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July 18, 2012 Articles

How Wal-Mart v. Dukes Affects Securities-Fraud Class Actions

The Dukes decision adds more fuel to the circuit split over whether materiality must be proven as part of the fraud-on-the-market presumption for class certification.

By Robert H. Bell and Thomas G. Haskins Jr.

District courts and circuit courts continue to grapple with the full import of the U.S. Supreme Court’s landmark decision on class certification in Wal-Mart Stores, Inc. v. Dukes. The way that the courts have applied the Dukes decision in class-certification decisions in securities-fraud class actions has general applicability to other types of class actions.

The Dukes Decision
In Wal-Mart Stores, Inc. v. Dukes, the U.S. Supreme Court reversed a grant of class certification to one of the “most expansive class[es] ever,” which consisted of some 1.5 million women alleging discrimination by their supervisors at Wal-Mart over pay and promotion matters, in violation of Title VII. 131 S. Ct. 2541, 2547 (2011). The plaintiffs’ theory was that Wal-Mart’s strong corporate culture allowed bias against female employees, infecting the decision making of local supervisors (who, according to Wal-Mart, had ample discretion in hiring and promotion decisions) and making all women at the company victims of discriminatory practices. Id. at 2548.

The district court certified the proposed class, which was then affirmed by a divided en banc Court of Appeals for the Ninth Circuit. The Ninth Circuit held that the plaintiffs’ claims for back pay could be part of a Rule 23(b)(2) class because they did not predominate over the requests for injunctive and declaratory relief. Id. at 2550.

In reversing the Ninth Circuit, the Supreme Court unanimously held that the claims for back pay were improperly certified under Rule 23(b)(2) because claims for monetary relief that are not incidental to the requested injunctive or declaratory relief cannot be certified under Rule 23(b)(2) (and should be part of a Rule 23(b)(3) class instead). Id. at 2557. This portion of the Dukes Court’s analysis is less readily applicable to securities-fraud class actions, which seek monetary relief and certification under Rule 23(b)(3).

The Court split 5–4, however, with respect to its analysis of the commonality requirement under Rule 23(a)(2). Justice Scalia, writing for the majority, observed that what matters for class certification under Rule 23(a)(2) is not common “questions” but common “answers.” Id. at 2551. The claims “must depend upon a common contention” that is “capable of class wide resolution—which means that determination of its truth or falsity will resolve an issue that is central to the validity of each one of the claims in one stroke.” Id. at 2545. It is not enough that members of the class “all suffered a violation of the same provision of law.” Id. at 2551.

The Court found that “significant proof” was absent in the Dukes case, as Wal-Mart had a policy explicitly forbidding sexual discrimination and local supervisors had discretion over employment matters. The Court also disregarded the expert report put forth by the plaintiffs, which sought to demonstrate that Wal-Mart’s corporate culture made it vulnerable to bias, as well as plaintiffs’ statistical and anecdotal evidence. Id. at 2553–56. As a result, the majority concluded that there was not a “common answer to the crucial question of why was I disfavored.” Id. at 2552.

Justice Scalia also reaffirmed that Rule 23 is not a “mere pleading standard”; instead, a party seeking class certification must “affirmatively demonstrate his compliance with the Rule—that is, he must be prepared to prove that there are in fact sufficiently numerous parties, common questions of law or fact, etc.” Id. at 2551. Justice Scalia acknowledged that this “rigorous analysis” will often necessarily overlap with the merits of the underlying claims. In a footnote, the Court noted that the “most common example” of overlap with a merits question during class certification is in the context of a securities-fraud class action—namely the predominance analysis under Rule 23(b)(3) and the applicability of the fraud-on-the-market presumption. Id. at 2552 n.6. This potentially critical footnote is discussed further below.

District Court and Circuit Court Decisions after Dukes
In the past year, the Dukes decision has been cited by well over a thousand lower court decisions, though often merely in passing, to establish the baseline class-certification prerequisites. And although the number of class-certification decisions in the securities-fraud context post-Dukes remains relatively small, there appear to be four ways in which courts are addressing the Dukes decision: holding that Dukes is an employment-discrimination case with unique factual issues that are not necessarily relevant to securities-fraud class-action litigation; treating it as a directive from the U.S. Supreme Court to tighten the analysis required at the class-certification stage, including with respect to issues of commonality; treating it as further guidance on the question of whether a full Daubert analysis is required for expert evidence submitted at the class-certification stage; and using it as ammunition for circuit courts that have held that materiality is not an element that must be shown to benefit from the fraud-on-the-market presumption at class certification, an open question for which there is currently a circuit split.

