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Basic and Beyond: Litigation and Expert Opinions in Securities Class Actions

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Basic and Beyond: Litigation and Expert Opinions in Securities Class Actions

Since the late 1980’s with the US Supreme Court’s landmark decision in Basic Inc. v. Levinson, in securities class actions, plaintiffs have been able to rely on the “fraud-on-the market” presumption of reliance at class certification. In recent years, the validity of that presumption and its evidentiary burdens at the class certification stage have been repeatedly questioned, leading to a “battle of the experts” to determine whether a class should be certified. This course examines the evolution of the fraud-on-the-market presumption and its uses at class certification and then delves into  expert’s role in securities class actions at the class certification stage.

Transcript

- [Deborah] Welcome to Basic and Beyond: Litigation and Expert Opinions in Securities Class Actions. I'm Deborah Renner. I'm a litigation partner at Dentons US LLP, and I specialize in class action defense. With me today is Jordan Milev, an economist at NERA. Jordan is an associate director at NERA. Our topic today is Securities Class Actions. Like any other class action, a securities class action needs to be certified under Federal Rule of Civil Procedure 23 in order to proceed as a class action. Now, securities fraud class actions are what we call money damages class actions under Rule 23. And what that means is that in order for a class to be certified, common issues must predominate over individualized issues. That can be a little tricky in the securities fraud context because, in securities fraud class actions, there has to be proof of fraud. And in this context, fraud requires proof of reliance on a misstatement or an omission of a material fact. So the issue that's played out in securities class actions is whether a plaintiff needs to show that all investors relied on a misstatement or an omission at the class certification stage. And today we're gonna walk through the case law that's developed from that issue. Because resolution of that issue has come to depend on experts, we'll then discuss the use of expert reports in this area. So we begin with the basics, so to speak, which is the first case in this area from the Supreme Court, which is Basic Inc. against Levinson. It's a 1988 case. Basic was a publicly traded company, and it began talks with another company in 1976 about merging or being acquired. But all the while that it was in those talks, it made public statements denying that there were any merger negotiations. And then in 1978, Basic announced the merger. Former Basic shareholders who sold after the merger denials but before the merger announcement filed suit, and the district court for the Northern District of Ohio certified a class by adopting what's called a presumption of reliance based on Basic's public statements. The Sixth Circuit affirmed the class, and then the Supreme Court got the case. At the Supreme Court level, the court adopted the so-called fraud on the market theory of classwide reliance. That theory's based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by all of the available material regarding the company and its business. Misleading statements can defraud purchasers of a stock even if the purchasers don't directly rely on any misstatements or omissions because the price of the stock embodies all of the material information about that particular company. So the elements for the fraud on the market presumption are that there were misstatements or omissions that the market incorporated that information into the market price. The investor bought at the market price implicitly relying on the integrity of that price. In other words, that the price incorporated all material information. So under Basic, classwide reliance is going to be presumed where the defendant made public misrepresentations or omissions and those misrepresentations or omissions were material. The shares were traded on an efficient market, which we'll discuss a little bit later what that means. And the plaintiff traded shares between the time the misrepresentations or omissions were made and the time the truth was revealed. Now under Basic, defendants can rebut the fraud-on-the-market presumption. And to do so, the defendant must sever the link, and those are the words actually from the Basic case, sever the link between the misrepresentation or omission and the price or the plaintiff's decision to trade. And this is exactly where the role of the expert comes into play to show, for example, that information correcting the misstatement had entered the market prior to the plaintiff's trade. Now Basic was in 1988, it's years later, it's 2013 that we get another fundamental decision from the US Supreme Court on what needs to be shown at class certification in order to get a securities class action certified. The issue in that case was the issue of materiality, whether an alleged misstatement or omission was material, and whether the determination of materiality could wait until the merit stage of the case or needed to be decided preliminarily at the class certification stage. Justice Ginsburg wrote the opinion in Amgen, and she held that materiality did not have to be proven at the class certification stage. And as an aside, when Justices Ginsburg and Scalia were alive, they often debated class actions and what needed to be shown in class actions at the certifications stage, be it in the securities realm or in the consumer fraud realm. And you often find Justice Ginsburg taking the side of the plaintiffs that class certification should not be that difficult to achieve and Justice Scalia taking the opposite view. So importantly, this is a Justice Ginsburg decision, and it's going to be pro plaintiff. And so what she holds, and most of the other justices agree with her, is that materiality, because it's an element both of the merits and of class certification, doesn't have to be proven at class certification. Materiality is an objective standard, meaning it's not individualized. So that means that it's necessarily subject to classwide determination. So that issue of whether it is or isn't doesn't have to be decided at class cert. And because materiality is not going to become an issue at class certification, obviously the defendant can't offer any kind of rebuttal evidence to say that a misstatement or an omission was not material. In addition to Amgen, there are two decisions arising from a company called Halliburton. And Halliburton deals with two issues, loss causation and price impact. There's Halliburton I, which was decided in 2011, and there's Halliburton II, which was decided in 2014. The Basic facts are the same in both cases. A fund called Erica P. John Fund sued Halliburton in 2002 in a 10b-5 class action, alleging that between 1999 and 2001, Halliburton made a series of misrepresentations regarding, among other things, it's potential liability in costly asbestos