The Pendulum Swings – A Primer on Caselaw By Eric Landau, Shawn Harpen, Travis Biffar & Kristel Robinson From the adoption of the “fraud-on-the-market” theory, to the demise of “scheme liability,” the U.S. Supreme Court has interpreted the anti-fraud provisions of the federal securities laws expansively, at times, and narrowly, at other times. After examining the watershed opinion from 1988 that kicked off the securities class action juggernaut, and pausing to observe the elimination of common law aiding and abetting liability in 1994, we review recent Supreme Court pronouncements that appear to telegraph a more conservative approach to the use of the class action as the favored vehicle to advance shareholders’ complaints. I. Where It Started: The Floodgates Are Opened Basic v. Levinson, 485 U.S. 224, 108 S. Ct. 978, 99 L. Ed. 2d 194 (1988), concerned the omission of information regarding a pending merger. Representatives from one company had meetings and telephone conversations with the officers of the “target” company concerning the possibility of a merger. 485 U.S. at 227. During the pendency of these discussions, the target company made three public statements, first denying that it was engaged in merger negotiations, and then disclaiming knowledge of any developments that would explain the abnormally high trading activity and price fluctuations in its stock. Id. at 227 & 227 n.4. A little more than a month later, the target company took the following actions on three successive days: (1) asked for a suspension of trading in its stock; (2) endorsed an offer to purchase its stock by the other company; and (3) publicly announced the approval of the offer. Id. at 227-28. Former shareholders who had sold their stock after the first public denial and before the trading suspension filed a putative class action against the target company and its directors, alleging that the defendants had issued three false or misleading public statements in violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b). Id. at 228. Adopting the “fraud-on-the-market theory,” the district court certified a class. Id. However, the district court granted summary judgment in favor of the defendants, finding that the alleged misstatements were immaterial, because “there were no negotiations ongoing at the time of the first statement, and although negotiations were taking place when the second and third statements were issued, those negotiations were not destined, with reasonable certainty, to become a merger agreement in principle.” Id. at 229 (internal quotations omitted). The 6h U.S. Circuit Court of Appeals affirmed the class certification ruling, “join[ing] a number of other circuits in accepting the ‘fraud-on-the-market theory’ to create a rebuttable presumption that respondents relied on petitioners’ material misrepresentations, noting that without the presumption it would be impractical to certify a class under Fed. Rule Civ. Proc. 23(b)(3).” Id. at 229-30. However, the 6th Circuit reversed the grant of summary judgment, finding that, while the target company had “no general duty” to disclose information about the merger talks, “any statement the company voluntarily released could not be ‘so incomplete as to mislead.’” Id. at 229 (quoting Sixth Circuit opinion, 786 F.2d 741, 746 (1986)). Further, “[w]ith respect to materiality, the court rejected the argument that preliminary merger discussions are immaterial as a matter of law, and held that ‘once a statement is made denying the existence of any discussions, even discussions that might not have been material in the absence of the denial are material because they make the statement made untrue.’” Id. (quoting Sixth Circuit opinion, 786 F.2d at 749). The Supreme Court granted certiorari to resolve the split among the circuits “as to the standard of materiality applicable to preliminary merger discussions, and to determine whether the courts below properly applied a presumption of reliance in certifying the class, rather than requiring each class member to show direct reliance.” Id. at 230. With respect to materiality, the Supreme Court expressly adopted, for claims brought under Section 10(b), the materiality standard previously applied by the Court in the proxy solicitation context – an omitted fact is material “‘if there is a substantial likelihood that a reasonable shareholder would consider the fact important in deciding how to vote,’” and if “‘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.’” Id. at 231-32 (quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S. Ct. 2126, 48 L. Ed. 2d 757 (1976)). The Supreme Court further held that, in suits brought under Section 10(b), in the context of preliminary corporate merger discussions, information “which would otherwise be considered significant to the trading decisions of a reasonable investor” is not excluded from the definition of materiality “merely because an agreement-in-principle as to price and structure has not yet been reached.” Id. at 236. However, the Supreme Court reversed the 6th Circuit’s opinion on one aspect of materiality, holding that information does not become material merely by virtue of a public statement denying the information: “It is not enough that a statement is false or incomplete, if the misrepresented fact is otherwise insignificant.” Id. at 237-38. Instead, “materiality ‘will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of company activity.’” Id. at 238 (quoting SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) (en banc)). Accordingly, “whether merger discussions in any particular case are material . . . depends on the facts.” Id. at 239. Notably, with respect to reliance, the Supreme Court expressly adopted the fraud-on-the-market theory, under which plaintiffs are entitled to a rebuttable presumption of reliance. Id. at 246-47. The Supreme Court emphasized, however, that “[a]ny 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.” Id. at 248. Nonetheless, this ruling removed the most significant impediment to class treatment of federal securities fraud claims. Arguably, the defense could no longer oppose class certification in this context, without rebutting the presumption, on the basis that individual issues of reliance predominated over class-wide claims. The floodgates had been opened. Page: 1 of 4 pages for this article 1 2 3 > Last »
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