages, and therefore the parties’ settlement calculus. In general, it is difficult for securities class action defendants to defeat class certification because putative classes often comprise similarly situated investors who purchased the same security, relied on the security’s market price, and suffered losses from the same market events. Should the Supreme Court side with Goldman, however, securities class action defendants may be able to argue at the class certification stage that alleged misstatements are too “general” to be actionable, effectively expanding the ways in which securities class action defendants can challenge certification. The Court’s decision has the potential to impact a substantial number of cases, given the frequency with which defendants argue that some or all of the alleged misstatements are too “general”—often termed “puffery”—to support securities fraud.
The misstatements alleged by Plaintiffs were statements by Goldman between 2006 and 2010 asserting, among other things, that Goldman’s “reputation is one of our most important assets,” that “[w]e have extensive procedures and controls that are designed to identify and address conflicts of interest,” and that “[w]e are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us.” Id. Plaintiffs alleged these statements were false because, in fact, Goldman knew at the time “that it was riddled with undisclosed conflicts of interest.” Id. at 259.
Plaintiffs’ claim rests in large part on allegations that Goldman marketed to investors a collateralized debt obligation as an “ordinary asset-backed security,” id. at 259, even while permitting the hedge fund Paulson & Co. (“Paulson”) to “play an active role in selecting the mortgages that constituted the CDO.” Id. Plaintiffs claim that Paulson chose mortgages it believed would default—many of which did default—earning Paulson approximately $1 billion because Paulson had bet against the CDO. Id. Plaintiffs also alleged that Goldman itself had sold short other CDOs it marketed to investors. See id. The Second Circuit summarized that “[t]he crux of their claim is that Goldman’s representations about being conflict free artificially maintained and inflated the stock price and that the revelations of Goldman’s conflicts” caused Goldman stock to decline. Id. In particular, investors alleged that Goldman’s shares declined sharply in value on three separate occasions, each of which followed directly from the announcement that government authorities were investigating Goldman’s alleged conflicts of interest. See id. at 259.
The District Court Denies Goldman’s Motion to Dismiss and Certifies the Class
Goldman initially moved to dismiss the complaint in the trial court, arguing that the alleged misstatements were “too general and vague for a reasonable shareholder to have relied on them.” Id. at 260. The District Court rejected this argument in large part, holding that “most of Goldman’s statements presented an actionable question of materiality,” though the District Court did dismiss certain statements as immaterial. Id.
After discovery, Plaintiffs sought class certification pursuant to FRCP 23. In opposing, Goldman challenged the Basic presumption, noted above. Under Basic, a court can presume that all class members relied on the alleged misstatements if plaintiffs establish that “defendants’ misstatements were publicly known, their shares traded in an efficient market, and [the] plaintiffs purchased the shares at the market price after the misstatements were made but before the truth was revealed.’” Id. at 260-61 (quoting Ark. Teachers Ret. Sys. v. Goldman Sachs Grp., Inc. (ATRS I), 879 F.3d 474, 484-85 (2d Cir. 2018)). A defendant can attempt to rebut the presumption, as Goldman did, by introducing evidence that the alleged misstatements had no effect on the share price. See id. at 261.
The District Court rejected Goldman’s arguments and certified the class. On appeal, the Second Circuit vacated, holding that the trial court “failed to apply the ‘preponderance of the evidence’ standard” and improperly rejected as irrelevant certain additional evidence that Goldman attempted to introduce. See id. at 261. On remand, the District Court evaluated Goldman’s evidence, again held that Goldman failed to rebut the Basic presumption, and again certified the class. Id. at 262.
Goldman Appeals Class Certification and the Second Circuit Affirms
Goldman appealed the second District Court decision on two main grounds. First, Goldman argued that the trial court failed properly to apply the “inflation maintenance” theory of liability, under which a plaintiff need not plead that each alleged misstatement caused artificial inflation in a company’s stock price, but only maintained existing price inflation that a stock would have shed had the Company instead made a true statement. See id. at 264. Goldman argued that the alleged misstatements were no more than “general statements” that can never be sufficient to support an inflation-maintenance theory of securities fraud liability. See id. at 264-65. Second, Goldman argued that the District Court abused its discretion when it held that Goldman’s evidence “failed to rebut the Basic presumption by a preponderance of the evidence.” Id. at 264.
In support of its first point, Goldman asserted that there are only two types of alleged misstatements that a plaintiff can argue maintain price inflation, that neither category includes the types of “general” misstatements identified by Plaintiffs, see id. at 266, and therefore the District Court should have found, at the class certification stage, that those “general” statements were insufficient to support liability. The Circuit rejected Goldman’s argument, noting in particular that none of Goldman’s cited authority limited the application of the inflation-maintenance theory to particular statements. See id. Of greater concern to the Circuit was that Goldman’s proposal, to rebut the Basic presumption by deeming certain statements too “general” on their face to have had any impact on the price of a stock, was “really a means for smuggling materiality into Rule 23,” id. at 267, which was contrary to the principle that “‘materiality . . . is not an appropriate consideration at the class certification stage.’” Id. at 267 (quoting Ark. Teachers Ret. Sys. v. Goldman Sachs Grp., Inc., 879 F.3d 474, 484-85 (2d Cir. 2018)). The Court also noted that Goldman’s test is contrary to FRCP 23(b)(3) because “[w]hether alleged misstatements are too general . . . has nothing to do with the issue of whether common questions predominate over individual ones.” Id. Even if Goldman’s proposed test “might weed out potentially unmeritorious claims,” the Court noted that “Rule 23 is not a weed whacker for merits problems.” Id. In support, the Court relied on Amgen Inc. v. Connecticut Ret. Plans & Tr. Funds, 568 U.S. 455, 474 (2013) for the proposition that “[m]erits questions may be considered to the extent—but only to the extent—that they are relevant to determining whether the Rule 23 prerequisites for class certification are satisfied.’” Id. at 268 (italics original).