litigation. Halliburton allegedly made several corrective disclosures which caused the company's stock price to drop and investors to lose money. Now, in Halliburton I, the district court denied class certification because the plaintiff had failed to prove what's called loss causation. And what that is is a causal connection between the defendant's alleged misrepresentations and the plaintiff's alleged losses. Without loss causation, the plaintiff could not invoke the presumption of reliance and the class could not be certified. The Fifth Circuit affirmed, but the Supreme Court reversed and remanded in 2011, holding that the plaintiff did not have to prove loss causation at the class certification stage, and therefore could rely on, or could present the classwide reliance through the presumption of fraud on the market. So then we come to Halliburton II, which has been widely discussed in scholarly literature at this point on remand. The plaintiff in fact invoked the fraud-on-the-market presumption, which Halliburton rebutted showing that the misstatements did not impact the market price. But the district court rejected that evidence at class certification, and the Fifth Circuit affirmed. The price related to materiality, the Fifth Circuit reasoned, which did not have to be decided at class certification under Justice Ginsburg's Amgen decision. So Halliburton II goes up to the Supreme Court on two issues. First, should Basic be overruled? That decision from 1988, was it no longer relevant for some reason? One of the arguments presented as to why Basic, the Basic presumptions that should no longer be allowed is because it had become increasingly clear that not all stocks trade efficiently. And Jordan, I don't know if you wanna weigh in on that now and talk a little bit about how important it is for the fraud-on-the-market theory that all stocks trade efficiently. - [Jordan] Right. Thanks, Deborah. What I can say on this is that the criteria that are typically used and have been adopted by courts to examine efficiency over time have allowed for more and more stocks to become eligible to fulfill those criteria. And so from the perspective of whether all stocks trade efficiently, whereas in days when Basic and the subsequent cases that determined those criteria were decided, those criteria might have been a good proxy for efficiency. We've seen that courts over time have started to adopt other criteria for market efficiency. And that to me suggests that courts are listening to what the financial economic community is finding is that as markets have evolved with the advent of different trading venues, different forms of trading, it may be more of a question for whether a stock that's listed on an exchange and trades is still trading in an efficient market by presumption. - [Deborah] Yeah, that's interesting, and we'll get into that a bit more. The real issue with the Basic decision, other than the sort of economic question of whether it's true that stocks trade efficiently, and how we gauge that, which Jordan will get into, is that Basic made it really easy for shareholders to get a securities class action certified and ultimately forced defendants to settle. And if you compare the securities context to the consumer fraud context, for example, where there is no presumption of classwide reliance, it's much easier in the securities context to get a class action certified because of this Basic presumption of reliance. And that's why it's so controversial because it sort of gives the plaintiffs a leg up that they don't have in other class actions outside of the securities context. And you know, the notion that it's too easy is countered, I suppose, by the plaintiff's bar, which say that otherwise it would be impossible to get a securities class action certified because you'd have to look at every single investor's decision to trade a stock. So those are the two arguments for and against the Basic presumption of classwide reliance in the securities context. So it's not an easy issue. The second question presented was whether price impact evidence should be considered at class certification. And that's really the meat of what our presentation is about today because it is about, ultimately, price impact evidence and how that's used at class certification and the expert analyses that go into that. And again, the issue is whether class certification is that point in time when price impact evidence should be considered, and the arguments again are, you know, if the defendant doesn't wanna be forced to settle a case, it should be able to defeat class certification early on in the case and have the case be just about the one or two named plaintiffs, not about an entire class of thousands of people. And the other argument is that determining price impact could involve substantial discovery, and maybe that is better to wait to discuss at the merits phase. So those are the two sort of arguments before and against presenting price impact evidence at class certification. Now let's go back to that first question about whether Basic should remain good law. Supreme Court held that the Basic presumption was necessary, as I said, because without class certification, you'd rarely be able, because without that presumption class, certification would rarely be available or attainable in securities cases. The court held that Congress may overturn or modify any aspect of our interpretations of the reliance requirement, including the Basic presumption itself. Given that possibility we say no reason to exempt the Basic presumption from ordinary principles of stare decisis, meaning that the Basic presumption has been in effect since 1988. If Congress wanted to change that presumption, it could. If Congress was worried about forcing defendants to settle, it could change the presumption. That hasn't happened and the court is going to adhere to what it's always done, which for since 1988, has done which is allow that presumption of classwide reliance under certain circumstances at the class certification stage. So the second question of whether a plaintiff could attempt to show price impact evidence to rebut the presumption of reliance of class certification stage was also decided in Halliburton II. Halliburton argued that the Basic presumption could not be reconciled with recent decisions governing class certification Under Rule 23. Those decisions have made clear that plaintiffs wishing to proceed through a class action must actually prove, not simply plead, that their proposed class satisfies each requirement of Rule 23. So what's important to understand here is, outside of the securities context, it had become increasingly difficult for plaintiffs to certify classes because they needed to not just plead, not just rely on the allegations of their complaints that a class should be certified, but they actually carried the burden to show that the requirements of Rule 23 were being met, including in money damages class actions, that common issues predominated over individualized issues. And that meant in consumer fraud cases that fraud had to be shown to be a