I. Introduction
At their peak in 2011, lawsuits against Chinese issuers accounted for more than one-fifth of all securities class action filings in the U.S. 1To get a sense of the scope of this trend, consider the following statistics: from 1997-2009 the average number of securities fraud filings against issuers with Chinese headquarters was two per year. Twelve such cases were filed in 2010, followed by 40 in 2011 and 18 in 2012. See Cornerstone Research, Securities Class Action Filings – 2012 Year in Review 11 (2013), available at http://www.cornerstone.com/getattachment/81e1daa9-7a2e-4589-9dd6-a443950b0837/Securities-Class-Action-Filings%E2%80%942012-Year-in-Revie.aspx. Many of these issuers entered the U.S. market by acquiring a U.S.-based publicly traded shell company, thereby allowing them to list shares without an initial public offering, in a process known as a “reverse merger.” The Chinese reverse merger (CRM) phenomenon has sparked much debate, led to new listing rules on U.S. exchanges, spawned numerous Securities and Exchange Commission investigations, and, as lawsuits brought by CRM investors progress though U.S. courts, has had the beneficial effect of prompting courts to clarify the limits of doctrines that often go untested.
Recently, these CRM shareholder lawsuits have entered the class certification phase, again requiring courts to apply familiar legal concepts in the peculiar context of the CRM. One of these concepts is that the plaintiffs’ burden under Fed. R. Civ. P. Rule 23(b)(3) to show that issues common to the class predominate over individual interests may be met by taking advantage of the presumption of reliance set forth in Basic Inc. v. Levinson, 485 U.S. 224, 241-42 (1988) for a “fraud-on-the-market” theory, which rests on the premise that certain well developed markets are efficient processors of public information. Although proving market efficiency for shares on a national exchange, like the New York Stock Exchange or the NASDAQ Stock Market, has rarely been an obstacle to class certification—as suggested by the 75 percent success rate for class certification motions between 2000-2012—two courts have now denied class certification of reverse merger suits on exactly those grounds.
But the reasoning of these cases is not necessarily cabined to Chinese reverse mergers. A recent decision by Judge Katherine Forrest in the U.S. District Court for the Southern District of New York denying certification for shareholders suing Deutsche Bank 2IBEW Local 90 Pension Fund v. Deutsche Bank AG, No. 11-cv-4209, 2013 BL 299553 (S.D.N.Y. Oct. 29, 2013) (Forrest, J.). suggests that market efficiency analysis may become more prominent in future class certification decisions.
II. Background
A. Class Certification of Section 10(b) Claims Under the Federal Rules.
To win class certification, plaintiffs in a purported securities fraud class action must meet each of the four requirements of Rule 23(a) 3The four requirements of Rule 23(a) are referred to as numerosity, commonality, typicality, and adequacy. plus at least one of the requirements of Rule 23(b). As relevant here, Rule 23(b)(3) states that certification is appropriate if the court finds that “the questions of law or fact common to class members predominate over any questions affecting only individual members, and that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy.” 4By contrast, class certification for claims under the Securities Act of 1933 generally does not require market efficiency because reliance is not an element. See, e.g., In re Countrywide Fin. Corp. Sec. Litig., 273 F.R.D. 586, 621 (C.D. Cal. 2009) (“Because §11 of the ’33 Act imposes nearly strict liability for misrepresentations or omissions in a registration statement, Plaintiffs do not need to rely on a fraud-on-the-market theory to establish class-wide reliance.”).
The questions of law that must predominate for a plaintiff alleging violations of Section 10(b) of the 1934 Securities Exchange Act (the “Exchange Act”) include the elements of the claim: “(1) a material misrepresentation (or omission); (2) scienter, i.e., a wrongful state of mind; (3) a connection with the purchase or sale of a security; (4) reliance, often referred to in cases involving public securities markets (fraud-on-the-market cases) as ‘transaction causation’; (5) economic loss; and (6) ‘loss causation,’ i.e., a causal connection between the material misrepresentation and the loss.” 5Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005) (internal citations and emphasis omitted).
