Chapter 12

• Jurisdiction: United States

Chapter 12 Securities Class Actions

Rule 23 of the Federal Rules of Civil Procedure

The modern class action rule was established in 1966. Prior to 1966, there were three types of class actions: "true," "hybrid" (involving rights to specific property), and "spurious" (which weren't really class actions at all because "class members" could opt out after an unfavorable judgment was entered). One of the purposes of the 1966 amendments to Rule 23 was to permit securities fraud litigation to proceed as a class action.¹

Rule 23 requires that the four requirements of part (a) be established and that one of the part (b) requirements be established in order to maintain a class action. Usually it is (b)(3) that is established (a common question of law or fact predominates over questions affecting only individual members). For that reason, securities class actions are almost always (b)(3) class actions in which the common question of fact is reliance on the efficiency of the market.

Numerosity. ("So numerous that joinder of all members is impracticable.") This is usually not a problem in securities class actions. The general (largely unspoken) rule is that a group of forty or more claimants is sufficient to meet the numerosity requirement and is capable of joinder and is not "impracticable." Orr v. Shicker, 953 F. 490 (7th Cir. 2020). However, the Seventh Circuit has recently held that other factors such as geographical dispersion, small dollar value of each claim, and the ease of contacting the class members could also be taken into consideration by a court when ruling on numerosity. Anderson v. Weinert Enterprises, 986 F.3d 773 (7th Cir. 2021).

Typicality. ("Claims or defenses of the representative party are typical of the Claims or defenses of the class.") In In re Flag Telecom Holdings Sec. Litigation, 574 F.3d 29 (2d Cir. 2009), "in and out" traders could not be class representatives because there was no loss causation, and they will not "even conceivably" be able to prove that there was. Thus their claims were not "typical" of the class.

Common Questions of Law or Fact. The common question must predominate, making the class action superior to other available methods for fairly and efficiently adjudicating the controversy. Usually reliance on the efficiency of the market is the common question of fact. Commonality and typicality tend to merge into one another, as "both serve as guideposts for determining whether the named plaintiff's claim and the class claims are so inter-related that the interests of the class members will be fairly and adequately protected in their absence." In re WorldCom, 294 F. Supp. 2d 392 (S.D.N.Y. 2003), held that 1933 Act and 1934 Act plaintiffs may join a single class. See Loftin et al. v. Bande, 574 F.3d 29 (2d Cir. 2009). In Wal-Mart Stores v. Dukes, 564 U.S. 277 (2011), the Supreme Court (Justice Antonin Scalia) added to the commonality test a requirement for a showing that the "capacity of a class-wide proceeding [will] generate common answers apt to drive the resolution of the litigation." This is a new test and it remains to be seen how far it will go. Wal-Mart requires an analysis of the alleged common issue. "Any competently crafted class complaint literally raises common 'questions.'" But according to the Supreme Court, to support a class action, the common question must be one "whose truth or falsity will resolve an issue that is central to the validity of each one of the claims in one stroke." It bears repeating that this articulation is not in the Rule; it was created by the Supreme Court. See, e.g., Grousman v. Motorola, Inc., 2011 WL 5554030 (N.D. Ill. 2011); but see Public Employees Retirement Systems of Miss. v. Merrill Lynch, 714 F. Supp. 2d 475 (S.D.N.Y. 2011) (class of mortgage-backed securities purchasers certified).

Class Representative. The class representative must be able to "fairly and adequately represent the interests of the class" and must not be subject to unique defenses that "threaten to become the focus of the litigation." This typically comes up when fraud-on-the-market is pleaded. The argument usually is that the representative plaintiff did not rely on the efficiency of the market but instead had "eyeball" reliance. Courts usually permit such cases to go forward anyway, at least at the class certification stage. As a practical matter, this issue usually disappears if the case actually goes to trial and the court has appointed a "most adequate plaintiff" under the PSLRA.

Professional Plaintiffs. Under the PSLRA (unless the court may otherwise permit), a person may be a lead plaintiff in no more than five securities class actions during any three-year period.

