The titans of the securities bar are lining up in solidarity with Goldman Sachs in objecting to a newly re-certified class action.

With a sky-is-falling franticness, they are beseeching the U.S. Court of Appeals for the Second Circuit to grant interlocutory review—again—in a hot potato of a case. On August 14, U.S. District Court Judge Paul Crotty on remand certified the $13 billion investor class action for the second time against Goldman, which is represented by Robert Giuffra Jr. at Sullivan & Cromwell.

In briefs filed last week, defense amici warn that Crotty's decision could lead to “runaway liability” (Jonathan Youngwood of Simpson Thacher & Bartlett for the Securities Industry and Financial Markets Association); “would eviscerate the right of defendants in securities fraud class actions (Todd Cosenza of Willkie Farr & Gallagher for law professors and former SEC officials); and “would subject virtually every corporation with securities traded in the United States to potentially ruinous class action lawsuits whenever it discloses bad news.” (Jared Gerber, Lewis Liman and Matthew Karlan of Cleary Gottlieb Steen & Hamilton for the U.S. Chamber of Commerce).

Still, if the stakes weren't so high, the underlying issue would almost be funny.

To wit: You know how companies like to boast about putting their customers first and having the highest ethical standards blah blah? The kind of stuff that might be on a motivational poster, accompanied by a photo of a mountaintop or soaring bird?

What if it wasn't just drivel from the marketing department? What if companies—brace yourself—were actually held to it?

In various annual reports and SEC filings, Goldman offered up such aspirational gems as “Our reputation is one of our most important assets” and “Our clients' interests always come first” and “Integrity and honesty are at the heart of our business.”

But then the investment bank got busted for allegedly packaging certain mortgage-backed securities to help one favored client who was short on the position at the expense of lesser clients, who lost $1 billion. In 2010, Goldman paid the U.S. Securities & Exchange Commission $550 million to settle the case, admitting it was a “mistake” not to disclose the role of favored client John Paulson in the so-called Abacus transaction.

But…but…how could this be if Goldman said it is “dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us”?

Jeez, it's like finding out Santa Claus isn't real.

To be clear, the plaintiffs in the class action aren't the investors who got ripped off by Abacus and three other transactions. (They brought their own fraud suit, now settled). They're Goldman shareholders who bought stock in the Wall Street giant between February 5, 2007, and June 10, 2010, when the firm's share price bottomed out amidst the allegations of misconduct.

Represented by Robbins Geller Rudman & Dowd and Labaton Sucharow, the plaintiffs originally argued that Goldman should have told its shareholders when it got a so-called Wells Notice that the SEC was investigating its conduct.

But that wasn't going to fly. Even the plaintiffs lawyers had to concede that no court has ever held that a company's failure to disclose receipt of a Wells Notice is an actionable omission.

So if the suit couldn't hang on an omission, what about a misstatement?

That's where the plaintiffs zeroed in on Goldman's we-care-so-much-about-our-clients-and-we're-so-ethical verbiage. Especially this statement: “We have extensive procedures and controls that are designed to…address conflicts of interest.”

Crotty bought it.

“Goldman must not be allowed to pass off its repeated assertions that it complies with the letter and spirit of the law, values its reputation, and is able to address 'potential' conflicts of interest as mere puffery or statements of opinion,” he wrote in 2012 when he refused to dismiss the case.

Crotty deserves credit for calling out Goldman on its hypocrisy. But as the amici point out, his decision to re-certify the class has some serious flaws.

It comes down to how he applied the price maintenance theory and preponderance of evidence standard.

The defense amici offer lots of examples from other cases to illustrate what they think legitimate price maintenance fraud-on-the-market should look like.  

For example, let's say you're about to go bankrupt but put out a statement boasting about your record-high net income and cash on hand for investing. Or maybe you lie about the results of a drug study or having met a financial target. The point is, you're preventing the market from discovering the truth—and keeping your stock price artificially propped up.

But here, the plaintiffs link the drop in Goldman's stock price to revelations that it hadn't made good on its pledges to be the very best that it could be.

Or… maybe the stock dropped because government's enforcement activities against Goldman became public.

So look, Crotty is nobody's fool. (Small disclosure: a long time ago, before I was a journalist and he was a judge, I worked for a small company and he was our outside counsel. He was very, very good.)

In recertifying the class, he accepted that news of the enforcement activity “would at least contribute to the stock price declines.”

But he didn't think it explained it entirely. Instead, he concluded that Goldman's claims about being so adept at handling conflicts of interest also played a role, crediting the plaintiffs' expert, “who at the very least establishes a link between news of Goldman's conflicts and the subsequent price declines.”

“Defendants have failed to establish, by a preponderance of evidence, that the alleged misstatements had no price impact,” Crotty wrote.  

But that's an impossible standard, the amici argue.

“The implications of the district court's contrary holding are radical,” wrote the Cleary lawyers for the Chamber of Commerce, which is also represented by Steven Lehotsky of the U.S. Chamber Litigation Center.

“Defendants put forward evidence of 'an alternative explanation' for the price declines,” they continued. “The district court held this evidence was inadequate because it failed to eliminate the possibility that some portion of the stock drop was due to corrective disclosure of the alleged misstatements. Because no defendant will ever be able to rule out this possibility entirely, the decision below essentially renders certification automatic.”

And just about every publicly traded company could get caught in the dragnet—because almost all of them “include general statements of corporate principle similar to those at issue here in their public filings as a matter of routine,” added Cosenza of Willke Farr for securities luminaries including Stanford Law professor Joseph Grundfest, a former SEC commissioner.

The result? “[N]early uniform and automatic class certification for putative securities fraud class actions across the board.”

Or as Youngwood from Simpson Thacher put it, “every company is one allegation of wrongdoing away from facing a similar securities class action lawsuit. That is not the law.”

 

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