Dukes Distinguished
It is likely that Dukes will ultimately have the greatest impact on employment-discrimination class actions, and many of the decisions citing Dukes are in that context. For example, relying extensively on Dukes, a New Jersey district court denied class certification in an employment-discrimination class-action suit claiming that Lockheed Martin Corporation’s policies and practices had a disparate impact on female employees’ compensation and advancement, basing its decision on the individualized nature of the claims, similar to those made by the Dukes plaintiffs. Bell v. Lockheed Martin Corp., No. 08-6292 (RBK/AMD), 2011 WL 6256978, at *8–9 (D.N.J. Dec. 14, 2011).

In the securities-fraud context, however, courts have found that securities-fraud lawsuits are “especially amenable to class action resolution.” E.g., Pub. Emps.’ Ret. Sys. of Miss. v. Merrill Lynch & Co., 277 F.R.D. 97, 101 (S.D.N.Y. 2011). As a result, the rationales underlying the Dukes decision may have less relevance. For example, Judge Rakoff in the Southern District of New York, in granting class certification related to the sale of mortgage pass-through certificates, found that the facts in Dukes were “entirely distinguishable” from that particular securities class action and had “little to no bearing on the issues before the Court.” Id. at 106.

In addition, a California district court observed that while the Dukes Court’s analysis on commonality had “theoretical bearing” on the question of predominance under Rule 23(b)(3), there were “myriad factual differences” between an employment-discrimination class action and the issues arising from a dispute over a third-party beneficiary contract claim (in connection with a broader securities case relating to an alleged Ponzi scheme). In re Med. Capital Sec. Litig., No. SAML 10-2145, 2011 WL 5067208, at *3 n.1 (C.D. Cal. July 26, 2011). The Dukes decision was further distinguishable because the defendants in Medical Capital had conceded commonality.

Commonality: A Heightened Standard or Clarifying Language?
Justice Scalia took the clear view that the “rigorous analysis” required at the class-certification stage may necessarily require “some overlap with the merits of the plaintiff’s underlying claim.” Dukes, 131 S. Ct. at 2551.

For commonality, the Dukes majority recognized that most class-action complaints will raise various common questions, but commonality requires more than that—the pertinent question for class certification is whether the proceedings will arrive at common answers. Justice Ginsburg, writing on behalf of the four dissenting justices on the portion of the ruling related to commonality, argued that the majority’s analysis “disqualifies the class at the starting gate, holding that the plaintiffs cannot cross the ‘commonality’ line set by Rule 23(a)(2). In so ruling, the Court imports into the Rule 23(a) determination concerns properly addressed in a Rule 23(b)(3) assessment.” Id. at 2562 (Ginsburg, J., dissenting).

In the Public Employees decision, Judge Rakoff also noted that the dissenting justices read the Dukes decision as heightening the commonality standard under Rule 23(a)(2). 277 F.R.D. at 106. However, this “clarifying language” regarding the standard for commonality from the Dukes opinion, as Judge Rakoff referred to it, did not affect his decision in Public Employees because the “common questions presented by this case—essentially, whether the Offering Documents were false or misleading in one or more respects—are clearly susceptible to common answers,” and so Rule 23(a)(2) was satisfied. Id.

The extent to which a court should examine the merits at the class-certification stage remains a subject of debate, however. The Sixth Circuit recently observed that, contrary to that circuit’s prior case law, Dukes “clarified that courts may inquire preliminarily into the merits of a suit to determine if class certification is proper, although courts need not resolve all factual disputes on the merits before deciding if class certification is warranted.” In re Whirlpool Corp. Front-Loading Washer Prods. Liab. Litig., No. 10-4188, 2012 WL 1537914, at *6 (6th Cir. May 3, 2012). The Third Circuit, after Dukes, reaffirmed its prior case law with a more limited holding, that the court need not address “any merits inquiry unnecessary to making a Rule 23 determination” and that “any findings for the purpose of class certification ‘do not bind the fact-finder on the merits.’” Behrend v. Comcast Corp., 655 F.3d 182, 190 (3d Cir. 2011).

Is a Full Daubert Analysis Required for Class Certification?
In light of the language in the Dukes decision regarding a plaintiff’s duty to affirmatively “demonstrate his compliance with the Rule,” 131 S. Ct. at 2551, parties are likely to argue that Dukes requires district courts to take a harder look at the evidence put forward at the class-certification stage. Along those lines, the majority suggested, but did not hold, that expert testimony at the class-certification stage should meet the standards for admission of expert testimony under Rule 702 and Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1993). Dukes, 131 S. Ct. at 2553–54.

Lower courts have interpreted this differently. For example, the Seventh Circuit reaffirmed its prior case law holding that a district court must rule on any challenges to an expert’s qualifications or submissions where the expert’s report or testimony is “critical to class certification” before it can rule on a class-certification motion. Messner v. Northshore Univ. Healthsystem, 669 F.3d 802, 812 (7th Cir. 2012). The Eighth Circuit requires a more “focused” Daubert analysis at the class-certification stage due to the “inherently preliminary nature of pretrial evidentiary and class certification rulings.” In re Zurn Pex Plumbing Prods. Liab. Litig., 644 F.3d 604, 613–14 (8th Cir. 2011). As a result of the divergence in the lower courts, further guidance from the Supreme Court may be needed on this issue.