predominant classwide issue and that individualized proof of reliance would not be necessary. And just as that is no easy feat in the securities context, it certainly was and is no easy feat in the consumer fraud context. So there's some disconnect that the court is pointing to between the securities context and everything else in class action law. The court held that Basic instead establishes that a plaintiff satisfies the burden, the burden that a class can be certified, by proving the prerequisites for invoking the presumption of classwide reliance, which are publicity, materiality, market efficiency, and market timing. And that the burden of proving these prerequisites still rests with the plaintiffs, except with the exception of materiality, which Justice Ginsburg had exempted in the Amgen decision. On the question of rebuttability, the court went back to the Basic decision and held that, of course, the presumption is rebuttable, as Basic held any showing that severs the link between the alleged misrepresentation and either the price received or paid by the plaintiff and their decision to trade at a fair market price is going to be sufficient to rebut the presumption of reliance. The court held that a defendant may try to rebut the presumption of classified reliance at the class certification stage by introducing evidence that the alleged misrepresentation or omission did not affect the stock price. And again, that's where the expert reports come in at the class certification stage. The court held that, while Basic allowed plaintiffs to establish the preconditions for class certification vis-a-vis the presumption of reliance, it didn't require a court to just ignore the defendant's evidence, which would be more direct, showing that an alleged misrepresentation or omission did not actually affect the stocks market price. The court went on to reason that the choice, in this case, was not between allowing price impact evidence at the class certification stage or relegating it to the merits, because the truth was that that evidence was going to be before the court anyway at class certification. So the only question was whether it would only be plaintiffs who would be allowed to present that evidence or whether defendants could rebut, and the court saw no reason not to allow the rebuttal. Now how does this factor in the Amgen decision and Justice Ginsburg's, you know, decision not to allow materiality to be questioned at the class certification stage? Justice Roberts who wrote the opinion in Halliburton II reason that price impact was different because it is Basic's fundamental premise, and that premise needs to be hashed out at class certification. May not be a a distinction that one agrees with, but that was the distinction that was made. And Halliburton thus puts experts into the frame at the class certification stage on the question of price impact. And experts have been submitting expert reports on price impact, as Jordan will discuss for quite some time. There was an interesting decision last year in the Supreme Court called Goldman Sachs Group against Arkansas Teacher Retirement System, and that was a Justice Barrett decision, and there were two questions presented. First, should generic alleged misrepresentations be considered at the class certification stage? And second, who bears the burden of persuasion to prove a lack of price impact by a preponderance of the evidence at the class certification stage? As I said, the decision is by Justice Barrett, and she has some odd bedfellows with her, Justice Roberts and Kavanaugh, but also Justices Breyer and Kagan join in full in her decision. In this case, the plaintiffs alleged that Goldman maintained an artificially high stock price between 2006 and 2010 by making generic statements about its ability to manage conflicts of interest, that these generic statements were false and misleading, and that once the truth about Goldman's conflict was revealed, the stock price fell, which caused shareholders to suffer losses. And the plaintiffs, of course, sought to certify a class using the Basic presumption of classwide reliance. And then Goldman sought to rebut the presumption. The district court held the Goldman failed to carry its burden and certified the class. And the Second Circuit affirmed. On the first issue of whether the court below should have considered the generic nature of the misrepresentation, the court held that the district court erred. At class certification, both sides had presented evidence of price impact, and after going up to the Second Circuit a couple of times, the Second Circuit affirmed the district court's decision to certify the class. But Judge Sullivan of that circuit had dissented, and his reasoning, which is adopted by Justice Barrett, essentially, is that the generic quality of Goldman's alleged misstatements coupled with Goldman's expert testimony, compelled the conclusion that Goldman proved a lack of price impact. Now here the price impact question went to the so-called inflation maintenance theory, where price impact is the amount of price inflation maintained by misrepresentation or an omission. So under this theory, plaintiff's point to a negative disclosure about a company and an associated drop in its stock price, alleged that the disclosure corrected an earlier misrepresentation or omission, and then claim that the price drop is equal to the amount of inflation maintained by the earlier misrepresentation. The expert issue arises where there's a mismatch, and this is what Judge Sullivan was getting to, between the contents of the alleged misrepresentation, for example, if it's generic, and the corrective disclosure, for example, if it's specific. And Just Barrett reasoned that the generic nature of the alleged misrepresentation, which Judge Sullivan had pointed to, must be considered. And Jordan, I don't know if you have some kind of viewpoint on that issue of generic versus specific representations, and whether a specific corrective statement, how that plays into an expert's analysis. - [Jordan] Yes, thanks, Deborah. With respect to this question, experts are trying within the event study approach, which I'll discuss later, to have a very clear view and a very focused analysis on the specific alleged misrepresentation and then the corrective disclosure. A mapping is necessary because without such a mapping, all you have is an analysis of two dates without the context and without the logical link between the two. So statistics by themselves don't address this particular question. And so economists use other tools at their disposal and conduct an analysis which is sometimes referred to as a qualitative event study to examine the relationship between the alleged misrepresentation and the nature of the corrective disclosure. Sometimes, and I've seen this in cases where corrective disclosure does not technically even correct the misrepresentation, but it's a precursor to an eventual disclosure that relates to the alleged misrepresentation. You can see plaintiff sometimes use the very first announcement of news that might tangentially