In what will hopefully be a short-lived opinion, a panel of the Ninth Circuit issued a per curiam opinion which appears to state that plaintiffs can never certify a class action for market manipulation....only for outright misrepresentations or ommissions---a curious if not frightening holding at a time when Wall Street has proven itself to be ....hmmm...shall we say less than ethical.
The issue: Whether stock purchasers are entitled to utilize a lesser variant of the "fraud on the market" doctrine, called the "integrity of the market" doctine, to create a rebuttable presumption of reliance, when a stock is maniplutated in a non-verbal way.
In Desai v. Deutsche Bank Securities (9th Cir. - July 29, 2009), a Ninth Circuit panel held that the lower court was correct in refusing to certify a class action based on market manipulation of the stock of GenesisIntermedia, Inc. by various bad actors, including various entities of Deutsche Bank, and one of its Canadian employees. The market manipulation scheme was complex, the Court accepted that "the scheme had driven GENI's Stock price from $12 per share to over $52 per share." It now trades for pennies. Plaintiffs sued and sought to certify a class of those who purchased the stock during the market manipulation.
Judge Wilson, in the Central District of California, refused to certify the class because each individual member of the class would have to prove its own personal reliance, presumably, the lack of market manipulation, and therefore individual questions of fact predominated. The appellate panel, consisting of Judge John T. Noonan, who wrote the per curiam opinion, and Justices Diermuid F. OScannlain, and Susan P. Graber, agreed.
Justices Noonan and Graber believed that they could reverse the lower court only for a clear abuse of discretion. Plaintiffs had conceded that they needed to prove reliance. ( I'm not sure I would have conceded reliance in a market manipulation case, though I would have conceded lack of knowledge is required). Justice Noonan then drew the battle lines:
Reliance can be presumed in two situations. In omission cases, courts can presume reliance when the information withheld is material pursuant to Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54 (1972). Reliance can also be presumed in certain circumstances under the so-called “fraud on the market theory.” Basic INc. V Levinson, 485 U.S. 224, 241-49 (1988), Precisely to which cases this presumption applies—that is, to misrepresentation, to omission, to manipulation cases, or to some combination of the three—is an issue the parties contest on appeal. The two presumptions are conceptually distinct.
As explained by the Court, the fraud on the market theory is “based on the hypothesis that, in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business.” Basic v. Levinson, 485 U.S. at 241 (internal quotation marks omitted).
So far so good!
But then , Justice Noonan loses his way by picking and choosing verbage from cases that state that the fraud on the market presumtion is available "only" when a plaintiff alleges a material misrepresentation or omission realting to a stock sold in an efficient market. On examination, however, it appear these cases are not market manipulation cases, probably because, up until now, they have been so rare or well hidden.
But plaintiffs had conceded that they could not prove an efficient market. (An efficient market quickly digests new information...from almost any source...causing the stock price to quickly adjusts to incorporate that new information. A thinly traded stock might not absorb the information quickly and therefore any news may not create a price reaction for weeks. In such a case, the disparity between individual investors knowledge becomes an issue. ) Having so conceded, they could not utilize the traditional definition of the fraud on the market presumption.
As for the Affiliated Ute presumption,the lower court rejected the theory that a manipulation was, in essence or fact, an omission. ( A holding with which I strongly disagree).
Applying a "clear abuse of discretion" standard, Judge Noonan agreed. The Affiliated Ute presumption has only been applied to cases of omission when there exists a duty to speak. The Court refused to extend the presumption to manipulative conduct which "has always been distinct " from omissions., for example, in Rule 10b-5. The Court then claims to "follow" the 10th Circuit in Joseph v. Wiles, 223 F.3d 1155 (10th Cir. 2000) which is not a market manipulation case. In fact the word "manipulation"only appears once in the lengthy opinion. For those who remember the 1989 Miniscribe class action, Wiles is a related individual case based upon a fraud whereby Miniscribe cooked its books by shipping bricks instead of product to warehouses, thereby overstating revenues and earnings....one of the good ol' frauds).
Regardless, to the extent that an omission might have existed, the plaintiffs failed to allege a duty. And the Court refuses to even attempt to discuss any duty of market participants to the market.
Next plaintiffs argued for a modification of the fraud on the market theory to fit such a situation, and claimed a rebuttable presumption based upon investors reliance upon the "integrity of the market." The lower court rejected this too.
Judge Noonan first concedes that investors rely on the integrity of the market, citing Basic :
[T]he theory presumes first that “[a]n investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price.” Id. at 247. Second, “[b]ecause most publicly available information is reflected in market price, an investor’s reliance on any public material misrepresentations . . . may be presumed for purposes of a Rule 10b-5 action.” Id.
He notes plaintiffs argument that investors "typically rely on the 'integrity of the market,' that is, that no one has destroyed its efficiency by manipulation [and] when manipulation allegedly destroys the efficiency of the market, and with it the reliability of the market’s price." And he does not disagree. But when asked to find, that as a matter of law, plaintiffs are entitle to such a presumption, Judge Noonan can only summon the argument, "We are chary."
