The Second Circuit Rules On The Application Of The Basic Presumption

The Second Circuit Court of Appeals rejected claims in In Re: Salomon Analyst Metromedia Litig., Case No. 06-3225 (2nd Cir. Sept. 30, 2008) asserting that a plaintiff relying on the fraud-on-the-market presumption of Basic, Inc. v. Levinson, 485 U.S. 224 (1988) must establish that the claimed representations actually affected the price of the securities traded in the open market and that it can only be used as to issuers. The court remanded the case to the district court with instructions.

Plaintiffs claimed that Citicorp USA, Inc., Salomon Smith Barney, Inc., their ultimate parent, Citigroup, Inc., and SSB research analyst Jack Grubman engaged in a scheme to defraud investors in Metromedia. The complaint alleged that defendants issued and disseminated research reports that contained false and misleading statements and material omissions. While the district court dismissed portions of the complaint, certain claims were permitted to move forward. The court certified the class as to those claims relying in part on the Basic presumption.

On appeal, defendants argued that the Basic presumption should not be applied to statements of someone other than the issuer – such as those of the research analyst here – and that plaintiff had to demonstrate that the statements impacted price. The Second Circuit rejected these claims as inconsistent with Basic.

First, the court concluded that there is no case which limits the Basic presumption to statements or omissions made by issuers. This is because the presumption is premised on the theory that in an efficient market share price reflects all publicly available information, including any misrepresentation. This conclusion is consistent with the Supreme Court’s recent decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, 128 S.Ct. 761 (2008), which applied the Basic test to statements of non-issuers.

Second, actual price impact need not be established because, under Basic, “if plaintiffs can show that the alleged misrepresentation was material and publicly transmitted into a well-developed market, then reliance will be presumed, for if a reasonable investor would think that the information would have ‘significantly altered the ‘total mix’ of information … then it may be presumed that, in an efficient market, investors would have taken the omitted information into account, thereby affecting market price ….'” (Citations omitted) This holding is based on principles of common sense, fairness and congressional policy, not economics, the court noted.

The Circuit Court remanded the case to afford defendants an opportunity to rebut the Basic presumption prior to certification, reversing the district court’s ruling on this point. In this regard, the Court stated that “we hold that plaintiffs must show that the statement is material (a prima facie showing will not suffice). However, once that is done, the burden shifts to the defense to show that the allegedly false or misleading material statements did not measurably impact the market price of the security.” (Emphasis original).