While reliance in Section 10(b) actions is rarely an issue at the motion to dismiss phase, plaintiffs that defeat the motion and seek certification of a class bear the burden of demonstrating that reliance can be addressed on a class-wide basis. Without this class-wide presumption, each class member would have to prove reliance individually, thereby defeating the Rule 23(b)(3) “predominance” requirement—i.e., that common issues predominate over individual issues. See, e.g., Amgen Inc. v. Conn. Ret. Plans & Trust Funds, 133 S. Ct. 1184, 1193 (2013) (“[a]bsent the fraud-on-the-market theory, the requirement that Rule 10b-5 plaintiffs establish reliance would ordinarily preclude certification”); George v. China Auto. Sys., Inc., No. 11 Civ. 7533, 2013 BL 178237, at *8 (S.D.N.Y. July 3, 2013) (“In the absence of reliance on a demonstrated efficient market, each class member would be required to demonstrate his or her own reliance on the particular misstatements or omissions; the need for such individualized showings would overwhelm common issues.”). By proving that the defendant company’s shares traded in an efficient market during the putative class period and invoking the fraud-on-the-market theory, the entire class can take advantage of a rebuttable presumption that they each relied on material misrepresentations aired to the general public. 6See Amgen Inc., 133 S. Ct. at 1192 (citing Basic, 485 U.S. at 241-49).
B. Proving Market Efficiency.
Market efficiency is a fact-based inquiry. While the relevant legal question is whether the market price quickly responds to publicly available information, courts rely on a number of factual indicators to judge market efficiency. Most common are five factors first enumerated in Cammer v. Bloom, 711 F. Supp. 1264, 1279-87 (D.N.J. 1989): (1) the average weekly trading volume of the stock; (2) the number of securities analysts following and reporting on the stock; (3) the extent to which market makers and arbitrageurs trade in the stock; (4) the issuer’s eligibility to file an SEC registration Form S-3 (which suggests information about the company may be widely known); and (5) the demonstration of a cause-and-effect relationship between unexpected, material disclosures and changes in stock prices. In addition, courts sometimes consider three additional factors added to this list by the court in Krogman v. Sterritt, 202 F.R.D. 467, 478 (N.D. Tex. 2001): (1) the company’s market capitalization; (2) size of the bid-ask spread; and (3) the percentage of shares held by the public (i.e., the public float). 7The eight Cammer and Krogman factors are not necessarily exhaustive. Some courts have supplemented their analysis with other criteria, such as the level of serial correlation (which relies on the theory that, if the security is efficient enough, its past movements will not predict its future movements) and put-call parity (which relies on the theory that a portfolio of put and call options plus risk-free bonds can be constructed to replicate the payoff from purchasing the underlying stock in an efficient market). These criteria are not proof of efficiency, although the presence of serial correlation or violations of put-call parity can be significant proof that a market fails even the minimal standard for “weak-form” market efficiency. See Mukesh Bajaj, Sumon C. Mazumdar & Daniel A. McLaughlin, Assessing Market Efficiency For Reliance On The Fraud-On-The Market Doctrine After Wal-Mart and Amgen, 26 Research in Law & Econ. (forthcoming) (available at http://ssrn.com/abstract=2302734).
Courts have regarded Cammer’s fifth factor—the existence of a cause-and-effect relationship between unexpected, material disclosures and changes in stock prices—as the most important. In the words of one court, this cause-and-effect factor is “the essence of an efficient market and the foundation for the fraud on the market theory.” Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc., 546 F.3d 196, 207 (2d Cir. 2008) (quoting Cammer, 711 F. Supp. at 1287). To show a causal connection, plaintiffs commonly hire an expert to conduct an event study that “attempts to determine whether new information correlates with a price movement—including the price movement’s direction and, perhaps, magnitude.” In re Countrywide Fin. Corp. Sec. Litig., 273 F.R.D. 586, 614 (C.D. Cal. 2009). That is, courts are invited to infer causation from evidence of a correlation. This inference is stronger under certain circumstances, such as “(1) the more statistically significant the correlation; (2) the more objectively defined the event is; (3) the better the study controls for nonfraud factors; and (4) the larger and more representative the sample.” Id.; Dean v. China Agritech, Inc., No. 2:11-cv-01331, 2012 WL 1835708, at *7 (C.D. Cal. May 3, 2012).