The Court argues, no authority compelled the lower court to adopt this new theory and that the Supreme Court has evidenced a "restrictive view" of private suits, and to not extend 10b-5 beyond its present boundaries, citing Stoneridge, 128 S. Ct. at 773.
The Court unfortunately pulls the Stoneridge quote out of context. In Stoneridge, the issue was framed as creating a private cause of action for aiders and abettors...a cause of action rejected more long ago in Central Bank. Hence the full quote is:
Concerns with the judicial creation of a private cause of action caution against its expansion. The decision to extend the cause of action is for Congress, not for us. Though it remains the law, the §10(b) private right should not be extended beyond its present boundaries. See Virginia Bankshares, supra, at 1102 (“[T]he breadth of the [private right of action] once recognized should not, as a general matter, grow beyond the scope congressionally intended”); see also Central Bank, supra, at 173 (determining that the scope of conduct prohibited is limited by the text of §10(b)).
Plaintiffs were not seeking to extend 10b-5 or create a private cause of action. The law clearly forbids market manipulation and private causes of action have existed under this law for decades.
Justice Noonan, thus, avoids any analytical examination of the requested presumption. Instead he concludes merely "that the district court did not abuse its discretion in refusing to adopt the integrity of the market presumption." In other words...he punts on what the law is or should be.
O'Scannlain, on the other hand, goes after his colleagues for dodging the legal issue, making out a good argument for en banc review:
Unfortunately, however, we are left to conclude abruptly with a declaration of the result, for we cannot agree on the correct approach. I believe that, because the validity of a presumption of reliance in securities class actions is a matter of law and because errors of law are per se abuses of discretion, we must explicitly decide whether Investors are entitled to this novel presumption as a matter of law. I write separately to explain my view.
Even so, O'Scannlain goes on to find the presumption legally unsupportable and logically inadvisable. On the legal side, he can only summon citations to non-market manipulation cases that have no application to these facts. On the logic side, he actually makes plaintiffs case. He starts by admitting:
Most investors do, I think it fair to say, assume that the markets are not corrupt. Cf. Basic, 485 U.S. at 246-47 (“It has been noted that ‘it is hard to imagine that there ever is a buyer or seller who does not rely on market integrity. Who would knowingly roll the dice in a crooked crap game?’ ” (quoting Schlanger v. Four-Phase Sys. Inc., 555 F. Supp. 535, 538 (S.D.N.Y. 1982))).
But then he concludes, in logic that escapes rigor, that if the presumption were adopted, then no plaintiff would ever have to prove reliance. In so concluding, he simply forgets that plaintffs seek only to apply this presumption to market manipulation cases....which the Court has just found to be distinct from misrepresentation and omission cases, legally.
Similarly he argues that the theory "would permit a presumption of reliance no matter how unlikely it is that the market price in question would actually reflect the alleged manipulation." Again, how is it that the presumption of reliance would not still require the plaintiffs to prove that the price during the entire class period was inflated by the manipulation, and by how much? O'Scannlain does not say.
Revealingly, O'Scannlain seems to back track and recognize the problems with his concurring opinion in his concluding. This footnote accurately captures the entire issue...and best statement for l an en banc court to tackle:
I recognize the possibility that certain allegations of manipulative conduct might change the application of the fraud on the market theory. This is because the plaintiff in manipulation cases often alleges that a defendant directly manipulated the price. Certainly, a plaintiff must still show that the market in question could absorb into the price the misinformation communicated by the alleged manipulation. But need a plaintiff show the same type of proof of an efficient market in a manipulation case as is required in a misrepresentation case? Although I note the doctrinal wrinkle, this is a question I would agree we actually do not need to reach, because Investors forsook the fraud on the market theory.
Justice Graber, in her concurring opinion, defends Justice Noonan's contention that the Court need not reach the legal question:
All we have to decide is whether the district court had to recognize that new theory. If so, then the court made a mistake of law (and hence abused its discretion, see Koon v. United States, 518 U.S. 81, 100 (1996) (“A district court by definition abuses its discretion when it makes an error of law.”)).
I agree with O'Scannlain that the Court should have addressed, as a full panel, a broader application of the fraud on the market theory in market manipulation cases. An efficient market should not and, indeed, cannot be a requirement where there are no statements to be absorbed by the market participants in making their decisions. The Court should not have said that a lower Court has no duty to find the right law for the right circumstances, even if it is a new application of a principle. How else does law evolve. It has to start in the lower Courts. Justices Noonan and Graber, shirked their duty.
But in the end, it may not matter that much to the plaintiffs bar. The reason why there is no authority on the subject is, as O'Scannlain states, simply reflects "the relative rarity of" manipulative conduct cases. So the impact will be minimal on securities fraud cases.....except now that the fear of a lawsuit is gone, maybe the fraudsters will start crawling through the cracks.
Shaun Martin's Blog California Appellate Report, has a very good discussion and first analysis of the case at Desai v. Deutsche Bank Securities (9th Cir. - July 29, 2009).
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