Second Circuit Clarifies Application of Presumption of Reliance

Skadden, Arps, Slate, Meagher & Flom LLP

In re Petrobras Sec., No. 16-1914-cv (2d Cir. July 7, 2017), Waggoner v. Barclays PLC, No. 16-1912-cv (2d Cir. Nov. 6, 2017) and Ark. Teachers Ret. Sys. v. Goldman Sachs Grp., Inc., No. 16-250 (2d Cir. Jan. 12, 2018)

The Second Circuit, in opinions by three different panels, has clarified the method by which plaintiffs may invoke, and defendants may rebut, the “fraud on the market” theory of reliance at the class certification stage.

In In re Petrobras Securities, decided last summer, the Second Circuit upheld the district court’s finding that Petrobras securities traded in an efficient market — a prerequisite for plaintiffs to rely on the fraud-on-the-market theory and thus obtain the benefit of the presumption of classwide reliance established by Basic Inc. v. Levinson, 485 U.S. 224 (1988). While declining to adopt a particular test for market efficiency, the Second Circuit held that the plaintiffs were not required to establish that the price of Petrobras securities increased in response to good news and decreased in response to bad news. Rather, it was sufficient to show that the price changed in response to significant events, regardless of the direction of the changes, and to offer “indirect” evidence of market efficiency, such as high trading volume, extensive analyst coverage and large market capitalization.

In Waggoner, the Second Circuit in November 2017 affirmed the district court’s certification of a class of investors in a bank’s American depositary shares (ADS) alleging claims in connection with the bank’s operation of an alternative trading system, or “dark pool.” The district court granted certification, finding that the plaintiffs were entitled to the Basic presumption of reliance based on indirect evidence that the ADS traded in an efficient market. On appeal, the Second Circuit affirmed, finding that the defendants had not met their burden to rebut, by a preponderance of evidence, the presumption of reliance. First, although there was an absence of direct evidence of price movement on the dates of the alleged misrepresentations, the plaintiffs proceeded on a price maintenance theory (i.e., the statements affected stock prices by maintaining already existent price inflation), and thus a lack of price movement alone did not rebut the presumption of reliance. Although defendants asserted that other market concerns impacted the stock price, they did not establish that the alleged misrepresentations did not also impact the price. Second, the court concluded that the ADS were traded in an efficient market. The court reasoned that evidence of price impact is not always necessary to establish an efficient market and was not necessary here in light of other factors, particularly the bank’s status as “one of the largest financial institutions in the world.” Separately, the court also found that the plaintiffs’ damages model complied with U.S. Supreme Court guidance in Comcast Corp. v. Behrend, 569 U.S. 27 (2013), even though some of the price decline may have been attributable to other market factors, and even though the model failed to account for variations in inflation over time. The defendant has filed a petition for writ of certiorari with the Supreme Court.

In Arkansas Teachers Retirement System, the Second Circuit in January 2018 vacated an order certifying a class of investors. The district court found that the plaintiffs were entitled to the Basic presumption of reliance because the defendant had failed to prove “conclusively” the “complete absence” of an impact on stock price by the alleged misrepresentations. The defendant had presented evidence of 34 dates on which news media reported the alleged misrepresentations without an attendant decline in the stock’s price. The Second Circuit held that the district court’s finding did not comply with the holding in Waggoner that defendants need only rebut the presumption by a preponderance of the evidence, and it stated that the district court had erroneously construed the defendant’s evidence of price impact (and lack thereof) as either a truth-on-the-market defense or evidence of a lack of materiality, neither of which would be appropriately considered at the class certification stage. To the contrary, the Second Circuit held that the defendant’s evidence that the price had not reacted to news media reports regarding the alleged misrepresentations was competent evidence that the allegedly misleading statements “did not actually affect the stock’s market price,” as needed to rebut the presumption of reliance.

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In Petrobras, Waggoner and Arkansas Teachers Retirement System, the Second Circuit addressed the practical application of the presumption of reliance first established by Basic and the standard for defendants to rebut it at the class certification stage. These cases remind litigants that plaintiffs are likely entitled to invoke the Basic presumption where the hallmarks of an efficient market are present, but defendants are afforded a meaningful opportunity to rebut any and all prerequisites of the presumption with competent evidence. In doing so, defendants need only meet a preponderance of the evidence standard to successfully rebut the presumption. The long-term impact of these opinions will be observed as the district courts apply them in coming years.

This summary can be found in the March 2018 issue of Inside the Courts.