Friday, October 4, 2019
When the news came out that Volkswagen had used defeat devices in order to fool regulators into thinking that its cars complied with environmental standards, massive amounts of litigation followed, eventually consolidated into an MDL so sprawling that it literally took me over an hour – plus two calls to Bloomberg – just to get the docket sheet loaded on my computer.
One set of claimants are the bondholders who purchased in an unregistered 144A offering just before the scandal broke. These bondholders contend that the offering memoranda failed to disclose critical information about the regulatory risks Volkswagen faced, in violation of Rule 10b-5. They’ve just got one problem: They’d like to bring their claims as a class, but because the bonds did not trade in anything like an efficient market, they cannot make use of the fraud-on-the-market presumption of reliance. Instead, they’ve turned to Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972), which holds that when a fraud consists of omissions rather than misstatements, reliance may be presumed.
Now, the first issue is, what counts as an omissions-based fraud? The fraud here included affirmative misstatements, and usually that would be enough prevent the use of Affiliated Ute. See, e.g., Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017). However, in a recent opinion denying summary judgment to defendants, Judge Breyer of the Northern District of California ruled that in the Ninth Circuit, plaintiffs may invoke the Affiliated Ute presumption even when affirmative misstatements are in the mix, so long as the center of gravity of the case concerns an omission. See In re Volkswagen "Clean Diesel" Mktg., Sales Practices, & Prods. Liab. Litig., 2019 U.S. Dist. LEXIS 166832 (N.D. Cal. Sept. 26, 2019).
That’s intriguing enough on its own, because when I think of what kinds of cases are likely to be primarily about omissions, they’re likely to be what the defense bar is now calling “event driven litigation,” namely, the company did a bad bad thing, and concealed that fact, and the only misstatements are things like “we acted ethically” and “we’re in compliance with the law.” Treating those as Affiliated Ute cases could conceivably make them easier to bring, which, well, aside from annoying the defense bar, further blurs the line between cases based on mismanagement (not permitted under Rule 10b-5), and cases based on deception (which are). See Santa Fe Indus. v. Green, 430 U.S. 462 (1977). This is especially so because Judge Breyer does not explain exactly what was deceptive here if we’re focusing on the omissions rather than the misstatements. If failure to disclose really important bad things counts as deception, well, we may as well give up on Santa Fe* altogether. (These are issues I talk about a lot in my articles; if you’re interested, you can find discussions in Reviving Reliance, Slouching Towards Monell: The Disappearance of Vicarious Liability Under Section 10(b), and Searching for Market Efficiency).
But that’s actually not the part of the opinion I want to focus on. Because the Affiliated Ute presumption of reliance is rebuttable. If defendants can show that even if they had disclosed the relevant information, the plaintiff would still have invested, then the presumption of reliance falls away. And courts have held that when plaintiffs don’t even read the relevant documents, then, necessarily, disclosure would not have affected the plaintiffs’ behavior, so reliance is per se rebutted. QED. See Eckstein v. Balcor Film Investors, 58 F.3d 1162 (7th Cir. 1995); Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981).
Way back in my very first blog post here – I remember it like it was yesterday – we were all wondering whether the Supreme Court was going to overrule Basic and jettison the fraud-on-the-market doctrine entirely, and I was thinking about whether Affiliated Ute could work as a substitute. At the time, I asked:
I can’t help but wonder whether defendants have the right to rebut Affiliated Ute in situations where they would not or could not have disclosed the truth, such that the disclosure hypothetical is off the table. This could occur, for example, if the “truth” was that the defendants had engaged in antitrust violations, or other forms of illegal behavior….
If those cases came up in a world where fraud on the market is off the table, would courts accept Affiliated Ute in situations where disclosure was not an option, because it would be too devastating to the company or its managers?
And that is sort of what just happened in Volkswagen. Because the plaintiffs invoked Affiliated Ute, but naturally, the lead plaintiff couldn’t show its investment manager actually read the offering memoranda – because that never happens, and even if it had, an inquiry into the reading habits of all the investment managers in the class would make class certification impossible – and so the defendants claimed they had rebutted the Affiliated Ute presumption of reliance. At which point, Judge Breyer said:
In the run-of-the-mill omissions case, an investor’s failure to read the relevant disclosure documents could indeed be fatal. Having not read those documents, any additional disclosures in them would have been unlikely to come to the investor’s attention. As a result, it would be difficult for the investor to prove that he would have acted differently—and avoided the investment—if additional disclosures were made in those documents.
This is not a run-of-the-mill omissions case, however. The omitted facts detailed Volkswagen’s large-scale and long-running defeat-device scheme. When that scheme was disclosed to the public, in September 2015, it was front-page news and prompted congressional hearings, video apologies by Volkswagen executives, and hundreds of lawsuits. The disclosure also prompted Plaintiff’s investment manager to reevaluate Plaintiff’s investment in Volkswagen bonds and to sell those bonds for a loss within a month’s time.
If Volkswagen had disclosed its defeat-device scheme in its 2014 bond offering memorandum, instead of waiting until September 2015, the same publicity, and the same response by Plaintiff’s investment manager, would likely have followed. The scheme was so substantial and blatant that it is hard to fathom that its disclosure would have gone unnoticed by the investing public, and that Plaintiff’s investment manager would not have been made aware of it.
Assuming, then, that Volkswagen’s evidence demonstrates that Plaintiff’s investment manager did not read the offering memorandum prior to purchasing the bonds, that evidence alone is insufficient to establish beyond controversy that Plaintiff’s investment manager would not have attached significance to the omitted facts about Volkswagen’s emissions fraud if those facts had been disclosed in the offering memorandum. As a result, Volkswagen has not rebutted Affiliated Ute’s presumption of reliance.
In other words, the plaintiff “relied” on the omissions in the documents, in the sense that the plaintiff could assume from the absence of scandal surrounding Volkswagen at the time of purchase that there was nothing scandalous disclosed in the memoranda. And that’s enough to satisfy Affiliated Ute.
To be honest – and this is something I talk about in that original blog post, as well as in Searching for Market Efficiency – I actually think this is the correct interpretation of the original Affiliated Ute case. The distinction between omissions-based frauds and affirmative-frauds is an odd one until you remember the full context of Affiliated Ute. The Court was trying to get at the idea that some omissions are so huge that they go to the heart of the deal – of course you would assume those facts were not present, merely by the regularity of the transaction – and that’s when it would be absurd to make the plaintiffs bear the affirmative burden to prove reliance.
And in Judge Breyer’s view, a huge scandal that dominates headlines has that same kind of quality.
*Oh why not: