The Ninth Circuit joined the Third and the Seventh in concluding that at the class certification stage plaintiffs in a securities fraud damage action need not prove materiality to utilize the fraud-on-the market. Three other circuits take a contrary view. The Circuit Court also held that the district court correctly rejected defendants’ efforts to rebut the fraud-on-the-market presumption with evidence of a “truth-on-the-market” defense at the certification stage. Connecticut Retirement Plans and Trust funds v. Amegen Inc., No. 09-56965 (9th Cir. Filed Nov. 8, 2011). The ruling is part of a clear split in the circuits on a key issue in securities fraud damage cases which at some point will have to be resolved by the Supreme Court.

Plaintiff Connecticut Retirement Plans brought an action against biotechnology company Amgen Inc. and several of its officers. The complaint alleges that the defendants misstated and failed to disclose safety information about two Amgen products used to treat anemia. Plaintiffs claim that four statements are misleading because they downplay the FDA’s safety concerns about the products, conceal details about a clinical trial that was cancelled because of concerns that a company product exacerbated tumor growth in some patients, exaggerated the safety of the products on labels and misrepresent the marketing efforts. The complaint alleges violations of Exchange Act Section 10(b).

The district court granted the motion for class certification based on Federal Rule of Civil Procedure 23(b)(3). That Rule requires that questions of law or fact common to the class members predominate over those affecting only individual members and that the class vehicle be superior to other methods for fairly and efficiently adjudicating the controversy. Under the Rule plaintiffs have the burden of demonstrating that its requirements have been met. The district court is charged with conducting a “rigorous analysis” to ensure that the plaintiffs have met their burden under the Rule.

The district court in this case concluded that common questions predominated. Those focus on whether false statements were made, if they were material and connected to a purchase or sale of securities, whether the statements were intentionally false and if they caused the loss of the class members. The court also concluded that reliance was common to the class members based on the fraud-on-the market presumption adopted in Basic Inc., v. Levinson, 485 U.S. 224 (1988). That case concluded that under the efficient market theory available material information regarding a security is reflected in its price. Those who purchase in an efficient market are presumed to rely on its integrity, obviating the need to prove individually the element of reliance. Finally, the court held that at the class certification stage Connecticut Retirement did not need to prove materiality. Rather, it could merely allege materiality although that issue would have to be proven at trial.

The Ninth Circuit affirmed. Under Basic a plaintiff seeking to rely on the fraud-on-the-market theory to establish reliance must first demonstrate that the securities were traded in an efficient market and that the claimed misrepresentations were public. Both of these points have been admitted here.

The key remaining question centers on the issue of materiality. Amgen argues that because plaintiffs did not prove that the claimed false statements were material the certification motion should have been denied since under those circumstances each individual plaintiff would have to prove reliance. The difficulty with this contention, the Ninth Circuit held, is that materiality is an element of the merits of a securities fraud claim. If the representations are material then the fraud-on-the-market presumption makes reliance common to the class. In contrast, if the statements are not material then every plaintiff’s claim fails on the merits and there is no need for a trial on the question of individual reliance. Thus plaintiffs’ claims stand or fall together. What is critical here is not the raising of common questions but whether the class vehicle can result in common answers that move toward the resolution of the case.

When invoking the fraud-on-the-market presumption issues regarding market efficiency and if the misstatements were public are not elements of the merits. If those elements are not established the presumption cannot be used. The question of materiality is a merits issue. While it is appropriate to “take a peek at the merits” and ensure that materiality, however, has been plausibly pleaded, the district court correctly concluded that the plaintiffs need not prove it now. This is in accord with decisions of the Third and Seventh Circuits.

The First, Second and Fifth Circuits, in contrast require that materiality be established at the class certification stage. This determination is based on footnote 27 in Basic which states that a plaintiff must allege and prove materiality in order to invoke the presumption. While clearly plaintiffs must prove materiality, Basic does not specify that it be done at the class certification stage, according to the Ninth Circuit. Reading Basic as requiring that a merits issue be reserved for that stage of the case is consistent with the Supreme Court’s decisions in Erica P John Fund v. Halliburton, 131 S. Ct. 2179 (2011) and Dukes v. Wal-Mart Stores, Inc., 603 S. Ct. 2541 (2011).

Finally, the district court correctly rejected Amgen’s efforts to rebut the fraud-on-the-market presumption at the class certification stage. The company sought to introduce evidence that public pronouncements were available which contained the truth about the drugs. This would negate any claim that the alleged misstatements impacted the price of the stock, according to the company. This truth-on-the-market defense however is “a method of refuting an alleged misrepresentation’s materiality . . . “ (emphasis original) the Court concluded. Thus it is properly reserved for consideration as a merits issue rather than at the class certification stage.

Tagged with: , ,