Goldman Sachs Cert Redux
POMERANTZ MONITOR | SEPTEMBER OCTOBER 2023
On August 10, 2023, the Second Circuit issued its highly anticipated decision in the long-running Goldman Sachs class certification saga. This action, begun almost eight years ago, has traveled on repeat visits through the federal judicial system, producing a series of interesting appellate rulings, including a 2021 decision by the Supreme Court. The current Second Circuit appeal arose from the district court’s decision to grant class certification for the third time following remand from the Supreme Court in 2021 and resulted in the Second Circuit decertifying the class based on the “mismatch” test established by the Supreme Court for cases premised on an “inflation maintenance” theory, like this one. In so ruling, the Second Circuit became the first federal court of appeal to apply the Supreme Court’s test, paving the way for a new body of law to emerge around this novel analytical framework.
The issue before the Second Circuit was whether defendants produced sufficient evidence to rebut the presumption of reliance established by the Supreme Court in its seminal 1988 decision, Basic Inc. v. Levinson. To gain class certification, plaintiffs must prove that common questions of law or fact predominate over individual questions. Basic dispensed with the need to prove, in securities class actions, that individual investors relied on a defendant’s misrepresentations when buying or selling securities. Instead, it established a legal presumption that the price of a stock trading on an efficient market like the NYSE or Nasdaq reflects all the company’s material public statements, including any misrepresentations, and, therefore, investors rely on the integrity of the market price when they decide to buy or sell that stock. Basic emphasized that a plaintiff’s claim to its presumption of reliance can be rebutted by defendants with competent evidence, and the Supreme Court has made clear in subsequent decisions that one way to do so is to show that the alleged misrepresentations did not actually affect the market price of the stock. Consequently, this has become a common battleground for parties litigating such cases.
The Goldman case presented a unique backdrop for this battle. The lawsuit was first filed in 2010 after it came to light that Goldman paid a $550 million fine to the SEC for allegedly failing to disclose conflicts of interest tied to several collateralized debt obligation (CDO) transactions. The plaintiffs alleged that Goldman misled investors by making several statements in its SEC filings claiming to have robust conflicts of interest procedures. It was undisputed that the challenged statements did not cause any cognizable increase in Goldman’s stock price, however that alone was not enough to rebut the Basic presumption of reliance. Even before Goldman was first filed, courts around the country had begun to accept the view that it is possible for misstatements to maintain inflation already existing in a stock price or, stated differently, prevent the stock from declining, depending on the nature of the misstatement, including, for example, if the misstatements align with market expectations. In such cases, the price drop that occurs when the truth is revealed serves as indirect evidence to infer that there was inflation present in the stock price at the time of the misstatements.
After surviving a motion to dismiss the case in 2012, the plaintiffs moved to certify a class. Goldman opposed the motion, seeking to rebut the Basic presumption by proving a lack of price impact. The trial court disagreed and certified a class in September 2015. In 2018, the Second Circuit overruled that decision and remanded for further proceedings. The Second Circuit held that defendants seeking to rebut the Basic presumption bear the burden of persuasion to prove a lack of price impact by a preponderance of the evidence, and the district court’s decision left unclear whether it applied that standard or not. It also held that the district court erred by failing to consider evidence that there was no decline in Goldman’s stock price in response to media coverage which reported on Goldman’s conflicts of interest on 36 different dates before to the first corrective disclosure in 2010.
On remand, the district court again certified a class, finding that Goldman’s evidence—including the pre-disclosure media reports—failed to prove a lack of price impact by a preponderance of the evidence. The Second Circuit affirmed. After accepting the case for review, the Supreme Court agreed that a defendant must carry the burden of proving a lack of price impact by a preponderance of the evidence to overcome to Basic presumption, but it declined to decide whether Goldman did so. Instead, it held that courts should consider “all probative evidence” that bears on the question of price impact, including the generic nature of the misstatements themselves, and remanded for further proceedings because it was unclear if the Second Circuit considered that evidence. In doing so, the Supreme Court observed that the generic nature of a misrepresentation can be important evidence of a lack of price impact in cases proceeding on an inflation maintenance theory because the probative value of a back-end price drop begins to break down when there is a “mismatch” between the specificity of a corrective disclosure and earlier misstatements. Because it is less likely that a specific disclosure actually “corrects” a generic misrepresentation, reasoned the Supreme Court, the ability to infer front-end inflation from the back-end drop becomes weaker.