Lead Counsel. The "most adequate plaintiff" selects and retains lead counsel for the class, subject to the approval of the court. In Pelletier v. Endo International PLC, No. 17 cv 5114 (E.D. Pa. Feb. 14, 2021), the court removed and replaced a previously appointed lead counsel for the class after it was disclosed that the plaintiff acquired shares in the defendant company ninety-seven seconds after the publication of a Bloomberg article disclosing the alleged corrective disclosure in the stock price. The court not only replaced the "most adequate plaintiff" but also replaced class counsel, who had misled and "misdirected" the court about the timing of the purchase, which the court found "alarming." In In re IPO Securities Litigation, 471 F.3d 24 (2d Cir. 2006), the court held that in order to sustain a securities class action, the district court must determine that each of the Rule 23 requirements has been met (not just that there has been "some showing"). It must resolve all relevant factual issues (even if there is an overlap with a merits issue), and it should not assess any other merits issues and may circumscribe discovery relating to Rule 23 issues and the hearing to ensure that the motion to certify the class does not become a partial trial on the merits. Preponderance of the evidence is the test. See Teamsters Local 445 Freight Div. Pension Fund v. Bombardier Inc., 546 F.3d 196 (2d Cir. 2008). Query: How do Halliburton II and Goldman Sachs affect this holding? Those cases permit a mini-trial on price impact at the class certification stage.

Time. The class must be certified at "an early practicable time." (Note that this Rule used to say "as soon as practicable" but that "did not reflect prevailing practice.")

Notice. Notice to all class members is required; be aware of the due process issues. Phillips Petroleum v. Shutts, 472 U.S. 797 (1985). Putative class members will be bound by the judgment in the class action unless they opt out of the class. That is why they must receive notice. The notice must be sufficient to satisfy due process. It must be "the best notice that is practicable under the circumstances, including individual notice to members who can be identified through reasonable effort." This usually includes mailing to purchasers identified by the company's transfer agent, and publication. A 2018 amendment to the rule provides that electronic notice may be made, provided the class has sufficient access to the internet. Notice must also give the absent plaintiff an opportunity to opt out, at least in cases seeking predominantly money damages. Notice must also describe the "binding effect of a class judgment on members." Rule 23(c)(2)(B)(vii). Would a U.S. class action judgment in favor of the defendant preclude foreign shareholders from bringing similar claims in foreign courts? That is, would a foreign court give preclusive effect to a U.S. judgment in favor of the defendant or would the foreign shareholder be able to sue again in a different country? Although some cases said that a positive answer to this question required a "near certainty," the Vivendi district court adopted a "more likely than not" standard. Is that satisfactory? In any event, there are no recorded instances of foreign shareholders suing a U. S. defendant in a foreign court after a U.S. court ruled in favor of the defendant.

Tolling. American Pipe v. Utah, 414 U.S. 538 (1974), held that the statute of limitations is tolled once a class complaint is filed. But what if the representative plaintiff had no standing to bring the case? Is the statute still tolled? Be aware that a statute of limitations is different from a statute of repose, which is not tolled by the filing of a class action.

Subclasses. What purpose do they serve? (Hint: not much.)

Opt-outs. There are opt-outs in approximately 3 percent of securities class action cases that are settled. Why? To get a larger settlement? To bring an action in state court? Opt-outs usually occur in larger settlements. Fifty-three percent of class settlements greater than $500 million had opt-outs. Some lawyers make a practice of representing opt-outs. Why would the lawyers representing the class not want too many opt-outs? (Hint: higher fees.)

Settlement Issues. Notice and court approval are required. A defendant's support of class certification for settlement purposes does not preclude it from objecting to class certification if the court rejects the settlement. The 2018 amendments to the rule require the court to analyze four factors before approving a settlement: (1) the adequacy of representation by class representatives and class counsel, (2) whether settlement negotiations were done fairly at arm's length, (3) the adequacy of the relief provided under the settlement, and (4) the equity of treatment of class members relative to one another. In Chapter 17, we discuss the different requirements for court approval of SEC settlements. The 2018 amendments also require that parties seeking preliminary approval of a settlement give the court the information that they propose to share with the class members in the approval process and the materials that they intend to submit to the court at the final approval stage. The concept is that this new rule will reduce costs and...