CLASS CERTIFICATION, SECTION 11 AND EFFICIENT MARKETS
In affirming the district court’s certification of the class in In re Constar International Inc. Sec. Litig., No. 08-2461 (3rd Cir. Oct. 29. 2009), the circuit court drew a sharp distinction between the requirements of a claim under Securities Act Section 11 and Exchange Act Section 10(b). The court rejected defendants’ primary argument that plaintiffs could only meet the dictates of Federal Civil Rule 23(b)(3), requiring that the questions of law or fact common to class members predominate, if they established the efficiency of the market for the securities. The court also rejected defendants’ related contention that, absent an efficient market, questions of materiality, loss causation and injury would need to be decided on an individual basis, thus requiring reversal of the certification order.
The case arose out of a November 2002 IPO in which Constar’s parent, Crown Holdings, sold 10.5 million shares to the public at an offering price of $12.00. According to plaintiffs, the offering price was inflated because the registration statement contained false and misleading statements. Constar, a manufacturer of plastic food and beverage containers, was a deteriorating business burdened with much of its parent’s debt, according to plaintiffs. This contrasts with the claims in the registration statement which depicted the company as a competitive business with a strong future.
In the summer of 2003, the truth about the business emerged. In a July press release, the company acknowledged that its results were disappointing. In the related earnings call, the company attributed the poor results to a loss of major customers. The share price dropped about 30%. The next month, the company issued a press release stating that its financial good will had been impaired by the trading price of the stock and other factors. Plaintiffs claim this means that the market had already absorbed this fact. The next month, after the share price had tumbled to just over $5, suit was filed.
The district court granted class certification, concluding that the Rule 23 requirements had been met. The Third Circuit affirmed, in an opinion devoted largely to a discussion of defendants’ claims regarding the efficient market hypothesis. The error in defendants’ claim that the efficiency of the market must be established, the court stated, is that the complaint is predicated on Section 11, not Section 10(b). A “prima facie case under Section 11 is straight forward, requiring only a showing of a material misrepresentation or omission from a defendant’s registration statement,” the court noted. Materiality, measured, by the “total mix” standard of the Supreme Court’s decision in TSC Industries, can be gauged through a post hoc look at the price movement immediately following the disclosure. This test, however, does not necessarily require that there be a demonstration that the market is efficient, according to the court.
Loss causation for a Section 11 claim is equally straight forward. In such a case, plaintiffs do not have to prove this element or reliance. Rather, defendants can assert it as a defense. Indeed, damages are simply the difference between the price paid and the price at the time of suit or at which the security was sold. Any decline in value is presumed to be caused by the misrepresentation in the registration statement. These Section 11 requirements contrast sharply with those of a Section 10(b) damage claim.
The court went on to acknowledge that the efficient market hypothesis can be of assistance in assessing materiality in both a Section 11 and Section 10(b) case. This however, does not mean that if there is no proof of efficiency materiality is an investor by investor inquiry as defendants contend. Since reliance is not an element of a Section 11 claim, the question in such a case is the conduct of the defendants, not the knowledge of the plaintiffs. The misrepresentation is material if a reasonable investor would have considered it important. This means that the impact of the false statement is uniform across the class of investors, regardless of market efficiency.
Likewise, loss causation under the Supreme Court’s decision in Dura is not an issue. In a Section 11 case, there is no requirement of individualized loss causation because it is presumed. Thus the court concluded “on both the materiality and loss causation fronts . . . the market efficiency issue . . . [is] a red herring.”