relate to an alleged misrepresentation as a corrective disclosure when in fact it it doesn't map cleanly onto the news that they say was misrepresented to begin with. So I think that analysis of the mapping between the alleged misrepresentation and the corrective disclosures is very important. - [Deborah] So Jordan, just to flesh that out a little bit, you talked about a qualitative analysis, I suppose, versus a quantitative analysis. And I know many of us, when we think about economists and their expert reports, we're thinking about more of a quantitative analysis. So how would it work in terms of a qualitative analysis, for example, when there's a generic misrepresentation, like, you know, we deal with our conflicts issues effectively versus a corrective disclosure that's very specific as to perhaps, you know, one issue that that had been dealt with on a conflicts issue? How does an economist look at the qualitative aspect of it? - [Jordan] Well, obviously you have to examine the case carefully to decide on the correct approach. But for example, what you might consider is, to the extent that the corrective disclosure is very particular and specific and you've conducted the quantitative analysis that lets you understand what is the price response to that corrective disclosure with respect to that particular, with respect to that particular item that was in the corrective disclosure, then you can go back to the alleged misrepresentation to the extent it is general and by examining the qualitative factors such as analyst reports published around that time, news, postings on message boards by investors, to perform an analysis to the extent that you can identify the portion of the price impact, if there was any, that is related specifically to the item that was in the corrective disclosure. So how much of that item was contained in the event which plaintiffs say is the alleged misrepresentation? And you might then consider that not the whole price impact on the alleged misrepresentation specifically relates to the corrective disclosure. And you can then potentially perform an analysis of the portion that is mapping onto the corrective disclosure, if there is such an item in the alleged misrepresentation. - [Deborah] Interesting, so in this particular case, we had the inflation maintenance theory as well. Can you describe how that sort of theory would play into an expert's analysis on price? - [Jordan] Yes, so the price maintenance theory relates to the idea that it wasn't that the alleged misrepresentations were made so as to increase the price of the stock, but rather they were made because the defendant continued to make statements that were designed to not let the price adjust corresponding to what plaintiffs say is a negative announcement, negative development at the company. And so in that context, your options with respect to the analysis of alleged misrepresentation are rather limited. You have to, again, examine very closely the nature of the news and the nature of analyst sentiment and investor sentiment of how that changed around these alleged misrepresentations. But ultimately, your analysis would focus more heavily on the corrective disclosure itself. And then try to infer from the way analyst sentiment, investor sentiment changed whether that type of news that was disclosed on the corrective disclosure would be considered material and would likely impact the stock price had it been affirmatively disclosed earlier. - [Deborah] Yeah, it's interesting that you mentioned the word material because it seems like, despite Amgen, this issue of materiality has seeped into the class certification analysis. - [Jordan] Yes, this is something that we as economists also discuss among ourselves is, because the techniques involved in analyzing these issues are so similar, materiality does have a way of seeping back in because, and I'll discuss this a little bit later, but you can imagine a situation where a disclosure, corrective disclosure is statistically significant and causes losses to investors. However, the nature of that disclosure is such that, several weeks or months earlier, that type of news would not have been yet material to the investors, to the extent that there were alleged misrepresentations made even prior to that earlier date when materiality first appears. It's really suggesting that materiality does have some implications for whether there would've been price impact and whether the price was really impacted by what was ultimately disclosed on the corrective disclosure at those earliest points in time. - [Deborah] Interesting. Okay, well let's move on and get through the Goldman case and then we can talk more about the expert reports. Now, the second issue that comes up in Goldman, which is really significant, is who has the burden of persuasion at class certification? And here the court affirmed the Second Circuit and held that it is the defendant that bears this evidentiary burden. And this is unusual because, again, outside of the securities context and in general, it's the plaintiff who bears the burden to show that a class can be certified. So here we have, from a defense attorney's point of view, a sort of shifting of the burden of persuasion. Now Goldman had argued here that, just as in any other case, Federal Rule of Evidence 301 should pertain, pursuant to which the party against whom a presumption is directed, has the burden of producing evidence to rebut the presumption. But this rule does not shift the burden of persuasion which remains on the party who had it originally. So in other words, under Federal Rule of Evidence 301, once a defendant produces rebuttal evidence, it's the plaintiff who should then carry the burden of persuasion on price impact. But Justice Barrett holds the Rule 301 cannot change the burden of persuasion, which she views as embedded in the Basic and Halliburton II decisions. The court reads those cases to hold that the defendant bears the burden of persuasion to, quote-unquote, sever the link between an alleged misrepresentation and the price of a stock. Judge Gorsuch wrote a stinging dissent, and in his dissent he said that actually this notion of the burden of persuasion isn't discussed in either Basic or Halliburton II, and he would've used Rule 301 as the guide here, which is what Goldman had suggested was the appropriate rule. Justice Gorsuch then says that the hard truth is that in the 30 plus years since Basic, this court has never before suggested that plaintiffs are relieved from carrying the burden of persuasion on any aspect of their own causes of action. And that really is sort of the issue in these securities cases. Let me just end by saying that, you know, securities class actions are different from all other class actions, and that's true in large part because of that Basic decision from 1988 and how it's been interpreted over the years through Amgen and Halliburton and other cases that are at the district court or circuit court level. But now we have a definitive ruling that it is the defendant who's gonna have to carry the burden of persuasion