Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System

Issues

Can a defendant in a securities class action rebut the presumption of class-wide reliance recognized in Basic Inc. v. Levinson by pointing to the generic nature of the alleged misstatements to show that the statements had no impact on the price of the security; and does a defendant seeking to rebut the Basic presumption have only a burden of production or also the ultimate burden of persuasion?

Oral argument:

March 29, 2021

Court below:

United States Court of Appeals for the Second Circuit

This case asks the Supreme Court to clarify whether a defendant in a securities class action may rebut the Basic presumption by pointing to the generic nature of the misstatements and by showing that those misstatements did not affect the price of the defendant’s securities. Goldman Sachs Group Inc. argues that courts must consider evidence of the generality of alleged misstatements when determining whether to certify a shareholder class in a securities class action suit. Goldman further argues that defendants only bear the burden of producing some proof that their misstatement did not negatively impact the stock price, while plaintiffs bear the burden of persuading the Court that investors relied on the defendant’s alleged misstatements. The Arkansas Teacher Retirement System counters that the lower courts properly weighed the evidence presented at the class certification stage of the litigation, including the generic nature of the misstatements, when it decided to grant certification of plaintiffs’ shareholder class. ATRS also argues that the defendants implicitly bear both the burden of production and the burden of persuasion when rebutting the presumption because they must make a showing that the particular misrepresentation at issue did not affect the stock’s market price. The outcome of this case will have implications on the availability of class-action lawsuits for investors and the risk of class-action litigation for corporate defendants.

Questions as Framed for the Court by the Parties

Whether during the certification stage of a securities class action, a defendant may rebut the Basic presumption by arguing that the generic nature of the alleged misstatements is evidence that such misstatements did not affect the price of the defendant’s securities, and whether the defendant bears the burden of persuasion when seeking to rebut the Basic presumption.

Facts

Between 2006 and 2010, Goldman Sachs (“Goldman”), an investment bank, made public statements regarding its efforts “to address potential conflicts of interest” and its dedication to “complying fully with the letter and spirit” of laws and ethical standards. Ark. Teacher Ret. Sys. V. Goldman Sachs Grp at 258. Contrary to those statements, there were allegedly several conflicts regarding collateralized debt obligations (“CDO”) transactions. Id. at 259. For example, Goldman marketed a CDO transaction involving subprime mortgages—Abacus 2007 AC-1 (“Abacus”)—as an “ordinary asset-backed security,” but allegedly permitted the hedge fund Paulson & Co. (“Paulson”) to choose the mortgages that would comprise Abacus. Id. Paulson purposefully selected risky mortgages to comprise Abacus, and then “bet against its success through short sales.” Id. From this scheme, Paulson made approximately $1 billion in profits. Id. Goldman later “admitted it failed to disclose” this conflict and reached a settlement with the SEC totaling $550 million. Id.

The plaintiffs, individuals and entities that purchased shares between February 5, 2007 and June 10, 2010, filed a class action suit in the United States District Court for the Southern District of New York. Id. The plaintiffs argued that Goldman, by representing itself to the public as conflict-free, artificially preserved its stock price. Id. The plaintiffs further asserted that after “corrective disclosures” (e.g., the news of the settlement with SEC) revealed Goldman’s conflicts, Goldman’s stock price declined. Id. Goldman’s stock prices continued to drop after announcements of several federal agencies’ investigations into Goldman’s conflicts. Id. As a result of these stock price declines, the plaintiffs lost over $13 billion. Id.

Goldman moved to dismiss the claim, which the district court denied. Id. at 260. After discovery, the plaintiffs moved to the class certification stage, a prerequisite in the securities class action to prove class-wide reliance on Goldman’s statements. Id. Under the Basic Inc. v. Levinson presumption, class action plaintiffs must “establish certain prerequisites…that [1] defendants’ misstatements were publicly known, [2] their shares traded in an efficient market, and [3] plaintiffs purchased the shares at the market price after the misstatements were made but before the truth was revealed.” Id. In establishing the price impact element of the Basic presumption, the plaintiffs relied on the “inflation-maintenance theory” by arguing that while the alleged misstatements did not directly inflate the stock price, they may have helped maintain the level of the inflated share price. Id. at 263. Goldman attempted to rebut the presumption by arguing that (1) the alleged misstatements did not affect the stock price and (2) the market did not react to corrective disclosures. Id. at 261. The district court rejected this challenge and certified the class. Id. Goldman appealed and the United States Court of Appeals for the Second Circuit vacated and remanded the case, finding that the district court failed to apply the correct standard and to consider additional evidence. Id.

