In In re DVI, Inc. Securities Litigation, 639 F.3d 623 (3d Cir. 2011), the Third Circuit affirmed the district court’s holding that common class issues predominated over individual issues. The Third Circuit found that the district court had correctly invoked the fraud-on-the-market presumption of reliance to partially grant plaintiffs’ certification motion.
Investors of DVI, a healthcare finance company that extended loans to medical providers for the purchase of medical equipment, commenced a securities fraud putative class action against DVI’s public accountant and outside counsel under Section 10(b) of the Securities Exchange Act of 1934 and corresponding Rule 10b-5. Plaintiffs alleged that defendants had engaged in a scheme to artificially inflate the price of DVI’s securities by, among other things, misrepresenting DVI’s assets. DVI’s accountant, plaintiffs alleged, had concealed DVI’s improper accounting practices, while DVI’s outside counsel had, among other things, conspired to omit material information about DVI’s financial condition.
Plaintiffs moved to certify a class under Rule 23(b)(3). The district court granted the motion with respect to DVI’s accountant, finding that plaintiffs had satisfied the predominance requirement by invoking the fraud-on-the-market presumption of reliance. The district court denied the motion with respect to DVI’s counsel, however, holding that the presumption could not be applied. The Third Circuit affirmed.
To succeed on a Rule 10b-5 claim, plaintiffs must prove, among other elements, reliance upon defendants’ alleged misrepresentations or omissions. If reliance must be proven individually, a proposed class cannot be certified, as common issues would not predominate over individual issues. In DVI, the Third Circuit recognized that the district court had properly used a rebuttable presumption of class-wide reliance based on the fraud-on-the-market theory to satisfy Rule 23(b)(3)’s predominance requirement. The court felt that plaintiffs had put forth adequate evidence to invoke the presumption by showing that DVI’s securities were traded in an efficient market and that the misrepresentations at issue (at least those related to DVI’s accountant) had become public. In determining that the market was efficient, the district court had relied on the fact that DVI’s securities had been traded on major exchanges and that changes in the price of DVI’s securities were directly correlated to DVI press releases. The Third Circuit agreed with the district court’s analysis.
In an efficient market, the Third Circuit explained, stock prices are directly affected by all publicly available information. Because public misrepresentations would therefore be incorporated into the market price, an investor’s reliance on any public material misrepresentations to calculate the security’s value may be presumed. While a defendant may rebut the presumption by showing that the market is not efficient–in other words, that stock prices are not affected by publicly available information and therefore not necessarily affected by public material misrepresentations¾the Third Circuit found that DVI’s accountant had not put forth sufficient evidence for rebuttal.
In so holding, the Third Circuit specifically rejected the Fifth Circuit’s approach in Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 487 F.3d 261 (5th Cir. 2007), in which the court had required plaintiffs to prove loss causation at the class certification stage in order to invoke the fraud-on-the-market presumption of reliance. The Third Circuit reasoned that requiring proof of loss causation at such an early point in litigation improperly shifted the parties’ respective burdens under the presumption as previously determined by the Supreme Court.
As a final matter, the Third Circuit affirmed the district court’s denial of class certification against DVI’s outside counsel. The district court found, and the Third Circuit agreed, that plaintiffs were not entitled to use the fraud-on-the-market presumption of reliance, as none of counsel’s alleged misconduct was publicly disclosed. Without counsel’s acts publicly known, those acts could not have affected the price of DVI’s securities in the market. Thus, among other reasons, the use of the presumption in this instance would be improper.
The debate on the use of fraud-on-the-market to presume reliance in the securities context thus continues, and defendants cannot simply rely on Oscar Private Equity in class certification battles.