on price impact at class certification, which again, is contrary to how this burden seems to work outside of the securities realm. And with that, I'm going to hand it over to Jordan to talk more about, to talk more about the role of experts at class certification. - [Jordan] Thank you, Deborah. And my name is Jordan Milev. I am a PhD economist and testifying and consulting expert, and I'm with NERA Economic Consulting. And we see and work on dozens of securities class actions every year. And what I'll talk about, take a step back first and do an overview of the role of economic experts as it relates to securities class actions. And then I will be focusing my commentary more on the class certification stage. But given what we discussed with Deborah earlier, it is natural that one considers how economics experts are used at all stages of the litigation, because the decisions that are made at the other stages of litigation with respect to expert analysis can find their way of seeping into the class certification stage analysis as well. At the pre-class certification, or the pre-motion to dismiss stage, and here I'm using the term loosely to mean at a stage where you would consider it's very early on and the cases just recently been filed or perhaps gearing up, there are a couple of types of analyses that economic experts do. One relates to estimating the size of the case, what is plaintiff's damages claim in aggregate? And the second type of analysis relates to the settlement of the case, what is the expected settlement? You can think of these questions as being asked by, not necessarily by counsel and in terms of the actual merits of the case even, but purely as a business issue. Those types of questions come up very early on. At the class certification stage, there are types of analysis that economic experts perform relate to two categories. One relates to the price impact. In other words, did the alleged misstatements have price impact? And how do we assess that in a rigorous way, that is subject to scrutiny and is a replicable and reliable methodology of assessing whether the alleged misstatements have price impact. And the second is market efficiency and again, was the security trading in efficient market, given that there is, as Deborah discussed earlier, this presumption of efficient markets on which one can then invoke a presumption of reliance on the market price? And a lot of the analysis at the class certification stage involves market efficiency. Following the class certification, you can consider the following analyses, and one is relating to the per-share inflation, which involves considering issues like loss causation and the parsing of the price reaction for confounding news. And then the issue of aggregate damages, which gets into some fairly complicated issues around modeling trading volume, which I will not go into a lot of detail, but I will mention because it is something that sometimes requires additional expert modeling. And the last issue I will discuss is opt-out analyses and the type of analyses we sometimes perform in terms of advising council about who may opt out and why. Now let's discuss briefly the analysis that are done at the pre-class certification or the pre-motion to dismiss stage. In terms of calculating plaintiff's aggregate damages claim, we examine the type of claim, is it a 10b-5 or Section 11 or a Section 12 claim? And then we model alleged inflation from plaintiff's perspective. We examine the complaint and identify the price declines, which are alleged to be loss causing in the complaint. And then we couple that with a trading volume analysis, which uses a statistical model to estimate when shares are bought and sold during the class period. Those types of models are sometimes referred to as multi-trader models or the 80/20 model where 80% of the volume is traded by 20% of very active traders with the rest being traded by less active traders. And there are certain assumptions about matching of purchases and sales. You might have heard these in terms of LIFO, or last in, first out or FIFO, first in, first-out matching. This analysis relies on publicly available data about trading volume, stock price, short interest, insider and large beneficial holder transactions, institutional holdings, market maker and other same-day trading, and the estimated propensity to sell, which may be assumed or may be estimated using brokerage data from other cases. You know, using these publicly available data, including the complaint itself, we can calculate an aggregate damages from plaintiff's perspective. In terms of the predicted settlement, we use data from previously-settled securities class actions. Every year, and as time goes by, we collect more and more data, and we code those previously observed settlements in terms of the types of claims, whether there is a parallel derivative claim, what is the size of the case, are there other securities involved? Is there an experienced institution or public pension fund as a plaintiff? Are there other co-defendants, and various other factors relating to the case, which statistical analysis shows have explanatory power to predict what the settlement is. The impact of those variables is estimated based on past data. And then when we make a predicted settlement for a given case, we code those same variables the same exact way as they've been coded for past historical settlements, and we put them into the model to make a prediction. The prediction results in a mean settlement and also a range. And the model gives associated probabilities of the settlement exceeding a certain amount as well. - [Deborah] Jordan, can I just ask a couple of questions on this? - Yes. - [Deborah] First one is, in the previous slide, you talked about really different types of investors when you're looking at the damages model, there are institutional investors and individuals who are investing. And I'm wondering how the disparity in sophistication, for example, between an individual investor versus an institutional investor might play into understanding this concept of classwide reliance. Is it fair and do you take into account, for example, the sophistication of an institutional investor when evaluating whether that institutional investor knew better, for example, than to rely on the price of the stock in making a trade? - [Jordan] That is a excellent question. So with respect to this particular question, I say the answer is absolutely yes. The issue is that when we're calculating aggregate damages from plaintiff's perspective, we are trying to adopt their view. And in that, to the extent that we can identify certain types of investors where they're trading, not because they're relying on the price, but they're trading for other reasons. For example, a market maker who's objective to trade is to provide liquidity in the market and the price, the price at which they buy and sell is pennies different. And they're doing this, you know, multiple times a day. Those types of investors, we would generally not say, even plaintiffs would say are damaged because they trade without