Securities Litigation after Amgen: It's Time to Reassess the Fraud-on-the-Market Presumption
Booth, Richard A., Regulation
Early last year, the U.S. Supreme Court missed yet another opportunity to make some sense out of securities litigation. In Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, buyers of the biotech stock sued, claiming the company had misrepresented concerns about two flagship drugs. In response, Amgen argued that the market was well aware of the facts. The company further argued that it should not be subject to a class-action lawsuit unless the alleged misrepresentations affected the market price of its shares, which should be determined before the suit could be certified to proceed as a class action.
Securities fraud class actions depend on the idea that investors rely on the integrity of market prices--that stock price reflects the market's appraisal of all information available about the firm. Thus, an investor may be presumed to have relied on a material misrepresentation even if he was unaware of it because the misrepresentation would have affected market price. Without this fraud-on-the-market (FOTM) presumption, class actions would be impossible; they would raise too many questions as to whether individual class members should be presumed to have relied on a misrepresentation.
Defendant firms can challenge the FOTM presumption in court. In the 1988 case Basic Inc. v. Levinson in which the Court first articulated the FOTM theory, it also ruled that the defendant may show that the misrepresentation did not affect market price and that the plaintiff thus cannot be presumed to have relied on the misrepresentation. But virtually all such cases settle out of court, long before the presumption can be challenged in the courtroom, because of the potential for massive liability in class action suits. A judgment against a defendant firm could result in damages wholly out of proportion with genuine investor losses, and firms would rather settle for a negotiated amount than risk an enormous loss in court.
This concern--or the lack of it--was central to the Court's recent decision in the Amgen case. Amgen argued that early in the legal process, when the court considers a motion to certify class status, defendants should be permitted to introduce evidence as to a lack of price impact--and that Basic itself so held. That way, the materiality of an alleged misrepresentation--and class reliance thereon--can be determined before the target company decides whether to settle or proceed with the case. The Supreme Court disagreed. As a result of the 6-3 decision, defendant corporations will be induced to settle many cases that would never succeed at trial.
WHY NOT WAIT FOR TRIAL?
The Court majority reasoned that if the plaintiff cannot prove materiality at trial, the action will fail for all class members. As for the argument that materiality will often never be tried because defendant firms will opt to settle, the Court responded that in many types of civil cases, the facts are never tried because of the pressure to settle. Why should FOTM cases be treated differently?
The problem with this reasoning is that materiality is not the point. The point is reliance--the presumption that members of the plaintiff class relied on the integrity of the market price (though not necessarily the accuracy thereof) when they decided to purchase the security in question. If a misrepresentation affected market price, it is presumed to be material and absent class members may be presumed to have relied on it. In other words, reliance cannot be presumed in the absence of price impact. But a misrepresentation may nonetheless be material (as the Court has defined the word) even if it does not affect market price.
It is telling that the Court describes the FOTM presumption as a substantive doctrine of federal securities fraud law that can be invoked by any plaintiff even outside the context of a class action. What the Court fails to appreciate is that the plaintiff can prove fraud without resorting to the doctrine. …