Goldman also made the policy-based argument that “rejecting its theory would open the floodgates to unmeritorious litigation by allowing courts to certify classes that it believes should lose on the merits,” and in particular that, in the event of a stock drop, a plaintiff could identify any previous positive statement and claim that it supports a theory of inflation-maintenance. See id. at 269. While acknowledging that “class certification can pressure defendants into settling large claims, meritorious or not, because of the financial risk of going to trial,” the Court was unimpressed by Goldman’s parade of horribles, explaining that (i) claims lacking merit because the statements are too generalized will not reach the class certification stage, id. at 269; (ii) a defendant has a second opportunity to attack materiality at summary judgment, id.; and (iii) a defendant can “present evidence to disprove price impact” of a particular statement “when seeking to rebut the Basic presumption,” as Goldman itself did. Id. Having rejected Goldman’s invitation to evaluate the “generality” of misstatements at the class certification stage, the Circuit held that the District Court did not abuse its discretion in finding Goldman’s evidence inadequate to rebut the Basic presumption. See id. at 270-74.
Further, in addressing this issue, the Second Circuit recognized that Goldman “bears the burden of persuasion,” id. at 272, meaning that “[o]nce the shareholders successfully invoke Basic, which happened here, the question is not which side has better evidence, but whether the defendant has rebutted the presumption.” Id. at 272 n.19.
Judge Sullivan dissented, observing that information concerning Goldman’s alleged conflicts of interest, which was the underlying factual basis for Plaintiffs’ allegations of falsity, were disclosed to the public in 36 news stories prior to the three significant stock drops identified by Plaintiffs, but that those prior 36 revelations had no effect on Goldman’s stock price. See id. at 277. Judge Sullivan also disagreed with the Court’s refusal to consider the “nature of the alleged misstatements”—meaning, in Goldman’s terms, their “generality.” See id. at 278. Judge Sullivan rejected the majority’s determination that it could not review materiality at the class certification stage, arguing that “[o]nce a defendant has challenged the Basic presumption and put forth evidence demonstrating that the misrepresentation did not affect share price, a reviewing court is free to consider the alleged misrepresentations in order to assess their impact on price.” Id. at 278. Judge Sullivan concluded that, although such an inquiry is similar to an assessment of materiality, that “does not make it improper,” and the “generic quality of Goldman’s alleged misstatements, coupled with the undisputed fact” that prior disclosures had no effect on the stock price, “clearly compels the conclusion that the stock drop following the corrective disclosures was attributable to something other than the misstatements alleged in the complaint.” Id. at 278-79 (italics original). Judge Sullivan would therefore have reversed and decertified the class.
The Issues Pending Before the Supreme Court
The parties have raised two issues for consideration by the Supreme Court. Each, unsurprisingly, characterizes them differently.
First, Goldman asserts that the first issue is whether a defendant in a securities class action can rebut the Basic presumption by “pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality.” Pet. for Writ of Cert., Goldman Sachs Group, Inc. v. Ark. Teacher Ret. Sys. (No. 20-222), at I (Questions Presented). Plaintiffs view the issue as whether a defendant can “defeat class certification by showing that its statements were immaterial, so long as it casts the argument as going toward price impact rather than materiality.” Br. in Opp., Goldman Sachs Group, Inc. v. Ark. Teacher Ret. Sys. (No. 20-222), at i (Questions Presented). Goldman has also reiterated its fear of the “ease with which inflation-maintenance plaintiffs will be able to obtain class certification” if courts are not empowered to evaluate alleged misstatements on their face. Pet. at 26. In response, Plaintiffs have noted the various protections Defendants have against unmeritorious claims. Opp. at 21-24.
Second, the parties dispute, and have also raised for consideration, whether a defendant seeking to rebut the Basic presumption has the burden only of production, or also of persuasion, the Second Circuit having held the latter. See Pet. at I; Opp. at i. Goldman alleges that there is a Circuit split on this issue, arguing that the Second and Seventh Circuits have determined that a defendant has the burden of persuasion to rebut the Basic presumption, but in the Eighth Circuit, the burden of persuasion remains with the plaintiff even if the defendant produces evidence to rebut the presumption. Pet. at 21-24. In Goldman’s view, “the private cause of action for securities fraud . . . and the Basic presumption are judicial creations,” and there is no statute or Rule of Evidence that would alter Federal Rule of Evidence 301, Pet. at 23, which provides that “the party against whom a presumption is directed has the burden of producing evidence to rebut the presumption,” but that such evidence “does not shift the burden of persuasion, which remains on the party who had it originally.” By contrast, Plaintiffs acknowledge that the Second and Seventh Circuits have, indeed, rejected Plaintiffs’ argument, but argue that the Eighth Circuit was speaking only in dictum, and there is no true Circuit split. Opp. at 27-29. On the merits, Plaintiff cites the Supreme Court’s decision in Halliburton Co. v. Erica P.. John Fund, Inc., 573 U.S. 258, 279 (2014), that a defendant can rebut the Basic presumption by showing a lack of price impact, and interprets “show” to mean a defendant must “actually rebut the presumption through evidence that persuasively shows a lack of price impact.” Id. at 29 (emphasis original).
The case is not yet set for argument, but it is unlikely to be heard before March 2021.