On remand, the district court held an evidentiary hearing with supplemental briefs from both parties. Id. at 262. The district court certified the class, finding Goldman’s evidence to be insufficient to sever the link between the drop in share price and the corrective disclosures Id. at 262–63. Goldman filed a petition for interlocutory appeal and the court of appeals granted the appeal. Id.

On the second appeal, the court of appeals rejected Goldman’s arguments to narrow the application of the inflation-maintenance theory and held that the district court did not err in holding that Goldman could not rebut the Basic presumption by a preponderance of the evidence. Id. at 270. The United States Supreme Court granted Goldman certiorari on December 11, 2020. Br ief for the Petitioners, Goldman Sachs Group, Inc. et al. at 1.

Analysis

CLASS CERTIFICATION OF A SECURITIES CASE

Petitioner Goldman Sachs argues that the court of appeals and district court failed to consider evidence that Goldman presented to rebut the Basic Inc. v. Levinson presumption at the class certification stage of the securities litigation. Brief for Petitioners, Goldman Sachs Group, Inc. et al. at 24. Goldman claims it was not given an opportunity to rebut the Basic presumption, which permits a rebuttable presumption in Rule 10b-5 cases brought under the Securities Exchange Act of 1934 where the members of a proposed plaintiff class action relied on alleged misstatements by the defendant if there was a corresponding stock price impact. Id. Citing Halliburton Co. v. Erica P. John Fund, Inc.¸ Goldman argues that the law requires courts to consider price-impact evidence, including evidence that there was no corresponding price impact, when determining whether to certify securities class action lawsuits. Id. at 25. Goldman contends that the lower court decisions to grant class certification failed to satisfy the class certification requirements of Federal Rule of Civil Procedure 23 and contradicted the Halliburton II precedent when they did not consider all of the relevant price-impact evidence offered by Goldman to counter the Basic presumption Id. at 26. Specifically, Goldman argues that the lower courts should have permitted Goldman to present any evidence that its misstatements did not affect the stock price. Id.

Goldman further argues that, when assessing price-impact evidence at the class certification stage of securities litigation, the court must consider the generic nature of the alleged misstatement because it is relevant to determining the effect of the alleged misstatement on the market price. Id. Goldman claims that the court of appeals’ decision to prohibit evidence of the “generic nature” of Goldman’s alleged misstatement impermissibly limited the kind of evidence a court may consider at class certification. Id. at 30. First, Goldman contends that the generic nature of the alleged misstatement is relevant to show, according to common sense, that the statement was less likely to affect the market price of the security than a less generic statement. Id. at 27. Second, Goldman contends that the generic nature of the alleged misstatement is relevant to a price-impact analysis that links a price drop to an alleged “corrective disclosure” of a misstatement because corrective disclosures are less likely to actually correct a misstatement the more generic the statement is. Id. at 28–29.

Respondent Arkansas Teacher Retirement System (“ATRS”) counters that the district court did not err in granting class certification under Federal Rule of Civil Procedure 23. Brief for Respondents, Arkansas Teacher Retirement System et al. at 24. ATRS asserts that the court considered relevant price-impact evidence during an evidentiary hearing, which included expert opinions on statistical event studies, before it concluded that the evidence established a “link” between disclosure statements and subsequent Goldman stock price declines. Id. at 24–25. According to ATRS, the lower courts considered the generic nature of Goldman’s statements both times the class certification issue was litigated, and each time, the court found that the materiality of the statements was a “merits question” that did not bar class certification. Id. at 39–40. ATRS contends that courts typically consider materiality arguments early in the litigation process in a motion to dismiss, and thus, the “general” nature of the alleged misstatements would have been dismissed if any general statements existed. Id. at 21–22.

