The US Supreme Court Opinion in Goldman Sachs v. Arkansas Teacher Retirement System
Revisiting evidentiary issues and the Basic presumption in inflation-maintenance cases
Two questions significant to securities laws’ jurisprudence were recently teed up for the US Supreme Court’s review in Goldman Sachs Grp., Inc., et al. v. Ark. Teacher Retirement Sys., et al., No. 20-222.
The first question asked whether the generic nature of a misrepresentation constitutes relevant evidence at the class certification stage of inflation-maintenance cases. The second question required the Court to determine whether the defendant carries the burden of persuasion to rebut the fraud-on-the-market theory—which is relevant to the reliance element in securities fraud—by showing a lack of price impact.
The Court answered ‘yes’ to both questions, dissecting several legal concepts related to securities fraud class actions and remanding the case to the Second Circuit. The Court instructed the Second Circuit to consider record evidence relevant to price impact notwithstanding any overlap between that evidence and merits issues.
Factual allegations from Goldman Sachs’ shareholders
Between 2006 and 2010, Goldman Sachs’ SEC filings and reports contained statements like “[w]e have extensive procedures and controls that are designed to identify and address conflicts of interest,” “[o]ur clients’ interests always come first,” and “[i]ntegrity and honesty are at the heart of our business.” Goldman shareholders sued the firm in a putative class action, arguing that the statements, though generic, caused the firm’s stock to trade at artificially high levels.
The shareholders argued that the statements were misleading in violation of § 10(b) of the Securities Exchange Act of 1934 and its implementing regulation, Rule 10b-5, because Goldman entered conflicted transactions without disclosing the conflicts. The shareholders further asserted that the firm’s stock price dropped, causing shareholder losses when the “truth” about Goldman’s conflicts surfaced through an enforcement action and related news coverage.
Goldman unavailingly moved to dismiss the suit, and the shareholders continued to prosecute their case by seeking class certification under the Federal Rule of Civil Procedure 23.
Section 10(b), Rule 10b-5, and the Basic presumption
Material misrepresentations and omissions in the sale of securities violate § 10(b) and Rule 10b-5. A private plaintiff may recover damages when such a violation occurs upon proof that it detrimentally relied on a defendant’s material misrepresentation or omission. Plaintiffs may more easily demonstrate reliance by invoking a rebuttable presumption based on the fraud-on-the-market theory—a presumption that the Court validated in Basic Inc. v. Levinson, 485 U.S. 224 (1988).
The Basic presumption presupposes “that an investor presumptively relies on a misrepresentation so long as it was reflected in the market price at the time of his transaction.” In invoking it, the plaintiff needs to show that (1) the alleged misrepresentation was publicly known, (2) the alleged misrepresentation was material, (3) the stock traded in an efficient market, and (4) the plaintiff arbitraged the stock between the time a defendant made the misrepresentation and the revelation of the misrepresentation.
The Basic presumption is especially important in securities fraud class actions because it enables plaintiffs to establish reliance using evidence common to the class while at the same time satisfying the Rule 23 predominance requirement. But satisfying the Rule does not require plaintiffs to establish the materiality of the misrepresentation—an element reserved to the merits phase of the action. Defendants can rebut the Basic presumption by showing that its alleged misrepresentation had no effect on the stock price.
Courts must consider all record evidence relevant to price impact in Rule 23 determinations, including the generic nature of a misrepresentation
The Goldman Sachs Court relied on its opinion in Halliburton Co. v. Erica P. John Fund, Inc. (573 U.S. 258 (2014)) to reiterate that a determination of whether Rule 23 is satisfied requires a consideration of all evidence bearing on price impact—which includes the generic nature of a misrepresentation. Such evidence is particularly important in inflation-maintenance cases, which hold that price impact equals the amount of price inflation caused by an alleged misrepresentation.
The Court noted that Goldman and the shareholders agreed that the evidence of the generic nature of Goldman’s alleged misrepresentations is relevant to the determination of a lack of price impact. But they differed as to whether the Second Circuit adequately considered it. And the Court signaled its agreement with the shareholders by remanding the case to the Second Circuit for its further consideration of evidence bearing on Goldman’s alleged misrepresentations.
Defendants bear the burden of persuasion to show a lack of price impact at class certification
Noting that the Second Circuit properly held that Goldman bears the burden of persuasion to establish a lack of price impact, the Court nonetheless vacated its judgment based on doubts that the Second Circuit adequately evaluated the generic nature of the alleged misrepresentations. Goldman argued that the Federal Rule of Evidence 301 applied to the Basic presumption to shift the burden of production—but not persuasion—to the defendant after the plaintiff’s successful invocation of the presumption.
The last sentence of Rule 301 essentially states that in civil cases, the party against whom a presumption is directed bears the burden of production, except where a federal statute or rule provides otherwise, and that the burden of persuasion remains on the party who had it at the outset. According to Goldman, Rule 301 required the shareholders to show price impact. The Court disagreed, writing that Rule 301 cannot restrict its power to change a burden of persuasion if a federal statute permitted it to do so.
The Court then remarked that Goldman did not challenge its authority to assign the defendant the burden of persuasion, allowing the Court to apply the Basic framework to Goldman. The Court wrote that under Basic, the defendant needs to “sever the link” between the misrepresentation and the price that applied to plaintiff—which a defendant cannot do by just producing evidence relevant to price impact.
The Court also noted that the “defendant’s burden of persuasion will have bite only when the court finds the evidence in equipoise—a situation that should rarely arise.”