Twilight of the Event Study

Could this be the beginning of the end for the event study in Section 10(b) class certification?

Yes, I’m probably overstating, but still, the Second Circuit’s opinion in In re Petrobras Securities, 2017 WL 2883874 (2d Cir. July 7, 2017), definitely takes a step in that direction.

As a recap, a private plaintiff alleging fraud claims under Section 10(b) of the Exchange Act must demonstrate that he or she “relied” on the defendant’s false statements.  In Basic Inc. v. Levinson, 485 U. S. 224 (1988), the Supreme Court held that reliance could be demonstrated via the fraud on the market doctrine – namely, the presumption that in an open and developed market, any material, public misstatement is likely to have impacted the market price of the security.  The fraud on the market doctrine is what allows Section 10(b) claims to be brought as class actions, since it eliminates the need for plaintiffs to demonstrate reliance on an individual basis.  Since Basic, then, battle has been joined between plaintiffs and defendants regarding what counts as an “open and developed” market for class certification purposes.

In recent years, it has become de rigueur for plaintiffs to use an event study to establish the necessary market conditions.  An event study is a statistical analysis comparing the change in a security’s price with an event, such as the release of new company-specific information.

The event study methodology, however, has come under heavy academic criticism, the thrust of which is that while it is a useful tool for studying markets generally, its utility is greatly diminished when deployed to examine a single company.  See, e.g., Alon Brav & J.B. Heaton, Event Studies in Securities Litigation: Low Power, Confounding Effects, and Bias, 93 Wash. U. L. Rev. 583 (2015).

In Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014), the Supreme Court held that the Basic presumption represents merely a “modest premise” that public information affects prices.  Commenters (including your humble blogger) interpreted Halliburton to mean that courts should loosen their criteria for identifying an “open and developed” market for Basic purposes.

Judge Scheindlin was one of the first judges to take up Halliburton’s invitation.  Acknowledging the criticism of event studies, she held that plaintiffs need not submit an event study to prove the existence of an open and developed market, so long as they submit other types of evidence.

In Petrobras, the Second Circuit appeared to follow her lead.  Though the Second Circuit stopped just shy of holding class certification does not require an event study – the court claimed that the issue was not squarely presented – it did acknowledge the academic critiques of event studies, and (quoting its earlier caselaw) “explicitly declined to adopt any particular test for the market efficiency of stocks or bonds.”  As the court put it, “Event studies offer the seductive promise of hard numbers and dispassionate truth, but methodological constraints limit their utility in the context of single-firm analyses.”  The court also noted that the various factors that go into a finding of an open and developed market – analyst coverage, trading volume, and so forth – would be of little use if in fact event studies were required in all instances.

Petrobras could have an enormous impact on securities litigation.  If event studies are not required, it may be easier for plaintiffs to win certification in cases involving securities other than exchange listed stocks – such as the notes at issue in Petrobras, as well as preferred stock, over the counter stocks, and so forth.  Beyond that, event studies have been critical to proving damages and loss causation; if they are suddenly deemed unreliable, it may open the door to a much wider variety of evidence on these elements, as well.