ATRS further argues that the generic nature of the alleged misstatements and its effect on Goldman’s stock price should be evaluated in light of “evidence, not personal intuition.” Id. at 26. ATRS asserts that price-impact analysis at the class certification stage requires inquiry into whether the market price was affected by the actual statements made and not whether the statements were less likely to impact the price “than an imagined, more specific statement” that was never made. Id. First, ATRS argues that price-impact is a “context-dependent” analysis and thus, judges should consider evidence of the relevant factors and not assume that a generic statement is necessarily less likely to affect market prices. Id. at 28. Second, ATRS also argues that the Amgen Inc. v. Conn. Ret. Plans & Tr. Funds and Halliburton II precedent proscribe courts from evaluating the materiality of the alleged misstatement at the class certification stage. Id. at 32. ATRS contends that the class certification question about whether the statement affected market prices is distinct from the materiality question of whether the statement would have affected reasonable investors. Id. ATRS thus posits that judges at the class certification stage should rely on expert testimony instead of their “commonsense” views to conduct their price-impact analysis. Id. at 30–31.

BURDEN OF PRODUCTION V. BURDEN OF PERSUASION

Goldman claims that the court of appeals erred in finding that a defendant in a securities class action suit retains the ultimate burden of persuasion in providing price-impact analysis evidence to rebut the Basic presumption. Brief for Petitioner at 37. In support of this argument, Goldman cites Federal Rule of Evidence 301, which places the burden of production to rebut the Basic presumption on the defendant, but imposes the ultimate burden of persuasion on the issue of price impact on the plaintiffs. Id. at 38. Goldman contends that, under the Halliburton II precedent, plaintiffs have the burden of persuasion at the class certification stage to provide evidence sufficient to meet the class certification requirements of Federal Rule of Civil Procedure 23. Id. at 39. Goldman argues that the court of appeals erred in stating that, under the Halliburton II precedent, defendants have the burden of persuasion when they rebut the Basic presumption that the alleged statement had a market impact. Id. at 40. Goldman contends that when the Supreme Court created the Basic presumption, the Court intended the presumption to be subject to the same federal evidence rules as “all presumptions.” Id. at 41.

ATRS counters that the defendant, and not the plaintiff shareholders, bears the burden of persuasion in proving price impact under securities law precedent. Brief for Respondents at 40. ATRS asserts that the Court in Basic and Halliburton II implicitly placed the burden of persuasion on defendants when it reasoned that defendants can rebut the presumption only by “showing . . . that the particular misrepresentation at issue did not affect the stock’s market price.” Id. at 41. ATRS argues that the defendant bears the burden of persuasion when rebutting the Basic presumption because courts treat defendants’ insufficient evidentiary showing at the class certification stage as a failure to persuade the court. Id. ATRS contends that courts would not consistently deny class certification when defendants successfully rebut the Basic presumption if the law required defendants to only bear the burden of production. Id. ATRS further argues that Federal Rule of Evidence 301 does not apply to the Basic presumption in securities litigation because the Basic presumption is not a presumption of fact or law, but rather a substantive federal securities rule the Court created in its precedent. Id. at 47–48. ATRS concludes that when Congress statutorily granted a cause of action for private securities class action suits, it intended to include a “burden shifting regime,” which would impose both the burden of production and the burden of persuasion on defendants rebutting the Basic presumption. Id. at 49.

Discussion

INFLATION-MAINTENANCE THEORY AND CLASS CERTIFICATION

The Washington Legal Foundation (“WLF”), in support of Goldman, argues that restraining the scope of the inflation-maintenance theory will bring public policy benefits. Brief of Amicus Curiae Washington Legal Foundation, in Support of Petitioners at 9. The WLF asserts that Congress intended to limit the expansion of meritless securities cases and their in terrorem effect, as evinced by its passage of the Private Securities Litigation Reform Act. Id. at 12. The WLF contends that there has been an increasing number of meritless class actions and the overuse of inflation-maintenance theory by class action plaintiffs. Id. at 11–13. The WLF argues that by allowing plaintiffs to simply invoke the inflation-maintenance theory to receive certification, the court of appeal’s decision will encourage the spread of meritless class actions led by a small group of plaintiffs’ law firms. Id. at 11–13, 15. A group of former SEC officials and law professors (“LPs”) argue that the court of appeal’s decision will thus degrade the process of class certification to a “mere formality” by allowing the inflation-maintenance theory to apply to general statements. Brief of Amici Curiae Former SEC Officials and Law Professors, in Support of Petitioner at 19.

