On June 21, 2021, the Supreme Court issued an opinion in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement Systems that should make it more difficult to certify a class action in stock-drop suits alleging that investors were duped by sweeping, generic company statements.
The case was on appeal from a class-certification decision in a suit alleging that Goldman misled investors through generic statements about its “extensive procedures and controls” to deal with conflicts of interest among its banking clients and various claims that its clients’ interests “always come first” and that integrity and honesty “are at the heart” of its business. The plaintiffs alleged that when the market learned the truth about Goldman’s conflicts from an enforcement action and subsequent news reports, Goldman’s previously inflated stock price dropped, causing shareholder losses.
The plaintiffs sought to certify a class of Goldman shareholders by invoking the “fraud-on-the-market” presumption discussed in Basic v. Levinson, 485 U. S. 224 (1988), which provides that investors rely on the market price of a company’s security, which in an efficient market incorporates all of the company’s public misrepresentations. Goldman sought to defeat class certification by rebutting the Basic presumption through evidence that its alleged misrepresentations did not affect its stock price. The district court decided that Goldman had failed to carry its burden of proving a lack of price impact and certified the class. The United States Court of Appeals for the Second Circuit affirmed that decision.
The Supreme Court affirmed that, at class certification, defendants like Goldman bear the burden to demonstrate by a preponderance of the evidence that the misrepresentations did not affect the stock price. But the Court remanded the case to the Second Circuit because of “sufficient doubt” that the lower court took into account the “generic nature of Goldman’s alleged misrepresentations.” Although the Court had previously held in Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 568 U. S. 455 (2013), that the issue of materiality was not up for consideration at the class certification stage, the Court clarified that lower courts must consider “all evidence” relevant to the issue of price impact, regardless of whether such evidence also bears on the question of materiality. Recognizing that materiality and price impact are “overlapping concepts” and that “evidence relevant to one will almost always be relevant to the other,” the Court ruled that courts must not use the overlap as a reason to refuse to consider all of the evidence.
The Court further explained that the “generic nature of a misrepresentation often will be important evidence of a lack of price impact” and this is “particularly” true in cases alleging that a company’s stock price was inflated because of such statements. The Court questioned whether a court can infer that a price drop means that the stock price was previously inflated because such an inference “starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure” at the time of the price drop. For example, the Court noted that where the earlier misrepresentation is generic (e.g., “we have faith in our business model”) and the later corrective disclosure is specific (e.g., “our fourth quarter earnings did not meet expectations”), it is “less likely that the specific disclosure actually corrected the generic representation,” which means that there is “less reason to infer front-end price inflation – that is, price impact – from the back-end price drop.” No. 20-222, slip op. at 8.
The Goldman decision is the first time the Court has ruled on the validity of an increasingly common “inflation maintenance” theory of price impact, which premises liability on representations which allegedly prop up, rather than inflate, stock price. The commentary in the opinion will assist defendants facing challenges of this nature and may help rein in securities litigation premised on various non-specific company statements, including statements concerning controls, compliance, and ESG-related representations.
As set forth in an amicus brief filed by the Securities and Exchange Commission, and as both sides agreed, in the wake of the Court’s 2014 decision in Halliburton v. Erica P. John Fund, 134 S. Ct. 2398 (2014), there have been only five cases in which defendants substantially prevailed at the class certification stage of the proceedings. Baker Botts represented defendants in two of those five cases.
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