Continuing the trend in the Second Circuit since the IPO decision for courts to “rigorously” determine whether class certification is appropriate, on March 27, 2012, Judge Miriam Cederbaum of the United States District Court for the Southern District of New York denied plaintiff’s motion for class certification in the putative class action brought against Freddie Mac’s CEO and CFO. The court conducted a Daubert hearing and held that the plaintiff could not demonstrate the viability of a “fraud-on-the-market” theory to justify a presumption of classwide reliance. Thus, because individualized issues of reliance predominated, a class could not be certified. While the Supreme Court’s Wal-Mart decision left open the question of whether Daubert scrutiny was required at the class certification stage, significantly and in contrast to cases in other circuits, the Freddie Mac decision applied a Daubert analysis to the predominance requirement under Rule 23(b)(3). The court reasoned that not only must a plaintiff establish that a class can be certified by a preponderance of the evidence, but that the evidence must be credible.
On January 9, 2009, Freddie Mac investors filed a complaint against Richard Syron, Freddie Mac’s former CEO, and Anthony Piszel, Freddie Mac’s former CFO, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5. Plaintiff alleged that the defendants materially misrepresented Freddie Mac’s underwriting and risk management practices, as well as the adequacy of its capitalization. Plaintiff sought to certify a class of all persons who purchased Freddie Mac “Series Z” stock during the period in which the alleged misstatements were made pursuant to Rule 23(b)(3).
The court focused its attention on the requirement that in order to warrant class certification a plaintiff in a securities fraud action must establish a presumption of reliance through the fraud-on-the-market theory. The district court held that, for the fraud-on-the-market presumption of reliance to apply, a plaintiff must demonstrate by a preponderance of credible evidence that the securities at issue were traded on an efficient market. Otherwise, each plaintiff must establish individual reliance on the material misstatement and the Rule 23(b)(3) predominance requirement cannot be met.
Applying Daubert, the district court conducted an evidentiary hearing and heard expert testimony from both sides regarding whether the market for Freddie Mac Series Z stock operated efficiently. While the district court held that some “factors support an inference of efficiency, these factors cannot substitute for evidence of a cause-and-effect relationship between unexpected news and market price. This is the critical factor – the sine qua non of efficiency.” Ultimately finding the plaintiff’s expert’s testimony to be “unreliable and unpersuasive,” the court held that plaintiff had not carried his burden of proving that the market for the stock responded immediately to unexpected corporate events or releases. The court thus found that the predominance requirement was not met and denied plaintiff’s motion to certify the class.
Although courts in different circuits may apply varying standards in evaluating expert testimony at the class certification stage, there is no question that a court’s mandate to conduct a rigorous analysis of the Rule 23 criteria calls for an in-depth evaluation of a plaintiff’s evidence. Thus, the class certification stage provides defendants with another opportunity to demonstrate the meritless nature of an action.