Corporate Governance

In re: Salomon Analyst Metromedia Litigation and the Presumption of Reliance

By Leah Jensen

In In Re: Salomon Analyst Metromedia Litigation, 544 F.3d 474 (2d Cir. 2008), defendants appealed a New York District Court holding that the Basic v. Levinson reliance presumption applied to misrepresentations made by research analysts. Additionally the court addressed whether the defendants were entitled to rebut the Basic presumption prior to class certification.

The suit alleged that Metromedia defrauded investors in violation of SEC Rule 10b-5 by issuing and disseminating reports that contained materially false and misleading statements. The district court certified a class of plaintiffs who purchased Metromedia stock between March 8 and July 25, 2001. The court concluded that the research analyst’s reports issued during this time period made material misstatements and omissions concerning Citigroup’s underwriting of a new credit facility for Metromedia.
The district court held that under Rule 23(b), the requirement that all class members prove reliance may be presumed under the fraud-on-the-market doctrine of Basic Inc. v. Levison.

The Basic doctrine states that reliance is presumed when the disputed statements become public; the statement then becomes part of the market price of the security and it may be assumed that investors who buy or sell stock at this market price are relying on the statement. The defendants appealed the district court ruling and argued that the Basic presumption does not apply to statements made by research analysts. The Second Circuit Court of Appeals rejected this claim, stating that reliance on any public material representations invokes the Basic presumption. The source of the misinformation is thus irrelevant.

The Second Circuit next rejected the defendant’s argument that plaintiffs must carry the burden of proving a “material affect on the market price.” The court in Basic analyzed this so-called “materiality” where it explained that courts should view materiality through the lens of a reasonable investor, not a showing of speculative state of facts of impact on market price. Therefore, the court held that plaintiffs do not bear the burden of showing an impact on price.

Despite overruling the district court's holding on the reliance and materiality challenges, the Second Circuit found that the district court applied the wrong standard for certifying the class. The district court required plaintiffs to make only “some showing” beyond the complaint in order to trigger the Basic presumption. The Second Circuit clarified that all evidence must be addressed and resolved relevant to Rule 23 and that the district court should have considered a rebuttal argument prior to class certification. While the defendants did not attempt a rebuttal at the district court stage, the court excused this omission as a possible confusion in the status of case law governing the entitlement to rebuttal. The court then vacated the class certification and remanded the case to allow defendants an opportunity to rebut the Basic presumption prior to class certification. The court, however, mentioned that the district court has considerable discretion to limit discovery in a hearing on Rule 23 requirements in order to avoid a protracted mini-trial.

The primary materials for this post are available on the DU Corporate Governance Website.

Full post as published by The Race to the Bottom on February 24, 2009 (boomark / email).