Saturday, November 18, 2023
Back when I was in practice, so many years ago, I spent a bit of time on the IPO Cases, namely, a series of around 300 class actions involving dot-com startup IPOs that, we alleged, had been manipulated by underwriters. Details differed from case to case, but the typical claim was that the underwriters used manipulative techniques, such as laddering, to cause dot com startups to “pop” in price upon their initial offering, thereby violating Section 10(b).
But we stumbled at class certification. For false statements, there’s a well established paradigm for creating a classwide presumption of reliance that satisfies Rule 23. For manipulative conduct there isn’t a paradigm, and our cases faltered. The Second Circuit reversed one grant of class certification and remanded, In re IPO Securities Litigation, 471 F.3d 24 (2d Cir. 2006) and 483 F.3d 70 (2d Cir. 2006). We moved for class certification a second time, and eventually matters settled.
Anyway, the recent decision denying class certification in In re January 2021 Short Squeeze Litigation, 21-2989-MDL-ALTONAGA (S.D. Fla. Nov. 13, 2023), takes me back. It is not on Westlaw or Lexis yet, so all I can do is link the Law360 article, which attaches the opinion. Anyway -
This a Robinhood case, where plaintiffs alleged that Robinhood manipulated the prices of various meme stocks when it halted trading and closed out positions. This was done, plaintiffs alleged, because Robinhood was experiencing liquidity issues at National Securities Clearing Corporation, but Robinhood misled the market as to the full extent of its actions and the reasons behind them.
The plaintiffs survived a motion to dismiss, but the court held that they could not prove reliance on a classwide basis. The plaintiffs explicitly alleged that the market was not efficient – Robinhood was manipulating it, by halting trades! Therefore, the plaintiffs could not claim the fraud on the market presumption of Basic v. Levinson, 485 U.S. 224 (1988), based on Robinhood’s lies. And because Robinhood affirmatively lied, there could be no omissions liability under Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972).
What about reliance on the manipulative conduct, specifically, that allegedly distorted market pricing? The court said, it would not accept some kind of lightened fraud on the market presumption for manipulation cases, that did not depend on market efficiency as articulated in Basic, because such a presumption “would prove too much while doing too little. Prove too much, because it would obviate the need for plaintiffs in manipulative conduct cases to prove reliance; do too little because it does not complete the causal connection between a plaintiff’s transaction in securities and a defendant’s manipulation.” (Op. at 60, quoting Desai v. Deutsche Bank Sec. Ltd., 573 F.3d 931 (9th Cir. 2009) (O’Scannlain, J., concurring)). Therefore, no class certification.
Well, I’m not in the weeds of the facts enough to be able to say whether the class should have been certified, but the court misunderstood – just as the Desai court misunderstood – the argument for a reliance presumption in manipulation cases. Properly interpreted, plaintiffs in manipulation cases should get a presumption of reliance, but they have a higher burden than for statement cases, and not a lower one, and plaintiffs do not need to ask for anything beyond what Basic already established.
We begin by observing that the fraud on the market presumption is actually two distinct propositions. As the Supreme Court explained in Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014):
The [Basic] Court based that presumption on what is known as the “fraud-on-the-market” theory, which holds that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.” Id., at 246, 108 S.Ct. 978. The Court also noted that, rather than scrutinize every piece of public information about a company for himself, the typical “investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price”—the belief that it reflects all public, material information.
See the two ideas? When I teach it, I call them the “objective” presumption – which is about how markets absorb information – and the “subjective” presumption – which is about how investors think about markets. The Halliburton Court was clear in distinguishing these when it discussed the defendant’s attacks on Basic:
Halliburton’s primary argument for overruling Basic is that the decision rested on two premises that can no longer withstand scrutiny. The first premise concerns what is known as the “efficient capital markets hypothesis.”…. Halliburton also contests a second premise underlying the Basic presumption: the notion that investors “invest ‘in reliance on the integrity of [the market] price.’”
See the two premises, objective, and subjective? Of course, as we know, the Supreme Court beat back Halliburton’s challenges, and the two presumptions – the objective and the subjective – remain intact. (That said, the subjective presumption is in fact somewhat controversial – many argue it shouldn’t be necessary to prove a case at all, see eg Donald C. Langevoort, Basic at Twenty: Rethinking Fraud on the Market, 2009 Wis. L. Rev. 151 – but it’s there, so I accept it.)
Together these two presumptions establish: first, that the false statements impacted market prices, and second, that investors relied on market prices when trading. Together, they create a syllogism: by relying on a price that was in fact manipulated, investors are deemed to have relied on the original false statement. That is ultimately what reliance means in this context: Investors relied upon a market price that defendants fraudulently manipulated.
In the typical fraud on the market class action, plaintiffs bring in experts to attest as to market efficiency. They demonstrate the market was liquid, followed by analysts, they show correlations between price movements and new information, they analyze bid-ask spreads, all in service of demonstrating that this is the kind of market to which the fraud on the market presumption should apply.
That evidence is important, but only for the objective presumption – namely, that false statements impact market prices. If the market is not liquid and widely followed and has not historically reacted to new information etc etc, then it may very well be inappropriate to simply presume, without more, that a false statement influenced price.
But is this evidence important for the subjective presumption, namely, what investors think about markets?
I submit not. No one conducts an event study to identify historic correlations between price and new information before they place a trade; they just trade. Investors, when deciding whether they “rely” on market prices, use a much looser set of criteria – is it widely traded, a famous stock, heavily analyzed, on a major exchange? That’s probably enough to get at whatever it is investors are in fact relying on in their heads when they “rely” on market prices, and it’s reasonable for them to do so.
If that’s right, then those loose indicia of market efficiency should be enough to presume that investors subjectively believed prices to reflect true value or a market price validly set or whatever work it is we think the subjective presumption is doing.
The detailed analysis, the event studies, the Cammer factors – that stuff is only necessary for the objective presumption, namely, that false statements did in fact impact the market.
Now, let’s think about manipulation claims – where the argument is “investors are misled to believe that prices at which they purchase and sell securities are determined by the natural interplay of supply and demand, not rigged by manipulators.” ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007).
There is no reason why the criteria should change for when we adopt the subjective presumption. That is, if we can presume investors rely on market prices from basic indicia of efficiency in the context of false statements – widely traded stock on a major exchange – we should be able to presume investors rely on market prices in manipulation cases from the same criteria. So, if the case concerns a widely traded and followed stock on a major exchange, the subjective presumption should be satisfied.
What about the second presumption, that false statements affect prices?
In a manipulation case, there are no false statements. Therefore, there is no presumption of price impact. Instead, the plaintiffs are expected to prove price impact. They are expected to come into court with evidence that the defendants’ manipulative conduct in fact affected the market price of the stock. They do not ask for or receive a presumption at all.
If they do that, if they satisfy their burden, they will have satisfied both halves of the Basic syllogism. The subjective presumption allowed them to show that investors relied on market prices, and the objective presumption was absent – it was replaced by actual facts proof.
In other words, manipulation plaintiffs are asking for less, not more. They want only half of the Basic presumptions; they will prove the other half. And they should be entitled that first half presumption.
So the Robinhood court was wrong when it followed Desai in holding that a presumption of reliance in the manipulation context would “Prove too much, because it would obviate the need for plaintiffs in manipulative conduct cases to prove reliance; do too little because it does not complete the causal connection.” The presumption that plaintiffs need is one that Basic readily provides; beyond that, plaintiffs don’t need a presumption at all.