relying on the price. Now this particular question applies to also other types of investors. And in past cases we've assisted counsel in deposing with the questions to put to the lead plaintiff, for example, in order to elicit the reasoning for their trade. And that has sometimes been helpful in the sense of revealing a type of strategy perhaps that exists by the plaintiff where plaintiff could be shown purchased the security for reasons unrelated to price. And so to answer your question, absolutely this is a very important factor to consider to the extent that you can elicit or infer that certain plaintiffs are purchasing the security for reasons other than price or irrespective of the price. That is relevant to the calculation and to whether they can be considered part of the class or they they should be considered as a special group. - [Deborah] The other question I had is on the next slide, when you're talking about, you know, as opposed to an exposure analysis, looking at a settlement analysis, do you also take into account the likelihood that the class will be certified versus not certified? - [Jordan] Yes. So one of the variables for this prediction is the stage of the litigation, and therefore that prediction is conditional on the stage of the case. In other words, as the case moves through the different stages, it is possible that the predictive settlement could increase or decrease depending on how the past decisions turn out. - Okay, thank you. - Yeah. Now I'm gonna talk about the class certification stage type analysis, and those are the broad categories of price impact and market efficiency. Now, with respect to price impact, the question is, was the price impacted by the alleged misstatement? And the key inside the areas price movement is not by itself indicative of price impact. In other words, the key insight says that price movement is not by itself indicative of price impact. You have to have an objective reasoning for having the opinion as an expert that the price was impacted or was not impacted by the alleged mistake. Experts perform a event study to assess that fact. The event study controls for other factors like market, industry movement, and the stocks volatility. And what the event study consists of is a regression analysis which captures the relationship between the security and the other factors that may be impacting the price, such as the market and industry and other factors. Once that relationship is estimated, then a prediction is made about how the stock price should react on the particular day that is the alleged misstatement. And the event study calculates the market adjusted price movement on the day of the alleged misstatement. And out of the model, there is a threshold for statistical significance. So once you've calculated the amount by which the stock price moved in excess of what the market and the industry would've predicted, you can also say in an objective way, is that additional market adjusted movement that cannot be explained by the market, is that movement large enough to be statistically significant and therefore to be different from the typical daily noise in the stock price that you see where stock prices move on a daily basis randomly by a certain amount, just purely based on on the trading and without any information at all? - [Deborah] So Jordan, if I could just interrupt you for a minute and ask another question. You know, in my experience, very often you see the plaintiff's side at the initiation of the lawsuit pointing in their complaints to a sudden move in the stock price during the time period where, you know, the truth has been revealed. And that that alone is proof enough that it must have been that revelation that caused the movement in the stock price. And it sounds like from what you're saying is that there's actually a much more nuanced analysis that can be done because prices move all the time. And you mentioned a regression analysis, and I'm wondering if you could explain to a layperson what a regression analysis entails. - [Jordan] Yes, so regression analysis is an estimation of the statistical relationship between two variables. And here we have the price of the stock. And so the stock every day in changing its price has a return. When the price increases, the return is positive, when the price decreases, the return is negative. At the same time, the markets also go up and down on a daily basis. And so the regression analysis takes the movement of the stock and the movement of the market and estimates the past statistical relationship between the two, the observed statistical relationship. Out of that, there are a couple of variables that come out of this. One is the coefficient on the market or the industry. The coefficient is the variable that tells you the relative size of the expected move given a move that is observed in the index on a particular day. So for example, if you estimate the relationship using a regression analysis and you get that the coefficient is two, what that means is that, on a typical day, this regression analysis tells you that, if the market goes up 1%, you would expect the stock to go up 2% just because the market itself has gone up 1%, and just because that is how the stock price movements relate on any day during this period of examination to the movements of the industry. And so that's helpful in understanding how the stock price moves without any stock-specific information. Some stocks are very tied to particular types of indices, and other stocks may relate to the broader market. Oil stocks, for example, might relate more closely to particular indices that are commodity indices such as oil. Other stocks might be, with a more diversified business, might have a beta coefficient that is actually less than one. Meaning that even if the market declines by 1%, their price, the price of a diversified stock, might be expected to decline by less than 1%. And so the regression analysis gives you that relationship. And that is very important because, if you just in the vacuum, observe that the stock price has declined 3% on a given day and plaintiffs point that out in a complaint, you have to be aware that that 3% decline could be very ordinary if the market had declined on the same day by 2% and there is a relationship coefficient between the two which can explain that decline purely because of the market decline. So that's in terms of price impact, and I've done a quick illustration here. This is the company stock price A, and then you have a broad index. Here, I've just taken as an illustration, the S&P 500, and you can imagine a particular decline by the company. And you have to examine whether the stock market declined on the same day and how that stock market decline overall, what does that imply about the price movement of the company. Because it is possible that the price movement of the company is explained by the price movement in the index on that day. The other big category of analysis at the class certification stage relate to market efficiency. And we discussed this earlier, you know, whether it is appropriate