Rebutting the Fraud-on-the-Market Presumption of Reliance

Thanks to two recent U.S. Supreme Court decisions, Amgen v. Connecticut Retirement Plans and Trust Funds, 133 S. Ct. 1184 (2013), and Erica P. John Fund v. Halliburton, 131 S. Ct. 2179 (2011), plaintiffs in securities fraud class actions brought under Section 10(b) of the Securities Exchange Act of 1934 and U.S. Securities and Exchange Commission Rule 10b-5 do not need to prove two of the essential elements of their claim, loss causation and materiality, at the class certification stage. These two judicial alterations to the securities class-action playing field give plaintiffs a strategic advantage in obtaining class certification and, therefore, in increasing the potential settlement value of their claims. Yet, both decisions leave open the question of whether defendants can defeat class certification by rebutting the fraud-on-the-market presumption of reliance with evidence that defendants' alleged misrepresentations did not measurably impact the market price of the security at issue.

By way of background, to establish a Rule 10b-5 violation, a private plaintiff must prove that the defendant (a) made a misstatement or omission (b) of material fact (c) with scienter (fraudulent intent) (d) in connection with the purchase or sale of a security (e) upon which the plaintiff reasonably relied and (f) the plaintiff's reliance was the proximate cause of his or her injury (loss causation). If courts strictly applied the reliance requirement in the class action context, then common questions would not "predominate" for purposes of Federal Rule of Civil Procedure Rule 23(b)(3) because each prospective class member would have to prove that he or she individually relied on the misrepresentation or omission at issue, and no class would ever be certified. Instead, courts allow plaintiffs to establish a rebuttable presumption of classwide reliance under the fraud-on-the-market theory adopted by the Supreme Court in Basic v. Levinson, 485 U.S. 224 (1988). Under this theory, courts presume that all members of the putative class indirectly relied on the alleged misrepresentation or omission through their reliance on the stock's market price, so long as the lead plaintiff can show that the stock traded in an efficient market.