The Supreme Court issued a couple of securities litigation opinions today. A snapshot:
Held: Proof of materiality is not a prerequisite to certification of a securities-fraud class action seeking money damages for alleged violations of Securities Exchange Act of 1934 Section 10(b) and Rule 10b–5.
A quick reminder: Elements of an implied Section 10(b) cause of action for securities fraud are:
- a material misrepresentation or omission by the defendant;
- a connection between the misrepresentation or omission and the purchase or sale of a security;
- reliance upon the misrepresentation or omission;
- economic loss; and
- loss causation.
Basic v. Levinson, an important case in the securities law area, provided, among other things, that fraud-on-the-market can establish the reliance element.
In addition, to certify a class, a plaintiff must also establish that the questions of law or fact common to class members predominate over any questions affecting only individual members. They are fighting for the group, so to speak.
Considering whether to certify a class in a securities fraud case, the court looked at whether proof of materiality is needed to ensure that the common questions of law or fact predominate over individual questions as the litigation progresses. The court said ‘no’ because:
- materiality is judged according to an objective standard, it can be proved through evidence common to the class; and
- a failure of proof on the common question of materiality would not result in individual questions predominating. Instead, it would end the case, for materiality is an essential element of a securities-fraud claim.
The second point was a focus of the dissenting justices, which said that the failure to establish materiality retrospectively confirms that:
- fraud on the market was never established;
- questions regarding the element of reliance were not common; and
- therefore, certification was never proper.
Therefore, the dissent said that the plaintiffs should not be excused at certification that questions of reliance are common merely because they might lose later on the merits element of materiality. Because a securities-fraud plaintiff invoking fraud-on-the-market to satisfy the certification rules should be required to prove each element of the theory at certification in order to demonstrate that questions of reliance are common to the class. However, they lost.
The Investment Advisers Act makes it illegal for investment advisers to defraud their clients and authorizes the SEC to bring enforcement actions against fraudsters. To do this, the SEC must file suit “within five years from the date when the claim first accrued.”
So, what does that time limit mean?
In this case, the SEC sought civil penalties in 2008 for fraud allegedly committed from 1999 until 2002. The SEC argued that the statute of limitations did not begin to run until the SEC discovered or reasonably could have discovered the fraud.
Held: The five-year clock in begins to tick when the fraud occurs, not when it is discovered.
The SEC argued that because of the fraud aspect, a plaintiff may not know it has been injured so the statute of limitations should begin at discovery.
The court said that it has never applied the discovery rule where the plaintiff is not a defrauded victim seeking compensation, but is instead the government bringing an enforcement action for civil penalties. The government is a different kind of plaintiff whose purpose, in the case of the SEC, is to root out fraud. The discovery rule helps to ensure that the injured get compensation, but civil penalties go beyond compensation, are intended to punish and label defendants wrongdoers.
In addition, deciding when the government knew or reasonably should have known of a fraud would also present particular challenges for the courts, such as determining who the relevant actor is in assessing government knowledge, whether and how to consider agency priorities and resource constraints in deciding when the government reasonably should have known of a fraud, and so on.
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