Plaintiff Takeaways from High Court’s Goldman Ruling

POMERANTZ MONITOR | JULY AUGUST 2021

On June 22, 2021, in Goldman Sachs Group Inc. v. Arkansas Teacher Retirement System, the United States Supreme Court rendered a decision critical to the future of federal securities fraud class actions. In a July 2 article in Law360, Marc I. Gross and Jeremy A. Lieberman analyzed what that means for the plaintiffs’ bar. The following is an abbreviated recap of their analysis.

The Court held that in determining whether allegedly misleading statements impacted stock prices, (1) a court should consider the “generic nature” of the statements by way of expert opinion, other empirical evidence and “common sense”; and (2) defendants bear the burden of persuasion to demonstrate that the statements had no impact on market prices.

While defendants have framed the holding on the first point as a big win for their bar, Marc and Jeremy beg to differ. [Eds: For a discussion of the second point, see this issue’s article on Pomerantz’s amicus brief.]

The generic nature of statements has often been considered at the motion-to-dismiss and class stages. What the Supreme Court made clear, though, was that the generic nature of statements did not render them per se unworthy of class certification, but rather, it is one factor to be weighed along with empirical evidence and expert testimony regarding actual price impact.

A central element of securities fraud claims is proof that investors relied upon allegedly misleading statements when purchasing shares. Following the 1966 adoption of Rule 23 in the Federal Rules of Civil Procedure, courts wrestled with how to prove reliance on a basis common to all class members. If each investor had to prove they actually read the misstatement, individual issues of proof would predominate, rendering securities fraud class actions unmanageable.

The concept that defendants’ misrepresentations create a fraud on the market was first developed by Abe Pomerantz, pioneer of shareholder rights litigation and founder of Pomerantz LLP, in the 1970 case, Herbst v. Able. Thereafter, courts recognized that if companies inflated their reported earnings, the stock market price of their securities would likely be inflated as well, thereby causing all investors to be defrauded.

In 1988, the Supreme Court embraced this concept in Basic Inc. v. Levinson, formalizing a “presumption” of reliance where stocks were traded in “efficient” markets, i.e., markets that rapidly priced all public information (including misinformation).

Basic also held that the presumption could be rebutted if individual investors relied on nonpublic information. The Supreme Court revisited this presumption in 2014’s Halliburton Co. v. Erica P. John Fund Inc. decision. While reaffirming the presumption’s viability, the court expanded the grounds for its rebuttal. Defendants could also cite evidence demonstrating that the misleading statements had no impact on the stock price.

The dispute in Goldman arose over market impact, or lack thereof, of statements by Goldman representing that the investment bank had “extensive procedures and controls that are designed to identify and address conflicts of interest” and that “integrity and honesty are at the heart of our business.”

The plaintiffs argued that these statements were materially misleading, citing revelations that Goldman had assembled a portfolio of mortgage-backed securities for the benefit of a short-seller, without disclosing this to Goldman clients to whom the bank sold the portfolios and who lost billions of dollars in the 2008 Great Recession. The SEC fined Goldman $550 million for its misconduct.

Goldman moved to dismiss the lawsuit, arguing that its statements were too generic and aspirational to warrant reliance. The U.S. District Court for the Southern District of New York denied the motion in 2012.

At the class motion stage, Goldman again argued that the generic nature of the statements had no market price impact, focusing on the absence of any price change when the statements were issued, nor when journalists questioned the company’s actual client conflict practices.

The plaintiff countered that Goldman had consistently denied any wrongdoing and that its misleading statements effectively maintained the price of Goldman shares until the truth was revealed, causing analysts to question the investment bank’s reputation and the stock price to crater.

The district court twice found that defendants failed to show that the Goldman stock price was not impacted by the misstatements. The U.S. Court of Appeals for the Second Circuit agreed twice. However, in the second decision, U.S. Circuit Judge Richard Sullivan dissented, asserting:

The obvious explanation for why the share price didn’t move after 36 separate news stories on the subject of Goldman’s conflicts is that no reasonable investor would have attached any significance to the generic statements on which Plaintiffs’ claims are based.

The majority retorted:

What the dissent really wants to do is to revisit the question of whether the statements are too general as a matter of law to be deemed material.

Goldman sought certiorari based on Judge Sullivan’s dissent, though its opening brief did not embrace his per se analysis, pivoting instead to the argument that generic nature is just one factor considered in determining price impact. Plaintiffs thus had no reason to disagree.

In her opinion on this issue, in which all the justices joined, Justice Barrett held that, in determining the price impact of generic statements, courts “should be open to all probative evidence on that question — qualitative as well as quantitative — aided by a good dose of common sense,” regardless of whether the issue overlapped with questions of materiality.

Critical to going forward is Justice Barrett’s observation that there may be a “mismatch between the contents of the misrepresentation and the corrective disclosure.” The Court suggested that this could occur where the earlier misstatement was very broad (e.g., “We have faith in our business model”), while the later corrective statement is specific (e.g., “Our fourth quarter earnings did not meet expectations”).

Frankly, both statements are generic and arguably a mismatch, since nothing in the prior statement targeted specific earnings growth. In contrast, in Goldman, the company stated it had strong procedures to prevent conflict of interests, yet those procedures had been flaunted.

Undoubtedly, class certification motions will now shift to battles over the degree to which misstatements and corrective disclosures match.

Courts have recognized that corrective disclosure need not be the “mirror image” of the alleged misrepresentation. Plaintiffs will likely argue that a sufficient degree of overlap in the before and after statements, coupled with empirical evidence (such as analysts’ interpretation of the corrective statements), should suffice to support certification. This will leave for later determination the degree to which the post-corrective stock price decline can be linked to the prior misstatement — an issue that experts often sort out through confounded event analysis.

Also relevant to the evaluation of price impact of such generic statements is their context; e.g., whether the generic statement was intended to distinguish the company from its own prior misconduct or that of its peers.

Plaintiffs will also likely argue that in assessing price impact, courts should consider not just what defendants said, but what they omitted. It is well settled, as expressed by the Second Circuit in 2016’s In re: Vivendi SA Securities Litigation, that “once a company speaks on an issue or topic, there is a duty to tell the whole truth, even when there is no existing independent duty to disclose information” on the matter.

In other words, having opted to burnish its corporate image by professing its integrity and internal control procedures to prevent conflicts, Goldman was arguably duty bound to disclose all related material information lest investors be misled by the omission thereof, including the risk that it had departed from that professed policy. Had Goldman acknowledged such departures, its stock price would likely have declined much earlier than it did.

Finally, courts will need to wrestle with just what is generic and what is meaningful in the minds of investors. This determination has often rested on the courts’ intuitive conception of a reasonable investor. Empirical studies have demonstrated that investors place considerable stock in the perception of management’s integrity and reliability, and that a substantial portion of a company’s market value is a function of that reputation, which such generic statements serve to burnish.

If such generic statements were intended to reassure investors of the company’s reliability and integrity, plaintiffs may well argue that such statements maintained the premium that investors were willing to pay for a company’s strong reputation. This arguably should bear upon class certification of generic statements, as well as their actionability at the pleading stage.

You may read Marc and Jeremy’s entire article on Law360.