to say that you can presume market efficiency for stocks, I think the Supreme Court largely has it right. And this relates to a concept held, and the concept held by, a view held by a lot of economists that market efficiency is not a yes-no proposition. The Supreme Court's opinion in Halliburton said that Basic's presumption of reliance does not rest on the binary view of market efficiency. And in indeed, in making the presumption rebuttable, Basic recognize that the market efficiency is a matter of degree, and accordingly, it's a matter of proof. So what does market efficiency mean? Deborah discussed this in detail before. In an efficient market, the price reflects all publicly available information, including the fraud. And so purchases are relying on the fraudulent information that is impounded into the price by the efficient market. What is meant by market efficiency? Well, economists talk about mainly three forms of market efficiency: the weak form, the semi-strong form and the strong form. And very briefly, so the weak form of market efficiency states that price reflects information already reflected in past prices. In other words, you cannot use past prices to predict where the price will go in the future. And that precludes opportunities where, if you see a stock price decline, for example, on one particular day, you can't reliably expect that there is going to be a recovery the next day. The weak form just means that the stock price considers all information that's already factored into the past prices of the stock. Now the semi-strong form expands the type of information that a stock price reflects. And so the semi-strong form is typically what courts mean when they discuss market efficiency in the sense of it matches what economists call the semi-strong form of efficiency, in that the semi strong form of market efficiency says that the price reflects all publicly-available information. In other words, if you see something that is notable and important to the price, in an efficient market, unless you can guarantee you're the first person seeing it, you can't expect that that information will lead to a systematic profit when trading because, presumably, that price that you just saw is seen by others and it's publicly available and is incorporated into the price through the efficient trading of market participants. The strong form of market efficiency is expanding the set of information even further in the strong form of market efficiency says that the price reflects all information, whether public or private. It's a somewhat extreme form, but useful in at least in just considering the different types of market efficiency. You can imagine a justification for a strong form if you believe, for example, that even information that is not publicly available has a way of getting impounded into the price through the efficient trading of those people who have it, or through actions of people who have access to this type of information. But again, when courts consider market efficiency, they typically refer to the, or they speak about the semi-strong form of market efficiency. And how do we analyze this? Following the Basic decision, the Cammer decision, Cammer versus Bloom, which outlined five criteria for deciding whether stock trades in an efficient market. And the distinction between liquidity and information is not in the opinion, but I think it gives a helpful framework for thinking about these factors. The first factor is the average weekly turnover. And so what this is is the percentage of the shares outstanding that turns over or trades in any single week. And the Cammer court talked about the idea that if that average weekly trading volume, or average weekly turnover of shares outstanding exceeds 1%, then there would be a substantial presumption of market efficiency. And if it exceeded 2%, then there would be a strong presumption of market efficiency. The second factor in Cammer is the number of securities analysts. And securities analysts are issuing analyst reports. They follow securities, and they comment on earnings, they comment on new developments, and they have their own models for the valuation of the company. And so the number of securities analysts has implications in terms of, the more analysts they are, the courts reason that would assist other investors in understanding the stock, and it would assist new information coming into the stock price. The number of market makers is the third Cammer factor. And that related to the securities in Cammer versus Bloom was trading on the Nasdaq, and on the Nasdaq, they were market makers. And at the time, it was a network of market makers. And so the court reasons then the more market makers making markets in the stock, the more that facilitates market efficiency. The fourth factor is the eligibility to file form S-3. Now form S-3 is a shorter form than the typical form S-1 required of companies to list securities, to issue securities. And so the court reason that, if the company was eligible to file form S-3 and met those criteria for using form S-3, the shorter form S-3 as opposed to the longer form S-1, that meant that the market already had more information about the company, and so it was more likely that information would be impacted into the stock price, impounded into the stock price. The last factor in Cammer versus Bloom is the price response to news. And I would say, this is commonly referred to as the fifth factor, and by far, the factor where most of the discussion and expert analysis is performed. And this price response to news has to be analyzed in an objective way. It should not be a proof-by-example type analysis. And courts have reasons that proof-by-example is not sufficient. One has to perform a objective test where you compare the price response on days with news to the price response on days with no news. And so you have to, in order to say that the price response to news is statistically significant, you have to have an objective standard where you know what the price response to news is and you also know what the price response on days without news is as well. And there is statistical difference between the two. And then, Deborah and I discussed this earlier, over time, courts have started suggesting and relying on several different other criteria for assessing market efficiency. And that's simply because market efficiency is not a yes-or-no proposition. There's no binary review of it, but there are different factors that could speak to the ultimate decision that the fact finder must make with respect to whether the presumption of market efficiency has been rebutted. And those factors are briefly the market capitalization of the security, the bid-ask spread, which just relates to, on a trading venue, there's always a bid, a best price to buy and a best price to sell a bid and an ask. And the difference between the two is called the bid-ask spread. In an efficient market, you could expect the bid-ask spread to be tight. In a less efficient market, you would expect it to be wider. And so how does that bid-ask spread compare to the