Originally published August 30, 2010
Keywords: class certification, securities litigation, loss, materiality,
The United States Court of Appeals for the Seventh Circuit has issued an opinion that relieves plaintiffs in securities litigation from making any showing of loss or materiality at the class certification stage. In so doing, the Seventh Circuit explicitly rejected the rationale of a recent decision by the Fifth Circuit. Absent further review of this decision by the United States Supreme Court, the ruling likely will increase the pressure on defendants in class actions filed within the Seventh Circuit to settle before resolution of the class certification issue. However, the clear conflict between the positions taken by the Seventh and Fifth Circuits makes review of the issue by the Supreme Court a distinct possibility.
In Schleicher v. Wendt, 2010 WL 3271964 (7th Cir. 2010), plaintiffs asserted a securities-fraud class action lawsuit against the managers of Conseco, a large, publicly-traded financial-services holding company. Plaintiffs alleged defendants had made unduly optimistic statements about Conseco's financial condition during the two years before Conseco filed for bankruptcy. Plaintiffs relied on the "fraud on the market theory" to establish that reliance and causation were common to all putative class members. The district court, pointing to plaintiffs' financial expert, concluded the market for Conseco's shares was "efficient," i.e., sufficiently large and widely followed by analysts that any statements made about Conseco could be transmitted to investors through the currently reflected market price. The district court rejected defendants' arguments and certified the class. Defendants brought an interlocutory appeal.
The Seventh Circuit affirmed the certification order, noting that a securities fraud claim has six elements: (i) falsehood in connection with the purchase or sale of a security, (ii) scienter, (iii) materiality, (iv) reliance, (v) causation and (vi) loss. The Seventh Circuit relied on the district court's finding that the market for Conseco's shares was efficient, then considered whether more needed to be demonstrated prior to certification of the class. The court rejected defendants' argument that a district court must determine whether the contested statement actually had materially affected the price prior to certifying the plaintiff class. The court affirmed the class certification order despite the fact that the putative class members included investors holding both long and short position Conseco stock.
Finally, the Seventh Circuit dismissed defendants' reliance on the Fifth Circuit's decision in Oscar Private Equity Investments v. Allegiance Telecom, Inc. In Oscar, the Fifth Circuit held that plaintiffs were required, at the certification stage, to establish loss causation by establishing how much of the price movement could be attributed to the allegedly false statements. According to the Fifth Circuit, failure to do so required denial of certification. The Seventh Circuit rejected this approach in favor of a more liberal class certification standard.
The Seventh Circuit acknowledged that although plaintiffs would eventually need to prove causation and materiality to prevail on the merits, "[t]he chance, even the certainty, that a class will lose on the merits does not prevent its certification." Instead, to obtain class certification, plaintiffs merely are required to show that common issues predominate over individual ones and that plaintiffs' allegations satisfy the requirements of the PSLRA. It is important to note, however, that the Seventh Circuit relied on the district court's finding that the market for Conseco shares was efficient. Accordingly, it is appropriate to challenge the efficiency of the market at the class certification stage where plaintiffs seek to base the propriety of the class device upon the fraud on the market theory.
As both the Oscar and Wendt courts recognized, class certification often increases the pressure on defendants to settle. The Seventh Circuit's decision in Wendt will make plaintiffs' road to class certification smoother, defendants' opportunity to avoid class disposition of a suit less likely, and defendants' ultimate cost of settlement greater.
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