A divided Supreme Court ruled on February 27th that proof of materiality is not a prerequisite to certification of a Rule 10b-5 securities fraud class action.Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, No. 11-1085 (Feb. 27, 2013).
The elements of a Rule 10b-5 claim include proof of a material misrepresentation or omission and reliance upon such misrepresentation or omission. Plaintiffs in securities fraud class actions typically seek to invoke the “fraud-on-the-market” presumption set out in Basic Inc. v. Levinson, 485 U.S. 224 (1988) to establish reliance. In Basic, a case in which only a bare quorum of six Justices participated, a bare majority of four Justices permitted plaintiffs who trade in an impersonal and efficient market to invoke a rebuttable presumption of reliance on public, material misrepresentations, and thus proceed with a class action even absent proof of individual reliance. ...
Notably, four Justices expressed a willingness to revisit Basic’s fraud-on-the-market presumption. Justice Thomas’ dissent (in which Justices Kennedy and Scalia joined all or in part) stated that the Basic decision is “questionable”. Justice Thomas noted that only four Justices had joined the portion of the Basic opinion adopting the fraud-on-the-market theory and that two other Justices had dissented from that portion of Basic and had expressed concern that the Court had replaced “traditional legal analysis” “with economic theorization”. Indeed, one law professor (whose article Justice Thomas referenced) has described the line-up of Justices that decided Basic as “remarkably skewed”. Justice Alito concurred in the majority opinion, but on the understanding that whether the Court should revisit Basic’s fraud-on-the-market presumption was not before the Court in Amgen and, he too, stated that “reconsideration of the Basic presumption may be appropriate”.
I did not see that one coming. But I direct your attention to William W. Bratton & Michael L. Wachter, The Political Economy of Fraud on the Market, available at SSRN: http://ssrn.com/abstract=1824324, which argues that:
The fraud on the market class action no longer enjoys substantive academic support. The justifications traditionally advanced by its defenders - compensation for out-of-pocket loss and deterrence of fraud - are thought to have failed due to the action’s real world dependence on enterprise liability and issuer funding of settlements. The compensation justification collapses when considered from the point of view of different types of shareholders. Well-diversified shareholders’ receipts and payments of damages even out over time and amount to a wash before payment of litigation costs. The shareholders arguably in need of compensation, fundamental value investors who rely on published reports, are undercompensated due to pro rata distribution of settlement proceeds to all class members. The deterrence justification fails when enterprise liability is compared to alternative modes of enforcement. Actions against individual perpetrators would deter fraud more effectively than does enterprise liability. If, as the consensus view now has it, fraud on the market makes no policy sense, then its abolition would seem to be the next logical step. Yet most observers continue to accept it on the same ground cited by the Supreme Court in 1964 when it first implied a private right of action under the 1934 Act in J.I. Case v. Borak - a private enforcement supplement is needed in view of inadequate SEC resources. Restating, even a private enforcement supplement that makes no sense is better than no private enforcement supplement at all.
But then again, maybe not. Contrary to their argument that there are "sticking points retarding movement toward fraud on the market's abolition" by the courts, that door now appears to be wide open.