typical bid-ask spread for these types of securities or these types of venue is relevant information, which the courts relied on. And last is the size of the float. So float is different from market cap. Float is also different from shares outstanding, which was, remember, relating to the average weekly turnover of shares outstanding, the first Cammer factor. Courts recognize that not all shares trade, not all shares are part of the float. Some shares are held by shareholders that never sell, and they're potentially insiders or large beneficial owners that have other reasons not to sell. And so the float relates to the shares that are not encumbered by, you know, other reasons for them not to trade, such as being held by an insider, subject to reporting and restrictions. And the last is, in the IPO security litigation, there was a consideration by the court for the fact that, following an IPO, there is a quiet period by analysts in which analysts do not issue analyst reports on the security that they just helped bring public. So over that period, there was a consideration by the court for the fact that information might not be as widely available, available because some of the analysts are preventing from issuing analyst reports shortly after the IPO. Now let me talk about the loss causation and damages stage a little bit, and here, I'll mention some of the concepts discussed earlier. The question there is, was there a loss caused by a disclosure of the alleged misstatement or omission? And the insight again is that price movement is not by itself indicative of price impact. After controlling four other factors, is the price decline statistically significant? Again, it's the same type of analysis that I discussed earlier. But then we also have this, does the information disclosed, and this was the Goldman issue, does the information disclosed correct the alleged misstatement or remission? There is what I call the quantitative loss causation analysis, which measures the stock price movement following the news, and also it provides an empirical objective test of whether there was a price movement due to the disclosure. But then there is also the qualitative loss causation analysis where use analyst reports, news and information from discovery. And let me go into a one particular example here, just speak about this briefly. Consider, for example, a stock which misrepresents that they have two barrels of oil when a barrel of oil costs $20 per barrel. And then, ultimately, oil prices increase to $100 a barrel. And at that point, the company discloses that the true quantity of oil that they have is not two barrels, they only have one barrel of oil. And so the stock price declines as a result of that news. And because the price of oil has increased so much at that point, when you analyze the stock price and the movement, you see that it is statistically significant. But again, the question is to what extent was that information significant earlier when the stock price was much lower? And so that is one of the key questions when we analyze per-share inflation. So to start with, when there is a disclosure, and it causes loss to investors because the stock price is large and statistically significant, it logically follows that prior to the price decline, at least at some point prior to the price decline, immediately prior, the price was inflated. And the inflation is really because, ultimately, we just said that there was loss to investors as a result of the decline. Now the issue is there is additional analysis that needs to be done to actually construct inflation for the entirety of the alleged class period. Merely assuming that that inflation was there early on is just that, an assumption. So you might be asking questions like, "Is the amount of inflation all due to that disclosure or was it due to other confounding information?" And that is also known as parsing the disclosure, parsing the price decline for other type of information. You can also consider was the amount of inflation a constant dollar or a constant percentage of the price? Meaning if you, for example, in the oil barrel example, the amount of inflation you could argue relates to the dollar price of oil, and therefore it would vary over time. Then again, the question is, was the amount of inflation the same over the entire class period? And at what point does it become material? Because that might have implications for when that type of information, if disclosed, would have had a price impact, as opposed to would have had no price impact. For example, if the price of oil was very low in the beginning of the alleged class period to the extent where economic analysis can show that, with such a low amount of price of oil, an extra barrel of oil would not have been a material misrepresentation by the company. And other questions relates to, did the alleged inflation exit the price all at once or over several alleged disclosures? When you have this per-share inflation estimate, you can then couple it with the volume model that we discussed earlier to calculate a aggregate damages estimate, assuming liability. And in that aggregate damages estimate, you can then model certain parameters or certain assumptions to assess the reliability of this aggregate damages estimate that you're performing or perhaps you're seeing plaintiffs perform. You can assess the sensitivity to assumptions, you can use alternative startup end dates, or you can assess how robust it is to changes in assumption about training volume modeling. And now for the last topic that I want to very briefly mention is the question of opt-outs. And I mention it because clients often ask us in aggregate damages calculations and in performing analysis for securities class actions, is it possible to identify likely opt-outs? And that analysis depends on an analysis of damages by institutions that report shares held. And by changes in the number of shares held, we can infer when they bought and when they sold stock. And so we can assess whether their likely damages claim would change based on different versions of liability theories put forward by plaintiffs. And so do they have a very different estimate of damages if you use the mainline inflation versus an alternative inflation? And we can then advise counsel with respect to who are the likely institutions that would see the biggest change in damages estimates as a result of these changes in assumptions. And that could also assist them in drafting opt-out provisions in settlements. And with that, I'll conclude, and I'll ask Deborah a question. Deborah, could you tell me, is there another consideration or another type of inquiry that you see counsel ask their experts to perform in securities class actions? - [Deborah] No, I think you've covered everything. And this was really super helpful, so thank you Jordan, I really appreciate all the hard work and thought that went into this. Thank you. - Great. Thank you, Deborah.

Presenter(s)

JMP
Jordan Milev, PhD
Associate Director
NERA Economic Consulting

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