By Julie Richmond
Two years ago in this newsletter, Berman DeValerio highlighted a new and troubling trend in securities lawsuits: a rise in defense challenges to class certification. Since then, these challenges have gained ground, forcing plaintiffs to expend substantial resources on a procedural milestone that was once largely a fait accompli.
Class certification is fundamental to every class action, and essential to preserving the vitality of the private right of action to enforce the securities laws. Without a class, individual plaintiffs have few realistic options to take on large, deep-pocketed corporate defendants.
Historically, courts have certified classes in shareholder lawsuits almost automatically. That’s because securities fraud fact patterns present the archetypal example of a defendant’s fraudulent conduct affecting every purchaser of the stock identically. These automatic certifications are no longer, thanks largely to the somewhat obscure economic debate over what constitutes an “efficient” securities market.
To appreciate the relevance of market efficiency, one must first understand the fraud-on-the-market presumption, which was adopted by the Supreme Court in a crucial 1988 decision.
Under this presumption, the court presumes that all investors have relied on a corporation’s public statements and the integrity of the market price of the company’s stock when deciding whether to buy or sell shares, as long as the stock in question was traded on an efficient market.
Defendants’ challenges to the underlying efficient-market hypothesis are appearing in recent oppositions to class certification. This has placed a heavier burden on plaintiffs.
A recent high-profile example of a class certification challenge stems from the more than 300 class actions involving initial public offerings issued between 1998 and 2000. The IPO action alleges that hundreds of public offerings during this period were manipulated by the investment banks that underwrote them.
In October 2004, a federal judge certified six selected “focus” cases among the 300 actions as appropriate for class action treatment. In her decision, Judge Shira Scheindlin of the U.S. District Court for the Southern District of New York held that a plaintiff must make only “some showing” of each of the elements for class certification established under the federal legal procedures known as Rule 23.
Defendants appealed, and on Dec. 5, 2006, the U.S. Court of Appeals for the Second Circuit reversed the order for class certification, ruling that courts must resolve any factual disputes relevant to each Rule 23 requirement.
In other words, instead of the generous “some showing” standard used by Judge Scheindlin, which typically would not require factual findings on the relevant issues, going forward a more rigorous “merits based” determination would be needed for each category under Rule 23.
These categories include the number of people involved in the class, the common issues and claims they share, and the adequacy of their legal representatives.
Using this stricter test for the IPO appeal, the 2nd Circuit held that individual issues predominated over common questions of law or fact, making class certification inappropriate. In particular, the appeals court found the market for IPO shares was not efficient, thus rendering the fraud-on-the-market presumption unavailable.
The particular characteristics of a market for an IPO are quite distinct from the market for the same stock after the “quiet period” is over, and public comment and analysis are encouraged. At that time, the market is highly likely to be “efficient.”
But until then, reliance on misstatements would have to be established on an individual basis.
In confirming that the new merits-based standard requires findings of fact, the court noted that judges may be required to resolve “factual disputes” tied to Rule 23 requirements. Counsel may take more discovery concerning the Rule 23 requirements and courts may begin conducting more mini trials concerning class certification.
Berman DeValerio is no stranger to such heightened class certification burdens. In the firm’s case against Xcelera, an Internet holding company, the defendants argued that the market for Xcelera’s stock was irrational and inefficient, in an attempt to destroy the presumption of reliance.
After a two-day evidentiary hearing, the judge sided with the plaintiffs, granting the motion for class certification in September 2004. U.S. District Judge Rya W. Zobel wrote: “The position of defendants’ expert suggests that market efficiency is a rare phenomenon. Whether or not that is true as a matter of pure economics, it does not function to shield defendants who mislead the public from the laws regulating securities.”
Unfortunately for plaintiffs, these class certification challenges have nothing to do with allegations of corporate fraud or the merits of a case. They are simply another tactical maneuver by defense lawyers to delay and deny shareholder claims.
Julie Richmond is an attorney in the firm’s Boston office.
*In August 2017, our firm name changed to Berman Tabacco. Case references and content published before that date may refer to the firm under our prior name, Berman DeValerio.