Goldman Ruling Undoing Investor Class Shows New Path for Peers

Goldman Sachs Group Inc.'s recent win in a securities suit over how it disclosed conflicts of interest is likely to resonate with other corporations facing investor class actions.

The Aug. 10 decision by the Second Circuit may well constrain investors’ ability to proceed as a class in other suits against companies, instead requiring them to sue individually if at all, attorneys say. And it shows judges a way of implementing a 2021 US Supreme Court ruling siding with Goldman in an earlier stage of the case.

“In securities litigation, this is very much a landmark decision,” said Todd Cosenza, a partner at Willkie Farr & Gallagher LLP in New York.

The decision is likely to be used heavily by corporate defendants in would-be class actions, said Cosenza, who authored a friend of the court brief for former Securities and Exchange Commission officials and law professors supporting Goldman in the case.

The ruling will make class certification harder and its logic will spill into dismissal motions attacking securities fraud claims, said Ann Lipton, a professor at Tulane University Law School in New Orleans.

Shareholders sued over an alleged conflict of interest in Goldman’s marketing of a collateralized debt obligation that collapsed during the subprime mortgage crisis. The plaintiffs say they were misled by Goldman about a CDO portfolio known as Abacus, with the bank allegedly withholding the fact that hedge fund Paulson & Co. had chosen the securities for Abacus and later bet against it. Goldman in 2010 agreed to pay $550 million to settle an SEC suit making similar claims.

Three-Round Fight

Goldman and the investors fought up and down in the courts over whether a class could be certified. After the district court in 2018 certified a class for the second time, the Supreme Court ruled in Goldman’s favor in 2021. The justices asked for another look at the company’s contention that its disputed statements were too generic to support a presumption that the full class of investors relied on them.

The district court certified a class again in late 2021, finding there wasn’t too much of a mismatch in how generic the statements and disclosures were. The lower court also credited the investors’ expert testimony more than Goldman’s, as it had in previous rounds. The US Court of Appeals for the Second Circuit reversed the certification in the decision issued Aug. 10.

Under the Supreme Court’s 1988 decision in Basic Inc. v. Levinson, courts can “presume that stock trading in an efficient market incorporates into its price all public, material information—including material misrepresentations—and that investors rely on the integrity of the market price,” the Second Circuit panel said.

Defendants can rebut the presumption by showing that the alleged misrepresentations didn’t affect the market price, the appeals court said. A complication arises where investors allege that misrepresentations have fraudulently propped up an already inflated stock price. A “mismatch” in how generic the alleged misrepresentation is, compared to the corrective disclosure, tends to defeat the plaintiffs’ intended inference of a price impact under the Supreme Court’s 2021 Goldman decision, the panel said.

“This is a court saying you’ve got to make a real connection here,” said Tyler Gellasch, CEO of the Healthy Markets Association in Washington, one of several former SEC officials who submitted a brief supporting the investors.

Lipton, who is critical of the opinion, said many cases will be affected. Most frauds involve “saying ‘Everything’s fine’ when it’s not fine,” the professor said. The Second Circuit has provided “no standard for what’s good enough” to establish a connection between the statement and the disclosure, she said.

There was some ambiguity as to what the Supreme Court’s 2021 ruling meant about matching the two, said Cosenza, who represents companies in securities litigation. The Second Circuit was the first appeals court to deal with that issue, and found Goldman’s statements, including that “honesty” and “integrity” are at the heart of its business, weren’t linked closely enough to later disclosures.

Investors will have to tie the misrepresentation “very closely and directly” to the corrective disclosure under this decision, Cosenza said. “It provides a real path forward in future class certification battles,” he said.

The decision will also likely be used in dismissal motions to determine “whether these sorts of claims are even material enough and actionable in the first place,” he said.

But the Second Circuit didn’t dismiss generic statements out of hand, said James Spindler, a professor at the University of Texas at Austin School of Law. “I think the most reasonable view of this is that it’s going to be more focus on the details, more focus on the expert witness reports, more focus on carefully delineating what the price impact is, tracing that initial statement to the corrective disclosure,” he said. “Ultimately, this leads to a lot more work for the lawyers and the experts.”

But “plaintiffs’ counsel are pretty industrious,” so the number of filed cases won’t shrink a lot, Spindler said.

Is Basic Dead?

Lipton took issue with the Supreme Court’s opinion in the case, saying it effectively overturned a decision it issued in 2011, Erica P. John Fund, Inc. v. Halliburton Co.—"without even recognizing it had.” The result is that “Basic v. Levinson is dead,” she said.

Gellasch, however, said the ruling isn’t far off from where the law has been since Basic. “It doesn’t appear to be as high a bar as defense counsel might suggest it is,” he said.

But the result still spells headaches for the market, according to Gellasch.

“That is a frustrating outcome for investors, regardless of whether it makes new law,” he said.

The case is Ark. Teacher Ret. Sys. v. Goldman Sachs Grp., Inc., 2023 BL 275384, 2d Cir., No. 22-484, 8/10/23.