A group of former SEC officials (“FSOs”), in support of ATRS, argue that enforcement of inflation-maintaining statements has been crucial to protecting the integrity of the capital market Brief of Amici Curiae Former SEC Officials, in Support of Respondents at 9–19. The FSOs assert that inflation-maintaining statements have caused substantial harms to investors. Id. at 14. The FSOs contend that the SEC has brought Rule 10(b)-5 enforcement actions based solely on the inflation-maintenance theory or in combination with other grounds of violations. Id. at 10–11. The FSOs argue that the logic of the inflation-maintenance theory permeates other realms of securities enforcement actions, allowing the SEC flexibility in “applying the range of tools at its disposal to fast-moving securities markets and product.” Id. at 12–13. The FSOs also maintain that private class actions supplement enforcement efforts by the SEC, an organization limited by resources and structural challenges. Id. at 19–20. Finally, the FSOs counter the concern that the court of appeal’s decision will open the door for meritless claims by reasoning that courts generally dismiss such meritless claims before they ever reach the class certification stage Id. at 19–21.

EXPOSURE TO CLASS ACTION LAWSUITS

The LPs argue that the court of appeal’s decision to bar consideration of the generic nature of the alleged misstatements will harm public companies. Brief of Amici Curiae Former SEC Officials and Law Professors, in Support of Petitioner at 16. The LPs contend that the decision will expose public companies to more class action lawsuits, since it is common practice among public companies to disclose generic corporate statements. Id. at 17. The LPs assert that class action plaintiffs have “weaponized” generic statements during volatile market conditions arising out of the COVID-19 pandemic and that the court of appeal’s decision will increase the risks of litigation to those companies. Id. The Retail Litigation Center (“RLC”), in support of Goldman, argues that the court of appeal’s decision will expose corporations to more class action lawsuits as they increasingly follow Environmental, Social and Governance (ESG) reporting standards. Brief of Amicus Curiae Retail Litigation Center, in Support of Petitioner at 16. According to the RLC, many U.S. companies face pressure from consumers to actively disclose their commitment to climate change, racial equity, and sustainability. Id. at 16–17. In this context, the RLC contends that the court of appeal’s reliance on generic statements in certifying the class will put corporations in a dilemma: either follow ESG guidelines and release generic statements (and thus accept the risk of exposure to class actions lawsuits), or refuse to disclose such statements to avoid litigation exposure (and thus fall behind ESG standards). Id.

A group of 19 public-sector institutional investors (“Investors”), in support of ATRS, counter that allowing expert evidence of actual price impact to be supplanted with court “theorizing about the ‘generality’ of statements” will preclude investors from bringing meritorious class action lawsuits. Brief of Amici Curiae Institutional Investors, in Support of Respondents at 21–22. The Investors maintain that the private right of action under Rule 10(b)-5 requires a presumption that investors be permitted to rely on “public information embedded in market prices.” Id. at 21. Without this presumption, the Investors argue that class action litigants face the insurmountable burden of proving whether hundreds of investors relied on the alleged misstatement. Id. The North American Securities Administrators Association (“NASAA”) argues that class action lawsuits play a pivotal role in promoting compliance with federal securities laws and deterring misstatements in the market. Brief of Amicus Curiae The North American Securities Administrators Association, Inc., in Support of Respondents at 5–6. NASAA contends that company defendants’ superior resources and information give them structural advantages over class actions plaintiffs. Id. at 7. NASAA asserts that class action lawsuits, by enabling small-victim plaintiffs to aggregate their claims and share litigation expenses, provide victims of securities violations with an affordable avenue for relief. Id. at 6–8. NASAA argues that, if the Court follows Goldman’s argument and precludes general statements from the Basic presumption determination, small investors are not likely to pursue litigation because the prohibitive costs of individual litigation will “dwarf their individual returns.” Id. at 7–8.