Supreme Court Update: Securities Class Actions and Litigation Finance
By Woodsford’s Bob Koneck
The Supreme Court of the United States issued a decision last week in Goldman Sachs Group, Inc. v. Arkansas Teacher Retirement System concerning a securities-fraud class action against Goldman Sachs. It had the potential to dramatically alter the landscape of securities-fraud class actions in the US.
But it didn’t. The Supreme Court declined the opportunity to increase the burden on plaintiffs seeking class certification in securities-fraud disputes. That said, the opinion may nonetheless complicate the journey to class certification for some cases. Litigation finance can help to neutralize this risk.
Plaintiffs in this case are a class of pension funds. They owned shares in Goldman around the time Goldman made public statements about its ability to manage conflicts of interest. Goldman’s statements include:
- “We have extensive procedures and controls that are designed to identify and address conflicts of interest.”
- “Our clients’ interests always come first.”
- “Integrity and honesty are at the heart of our business.”
Goldman Sachs Grp., Inc. v. Ark. Teacher Ret. Sys., No. 20-222, Slip Op. at 5 (U.S. 2021). Plaintiffs allege that these statements were false and misleading because there existed serious undisclosed conflicts of interest relating to Goldman’s sale of collateralized debt obligations. Plaintiffs further allege that these false and misleading statements maintained an artificially inflated stock price for Goldman. The inflated stock price then dropped when the public learned of certain conflicted transactions from a government enforcement action, causing Plaintiffs to suffer losses.
In response, Plaintiffs initiated this class action seeking to recover damages for losses attributable to the artificially inflated stock price. This is the “inflation-maintenance theory” of securities fraud, and the Supreme Court had never before taken an opportunity to opine on its validity.
To prevail, Plaintiffs had to “prove, among other things, a material misrepresentation by [Goldman] and [Plaintiffs’] reliance on that misrepresentation or omission.” Id. at 3. Plaintiffs sought to establish reliance using the rule from Basic Inc. v. Levinson, 485 U.S. 224 (1988).
Basic allows plaintiffs to “invoke a rebuttable presumption of reliance based on the fraud-on-the-market theory.” Id. In other words, Basic creates a rebuttable presumption that “investors”—here, Plaintiffs—“rely on the market price of a company’s security, which in an efficient market incorporates all of the company’s public misrepresentations”—here, Goldman’s statements about its ability to manage conflicts. Id. at 1-2. Put simply, under Basic, reliance on stock price may equal reliance on the public misrepresentations. A defendant may rebut the Basic presumption by showing by a preponderance of evidence that its alleged misrepresentations did not impact stock price.
The Basic presumption is critical to the survival of securities-fraud class actions. With it, class members may satisfy the reliance element on a class-wide basis. Without it, “individualized issues of [each class member’s] reliance” would typically prevent class certification. Id. at 4.
Plaintiffs invoked the Basic presumption in moving for class certification. Goldman opposed certification by attempting to rebut the Basic presumption with evidence that its statements “actually had no impact on its stock price.” Id. at 2. Both sides submitted “extensive expert testimony on the issue.” Id. at 5.
The district court found that Goldman “had failed to carry its burden of proving a lack of price impact.” Id. at 2. It certified the class, Goldman appealed, the Second Circuit affirmed, and Goldman appealed again.
Goldman insisted that the Second Circuit erred in two ways. First, it wrongly held “that the generic nature of [Goldman’s] alleged misrepresentations is irrelevant to the price impact inquiry.” Id. at 2. Second, it wrongly assigned “Goldman the burden of persuasion to prove a lack of price impact,” rather than assigning the price impact burden to Plaintiffs. Id.
The Empty Goldman Victory
Goldman won a reversal of the class certification decision. But it may be a hollow victory.
On the first issue, “the parties’ dispute [had] largely evaporated” by the time of the Court’s decision. Id. at 6. The parties “agree[d, as did the Court,] . . . that the generic nature of a misrepresentation often is important evidence of price impact that courts should consider at class certification.” Id. at 2. “The parties further agree[d] that courts may consider expert testimony and use their common sense in assessing whether a generic misrepresentation had a price impact.” Id.at 7.
Only one dispute remained: “whether the Second Circuit properly considered the generic nature of Goldman’s alleged misrepresentations.” Id. at 8. The answer was unclear to the Court. So it remanded to give the Second Circuit an opportunity to ensure consideration of the generic nature of the alleged misrepresentations.
On the second issue, the Court summarily rejected Goldman’s invitation to shift the burden of persuasion to class action plaintiffs to show price impact. A contrary ruling would have tipped the scales in favor of defendants and potentially endangered the survival of many securities-fraud class actions.
Also of note: the Court offered no view on the validity of the inflation-maintenance theory of securities fraud, which came as a relief to anyone concerned that the Court would use Goldman Sachs as a vehicle to undermine this widely used theory of securities liability.
The Impact of Goldman Sachs
Goldman Sachs offers no seismic shift in securities-fraud disputes, as defendants may have hoped and plaintiffs feared it could. But it remains to be seen whether Goldman Sachs will result in other, subtler changes in securities-fraud disputes.
On one hand, the Court preserved the burdens of persuasion and underscored the importance of courts considering information relevant to price impact, such as the generic nature of a misrepresentation. This is hardly groundbreaking.
On the other hand, the Court emphasized that the “generic nature of a misrepresentation often will be important evidence of a lack of price impact, particularly in cases proceeding under the inflation-maintenance theory.” Id. at 8. This language will probably incentivize securities-fraud defendants to argue more aggressively that the generic nature of an alleged misrepresentation prevented a price impact. This may be especially true in actions premised on inflation-maintenance theory, where the Court implied that considerations of generality could assume heightened importance.
What is more, the Court attempted to minimize the impact of its ruling with the following conclusion, which may, paradoxically, add considerable weight to its ruling:
Although the defendant bears the burden of persuasion [on price impact], the allocation of the burden is unlikely to make much difference on the ground. . . . [T]he plaintiffs and defendants [will] submit competing expert evidence on price impact. The district court’s task is simply to assess all the evidence of price impact—direct and indirect—and determine whether it is more likely than not that the alleged misrepresentations had a price impact. The defendant’s burden of persuasion will have bite only when the court finds the evidence in equipoise—a situation that should rarely arise.
Id. at 11-12. The Court thus “emphasize[d] . . . that the [defendants’] burden of persuasion should rarely be outcome determinative.” Id. at 2.
The above statements about the general irrelevance of the burden of persuasion could, in practice, encourage lower courts to treat the burden of persuasion as irrelevant, thereby emboldening them to more readily find no price impact, and, on that basis, deny class certification.
Time will tell.
Goldman Sachs and Litigation Finance
Litigation funders like Woodsford provide capital for fees and costs to counsel in securities-fraud class actions in exchange for a share of an eventual recovery. This funding is passive—meaning the funder has no decision-making authority—and non-recourse—meaning the funder receives its deployed capital and return only if plaintiffs prevail.
Among other benefits, this arrangement allows plaintiffs and counsel to shift the financial risk of pursuing a class action to a litigation funder. If plaintiffs and their counsel are evaluating the impact of Goldman Sachs on the battle for class certification, they may benefit from consultation with an experienced litigation funder and from using litigation funding to offload their financial exposure and neutralize the risk of loss.
Woodsford has experience financing securities class actions. If you’re an attorney specializing in securities actions or representing an investor seeking redress, we’d love to talk to you. Email Bob directly.