The Supreme Court ruled yesterday that there is no requirement to prove materiality before certification of a class action under Rule 10b-5. Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, No. 11-1085 (U.S. Feb. 27, 2013). However, the victory for plaintiffs was tempered by hints of a larger victory for defendants in the future, as several Justices suggested that it is time to reconsider the fraud-on-the-market theory. In a separate case, the Supreme Court also ruled that the five-year limitations period for civil penalties in enforcement actions brought by the Securities and Exchange Commission (and other federal regulators) begins to run when the fraud occurs, not when it is discovered. Gabelli v. SEC, No. 11-1274 (Feb. 27, 2013).
Federal Rule of Civil Procedure 23(b)(3) requires that, for a class action to be certified under that provision, the question of law or fact common to class members must predominate over any questions affecting only individual members. In the Amgen case, the defendant argued that, to meet the predominance requirement, certification must be denied unless the plaintiff proves materiality, because immaterial misrepresentations or omissions, by definition, would have no impact on the defendant's stock price in an efficient market. The circuits have split on the issue, with the Second Circuit supporting the defendant's view and the Seventh and Ninth Circuits opposing it. Justice Ginsburg, writing for a 6 - 3 majority, ruled that, because materiality is judged according to an objective standard that applies equally to all investors, proof of materiality can wait until after a plaintiff class has been certified.
The plaintiff in the Amgen case, like the plaintiffs in most Rule 10b-5 cases, relies on the fraud-on-the-market doctrine. In a private cause of action under Rule 10b-5, the plaintiff must prove reliance upon the misrepresentation or omission. Traditionally this requirement was met by showing that the plaintiff was personally aware of the defendant's statement and engaged in a relevant transaction based on that specific misrepresentation. In 1988, however, the Supreme Court, in a 4 - 2 vote (only six Justices participating), endorsed the fraud-on-the-market theory, which recognizes a rebuttable presumption of classwide reliance on public, material misrepresentations when shares are traded in an efficient market. Basic Inc. v. Levinson, 485 U.S. 224 (1988). The fraud-on-the-market theory facilitates the use of class actions in securities fraud cases; the requirement to establish reliance otherwise would ordinarily preclude certification of a class action, because individual reliance issues would overwhelm questions common to the class. In the Amgen case, four Justices, including Justice Alito, who concurred in the majority opinion, suggested that reconsideration of the fraud-on-the-market presumption may be appropriate in a future case. The majority opinion noted these views and did not attempt to refute them, but noted that, since the defendant had conceded that the market for its securities is efficient, the present case was a poor vehicle for exploring the issue.
The tea leaves, then, plainly indicate that four Justices are willing, in an appropriate case, to grant review of a case presenting the question whether the fraud-on-the-market doctrine should be overturned, which would largely put an end to securities fraud class actions under Rule 10b-5. (It would not, however, put an end to class actions brought under Sections 11 and 12 of the Securities Act of 1933 for securities fraud involving public offerings of mutual funds and other issuers, as those provisions do not include a reliance requirement.) What's more, none of the other five Justices even expressed an opinion on the issue. It would take only one of those five Justices to overturn the doctrine. Of course, it may take a while for an appropriate case to reach the Supreme Court, and there is no assurance that the court would still have the same membership at that time.
The Gabelli case involved the construction of 28 U.S.C. § 2462, which applies a five-year statute of limitations to federal actions for civil penalties, including SEC enforcement actions. The SEC brought a civil enforcement action six years after the defendants allegedly aided and abetted market timing, and the Second Circuit ruled that the statute of limitations did not accrue until the claim was discovered, or could have been discovered with reasonable diligence, by the plaintiff. The Supreme Court reversed in a unanimous opinion by Chief Justice Roberts, ruling that a federal regulator's claim based on fraud accrues, and the five-year clock of 28 U.S.C. § 2462 begins to tick, when a defendant's allegedly fraudulent conduct occurs. The court distinguished cases in which the government is itself a defrauded party, in which case it does have the benefit of the discovery rule. The opinion noted that it did not address the application of the fraudulent concealment doctrine, when the defendant takes steps beyond the challenged conduct itself to conceal that conduct from the plaintiff. The ruling also does not apply to enforcement actions for injunctive relief and disgorgement, which are not subject to a statute of limitations.
The opinion in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds is available at
The opinion in Gabelli v. SEC is available at
John M. Baker
Stradley Ronon Stevens & Young, LLP
1250 Connecticut Avenue, NW, Suite 500
Washington, DC 20036
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