Strike Four: Assessing Putative Securities Class For Fourth Time, Second Circuit Tightens Link Between Generic Alleged Misstatements And Specific Corrective Disclosures

• Published date: 15 September 2023
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, Corporate and Company Law, Class Actions, Trials & Appeals & Compensation, Securities
• Law Firm: Mayer Brown
• Author: Mr Joseph De Simone, Michelle J. Annunziata, Jacqueline Vallette, Glenn K. Vanzura and Luc W. M. Mitchell

After twelve years of litigation, the Second Circuit has decertified an investor class action lawsuit for the third'and perhaps last'time.¹ In 2011, following disclosures of conflicts of interest that caused the defendant bank to pay a $550 million fine to the SEC, plaintiffs sued the company for securities fraud, alleging that its earlier public statements such as "Integrity and honesty are at the heart of our business" and "We have extensive procedures and controls that are designed to identify and address conflicts of interest" were false and misleading. After three certifications by the district court, a reversal and affirmance by the Second Circuit, and a reversal by the Supreme Court, the case landed back at the Second Circuit's doorstep.

The key issue at class certification in ATRS IV, as the opinion is known, was whether the plaintiffs could show class-wide reliance on such generic alleged misstatements. In holding against the plaintiffs, the Second Circuit found that generic alleged misstatements must be more closely tethered to specific corrective disclosures. The salient question, the court found, is not "what would have happened if the company had spoken truthfully"'by disclosing the full "details and severity of [its] misconduct"'but, instead, "what would have happened if the company had spoken truthfully at an equally generic level" as the generic alleged misstatement.²

The opinion heightens the requirements for plaintiffs pleading class-wide reliance, and should be welcome news to defendants (current and future) in securities cases. It also suggests that some platitudinally generic alleged misstatements'think "Integrity and honesty are at the heart of our business"'should rarely, if ever, be actionable.

Background

The opinion is the latest installment in the "long and difficult history" of a securities class action.³ The case began in April 2010, when the SEC began an enforcement action against the bank and an employee regarding a CDO transaction known as Abacus 2007 AC-1.⁴ The SEC said that the bank had not disclosed to institutional customers that a hedge fund (Paulson & Co.) had had an active role in the CDO's asset-selection process, and had claimed that Paulson had a long (rather than short) interest in the CDO.⁵ The next day, the company's stock declined by nearly 13%.⁶

The bank ultimately paid $550 million as part of a consent judgment. Though it neither admitted nor denied the SEC's allegations, the company "'acknowledged' that the Abacus marketing materials were 'incomplete' and that it was a 'mistake' to state that the reference portfolio was 'selected by' ACA Management LLC 'without disclosing the role of Paulson.'"⁷

In 2011, plaintiffs filed a consolidated class action complaint against the bank and certain former executives in the United States District Court for the Southern District of New York, accusing the defendants of violating Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder.⁸ The plaintiffs accused the defendants of making material misstatements about the bank's business practices and management of conflicts of interest.⁹ These alleged misrepresentations fell into two buckets. First, there were statements about business principles. For example:

• "We are dedicated to complying fully with the letter and spirit of the laws, rules and ethical principles that govern us Our continued success depends upon unswerving adherence to this standard."¹⁰
• "Integrity and honesty are at the heart of our business."¹¹

Second, there were statements about what the bank identified as conflict-of-interest-related "Risk Factors" in its yearly Form 10-Ks. In particular:

• "We have extensive procedures and controls that are designed to identify and address conflicts of interest, including those designed to prevent the improper sharing of information among our businesses."¹²

The plaintiffs sought more than $13 billion in damages.¹³

Class certification: To the Supreme Court and back again (with many stops in between)

Twelve years of litigation followed. In 2012, the district court denied the defendants' motion to dismiss,¹⁴ and in 2015 it certified a class.¹⁵ In January 2018, the United States Court of Appeals for the Second Circuit vacated and remanded;¹⁶ that August, the district court again certified a class.¹⁷ This time, in 2020, the Second Circuit affirmed.¹⁸ The Supreme Court granted certiorari in 2020,¹⁹ and vacated and remanded in 2021;²⁰ the Second Circuit likewise vacated and remanded later that year.²¹ Also in 2021, the district court certified a class for a third time.²² Then'on August 10, 2023, in the decision discussed here'the Second Circuit reversed.²³

The primary issue driving this decade of litigation was the class-certification requirement of predominance. "That requirement, set forth in Rule 23(b)(3), demands that common questions of law or fact predominate over individual questions that pertain only to certain class members."²⁴ As applied to the securities context, the question became whether there was class-wide "reliance upon the misrepresentation or omission."²⁵

Securities plaintiffs frequently seek to prove reliance through what is known as...