On January 12, 2018, the Second Circuit Court of Appeals (which hears appeals from Connecticut, New York and Vermont) vacated a district court order certifying a securities fraud class action brought by purchasers of common stock in The Goldman Sachs Group, Inc. ("Goldman"). The district court had certified the class, ruling that defendants failed to rebut the presumption of reliance, as first articulated in Basic Inc. v. Levinson ("Basic"). According to the district court, the defendants did not "conclusively" prove a "complete absence of price impact," one of the requirements for rebutting the presumption—at the class certification stage—that the plaintiffs relied on the defendants' alleged misstatements.
On appeal, the Second Circuit ruled that, consistent with its precedent, defendants seeking to rebut the Basic presumption of reliance must do so by a preponderance of the evidence. Because it was unclear whether the district court applied a more demanding standard than preponderance of the evidence, the Second Circuit vacated the district court's decision and remanded it to consider the defendants' evidence under the proper standard.
In their complaint, the plaintiffs had alleged that Goldman and several directors made material misstatements about their efforts to avoid conflicts of interest in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The plaintiffs claimed that the statements about efforts to avoid conflicts of interest were false and misleading because Goldman acted against the interests of its client in at least four collateralized debt obligations (CDO) transactions. The plaintiffs alleged that news of Government enforcement actions against Goldman related to the CDOs revealed the falsity of the defendants' statements and caused Goldman's share price to decline. Specifically, the plaintiffs claimed that, through these news reports, the market learned for the first time that Goldman had allegedly created "clear conflicts of interest with its own clients" by "intentionally packaging and selling securities that were designed to fail, while at the same time reaping billions for itself or its favoured client by taking massive short positions" in the same transactions.
In support of its motion for class certification, the plaintiffs argued that they met the "commonality" requirement for class certification, because common issues of law or fact predominated over issues affecting only individual members of the class. To establish the predominance requirement for class certification—the requirement that questions of law or fact common to class members predominate over any questions affecting only individual members—with respect to the element of reliance, plaintiffs argued that, under Basic, they were entitled to a presumption that all class members relied on the defendants' misstatements in choosing to buy Goldman's stock.
For their part, defendants attempted to rebut the Basic presumption by presenting evidence in the form of declarations and sworn affidavits that Goldman's stock experienced no price increase on the dates the alleged misstatements were made, and no price decrease on 34 occasions when the press reported Goldman's alleged conflicts of interest in the CDOs. The district court rejected the defendants' arguments and certified the class. In so holding, the district court ruled that the defendants failed to rebut the Basic presumption because they "did not provide conclusive evidence that no link exists between the price decline [of Goldman's stock] and the misrepresentations."
In vacating the district court order and remanding for further consideration, the Second Circuit relied on its 2017 decision in Waggoner v. Barclays PLC (which we discussed in a previous memorandum), in which the court held that, in seeking to rebut the Basic presumption of reliance, defendants have the burden of persuasion and must rebut the presumption by a preponderance of the evidence. It ruled that the defendants failed to rebut the Basic presumption because they did not "conclusively" prove a "complete absence of price impact." Because it was unclear whether the district court required more of defendants than a preponderance of the evidence, the Second Circuit vacated the district court's order and remanded it for reconsideration.
Finally, the Second Circuit provided guidance to the district court on how to consider the defendants' evidence on remand. The Second Circuit noted that the district court had improperly construed the defendants' evidence as "an inappropriate truth on the market defence," or as evidence of the statements' lack of materiality, neither of which the district court thought it could consider at the class certification stage. The Second Circuit stated that the district court's view of the defendants' evidence was erroneous and that, on remand, the district court should evaluate the evidence to determine whether the defendants established by a preponderance of the evidence that the misrepresentations did not in fact affect the market price of Goldman' stock.
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