Tipping the Scales in the Circuit Split over Proving Materiality
Perhaps the most interesting way in which Dukes has been cited in the securities-fraud context pertains to Justice Scalia’s footnote regarding the fraud-on-the-market presumption. This footnote, together with the footnote in the Supreme Court’s decision in Basic Inc. v. Levinson, makes for a battle of footnotes that may well find itself center stage in a future decision resolving the ongoing circuit split over whether materiality is required to be proven at the class-certification stage for a plaintiff to benefit from the fraud-on-the-market presumption.

Reliance on the alleged misrepresentation or omission is a key element of a private right of action under Rule 10b-5, adopted pursuant to Section 10(b) of the Securities Exchange Act of 1934. Erica P. John Fund, Inc. v. Halliburton Co., 131 S. Ct. 2179, 2184 (2011). The Supreme Court has recognized that “‘requiring proof of individualized reliance from each member of the proposed plaintiff class effectively would’ prevent such plaintiffs ‘from proceeding with a class action, since individual issues’ would ‘overwhelm the common ones.’” Halliburton, 131 S. Ct. at 2185 (citing Basic Inc. v. Levinson,485 U.S. 224, 242 (1988)). To combat this, the fraud-on-the-market presumption allows plaintiffs to show reliance by proving the existence of certain elements, at least two of which are that the securities they purchased were purchased in an efficient market and that the allegedly misleading statements were made publicly.

There is disagreement among the circuit courts, however, as to whether a third element, materiality of the allegedly misleading statements, must be proven at the class-certification stage. In Halliburton, the Court may have implicitly recognized this divergence when it acknowledged that securities-fraud plaintiffs “must prove certain things” to invoke the rebuttable presumption of reliance: Plaintiffs “must demonstrate that the alleged misrepresentations were publicly known . . . , that the stock traded in an efficient market, and that the relevant transaction took place ‘between the time the misrepresentations were made and the time the truth was revealed.’” Halliburton, 131 S. Ct. at 2185 (citation omitted). The Court held that plaintiffs were not required to prove loss causation at the class-certification stage, but the Court also declined to “address any other question about Basic, its presumption, or how and when it may be rebutted.” Id. at 2187.

Currently, the First, Second, and Fifth Circuits require plaintiffs to prove materiality. These courts support their position by relying on a footnote in Basic Inc. v. Levinson, which states: “The Court of Appeals held that in order to invoke the presumption, a plaintiff must allege and prove . . . that the misrepresentations were material.” 485 U.S. at 248 n.27. See, e.g., In re Salomon Analyst Metromedia Litig., 544 F.3d 474, 481 (2d Cir. 2008).

The Ninth Circuit recently joined the Third and Seventh Circuits in holding that plaintiffs need not prove materiality at the class-certification stage. See Conn. Ret. Plans & Trust Funds v. Amgen Inc., 660 F.3d 1170, 1176 (9th Cir. 2011). In reaching its conclusion, the Ninth Circuit cited not only the formulation set forth above from Halliburton but also Justice Scalia’s formulation of the presumption in the Dukes footnote, both of which “do not mention materiality as a requirement.” 660 F.3d at 1176 (citing Dukes, 131 S. Ct. at 2552 n.6). Of course, in the same opinion, the Ninth Circuit apparently contradicted itself by distinguishing Dukes because it was not a securities-fraud case and by observing that the Supreme Court there did not have “occasion to decide whether a securities fraud plaintiff must prove materiality to avail herself of the fraud-on-the-market presumption of reliance.” Amgen, 660 F.3d at 1174.

Although the Ninth Circuit apparently finds support for its position on materiality from the Dukes footnote, whether the Dukes decision signals a tipping of the scales in this circuit split remains an open question for the Supreme Court to address. This may be resolved sooner rather than later, as the Supreme Court recently granted certiorari on this very issue in the Amgen case.

The Dukes decision will continue to affect class-certification decisions, although the full impact is still an open question one year after its issuance. Whether it has a significant effect in the securities context remains to be seen, although it will likely continue to serve as a reminder that a rigorous analysis is required, and it will also likely give greater support to a thorough analysis of expert evidence as a prerequisite for class certification. The more significant effect is that the Dukes decision, in particular Justice Scalia’s footnote, adds more fuel to the circuit split over whether materiality must be proven as part of the fraud-on-the-market presumption for class certification.

Keywords: litigation, class actions, derivative suits, commonality, fraud on the market, circuit split, Daubert

Robert H. Bell and Thomas G. Haskins Jr. – July 18, 2012

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