Applying the Supreme Court’s mismatch test, the district court certified a class for the third time in late 2021, and the Second Circuit once again agreed to review the decision.
In its recent ruling, the Second Circuit first determined that the district court was not wrong to reject Goldman’s attempt to present the 36 pre-disclosure reports as “alternative corrective disclosures” in an effort to blunt or negate the corrective nature of the corrective disclosures from 2010 set forth in the complaint. Among other things, the Second Circuit credited the district court’s findings that the pre-disclosure reports did not reveal many of the facts in the 2010 disclosure that detailed the conflicts of interest, including “incriminatory emails and memoranda,” and, unlike the 2010 disclosure, their corrective impact was mitigated by repeated denials by Goldman.
However, the Second Circuit disagreed with the district court that several of the misstatements were not too generic when read in conjunction with the other less generic, more specific, misstatements. The panel highlighted that the two sets of statements at issue were made in separate SEC filings, and while an otherwise generic statement can be misleading based on its “context,” that refers to the state of a company’s affairs at the time of the statement, not to other statements made in separate SEC filings.
The Second Circuit also faulted the district court for using the specific facts revealed in the 2010 corrective disclosure as a basis to determine how the market would react if the company had spoken truthfully instead of making a misstatement. After reviewing its previous decisions on the inflation maintenance theory and the Supreme Court’s recent guidance, it explained that, in cases where there is a mismatch and the corrective disclosure does not directly refer to the earlier generic statements, the proper inquiry focuses on whether an equally generic truthful statement would have dissipated the inflation maintained by the generic misstatement. This, the Second Circuit said, can take the form of evidence that (i) the generic statement was capable of maintaining inflation in the stock price; or (ii) that an equally generic truthful statement would have had a negative effect on the stock price. Citing a recent class certification win by Pomerantz in Ferris v. Wynn Resorts Ltd. as an example, the Second Circuit explained that “pre- or post-disclosure discussion in the market regarding a generic front-end misstatement” can provide powerful evidence of this sort. But it cautioned that commentary merely focusing on the “topic” of the disclosure is insufficient; the commentary must address the generic statements themselves to bear on the question of price impact.
Applying these principles, the Second Circuit decided that decertification of the class was warranted because Goldman successfully severed the link between the specific disclosures that precipitated the back-end drop and the generic front-end misstatements. It highlighted that Goldman came forward with 880 analyst reports issued before the 2010 corrective disclosure which made no reference to those statements, and that the market commentary advanced by the plaintiffs only addressed the “subject matter” of Goldman’s conflicts without touching on any of the misstatements on that topic.
There is something for everyone in the Goldman decision. But whether its logic extends to stages of litigation other than class certification, or its unique facts will merely reinforce the distinctive nature of this case, remains to be seen. Even the Second Circuit recognized that “whatever analytical approaches might be warranted in future cases” remains an open question. At the very least, it offers new guidance for parties litigating price impact in mismatch cases, particularly with respect to evidence of market commentary, and demonstrates just how challenging the issues that arise in connection with that seemingly straightforward inquiry can be. What this decision means for plaintiffs going forward is still unknown, but it has certainly imposed obstacles to attaining class certification and, thus, will likely lead to an increase in mismatch disputes at the class certification stage. As such, plaintiffs may focus their challenge on more specific misstatements to avoid such disputes altogether or otherwise increase their reliance on other forms of evidence beyond market commentary which have the potential to bear on the question of price impact.