“Generally, claims alleging violations of Section 10(b) of the Exchange Act are especially amenable to class certification.” In re Smith Barney Transfer Agent Litig., 290 F.R.D. 42, 45 (S.D.N.Y. 2013) (internal marks and citation omitted). As this suggests, courts have historically tended to grant class certification for securities fraud class action lawsuits. Indeed, 75 percent of class certification motions decided between January 2000 and December 2012 were granted in whole or in part. 8Nera Econ. Consulting, Recent Trends in Securities Class Action Litigation: 2012 Full-Year Review 20 (2013), available at http://www.nera.com/nera-files/PUB_Year_End_Trends_2012_1113.pdf.
Courts have most readily presumed an efficient market where the plaintiffs purchased securities traded on a major exchange like the NYSE, AMEX, or NASDAQ. See, e.g., Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, Inc., No. 05 Civ. 1898 (SAS), 2006 BL 145675, at *8 (S.D.N.Y. Aug. 1, 2006) (“[i]f, for example, a security is listed on the NYSE, AMEX, NASDAQ, or a similar national market, the market for that security is presumed to be efficient”), aff’d 546 F.3d 196 (2d Cir. 2008). Some courts have treated a listing on a national exchange as dispositive. See Local 703, I.B. of T. Grocery & Food Emps. Welfare Fund v. Regions Fin. Corp., 282 F.R.D. 607, 619 n.13 (N.D. Ala. 2012) (“Given that the NYSE is recognized as the epitome of market efficiency, the court does not set forth here the five factors meant to help guide a court’s determination regarding market efficiency.”); In re DVI Inc. Sec. Litig., 249 F.R.D. 196, 208 (E.D. Pa. 2008) (noting that “neither Defendants nor this Court have been able to locate a single case where the market for a NYSE-traded security was deemed inefficient”). 9aff’d 639 F.3d 623 (3d Cir. 2011) abrogated on other grounds by Amgen, 133 S. Ct. 1184 (2013).
Cases where courts have found that plaintiffs failed to demonstrate market efficiency generally fall within one of three categories:
(1) IPO stock. Plaintiffs sometimes fail to demonstrate market efficiency for shares purchased following an IPO. During the “quiet period” following an IPO’s first day of public trading, analysts cannot report on the securities, thereby precluding the contemporaneous reports by a “significant number of reports by securities analysts” that are a characteristic of an efficient market. In re Initial Pub. Offerings Sec. Litig., 471 F.3d 24, 42-43 (2d Cir. 2006) (plaintiffs could not establish a fraud-on-the-market theory of reliance because “the market for IPO shares is not efficient”).
(2) Securities that are not common stock. Investors have experienced some difficulty convincing courts to apply the fraud-on-the market doctrine in cases involving securities that are traded and valued differently from common stock, including: (a) Asset-backed debt, see In re Countrywide Fin. Corp. Sec. Litig., 273 F.R.D. at 620; Bombardier, 546 F.3d at 210; (b) Preferred shares, see In re Fed. Home Loan Mortg. Corp. (Freddie Mac) Sec. Litig., 281 F.R.D. 174, 182 (S.D.N.Y. 2012); or (c) Mutual Funds, see Siemers v. Wells Fargo & Co., 243 F.R.D. 369, 373-74 (N.D. Cal. 2007).
(3) Securities traded in over-the-counter markets. Claims have also failed where the securities traded only in OTC markets. See Krogman, 202 F.R.D. at 478 (plaintiffs fail to show market efficiency of OTCBB stock); Binder v. Gillespie, 184 F.3d 1059, 1065 (9th Cir. 1999) (no efficient market during time period “AVBC’s stock traded exclusively in the OTC market”).
In sum, securities fraud class actions have enjoyed considerable success at the class certification stage when brought (1) outside the context of an IPO and (2) on behalf of purchasers of common stock (3) traded on a major U.S. stock exchange.
III. Chinese Reverse Merger Cases
In contrast to the high success rate plaintiffs have enjoyed historically on class certification motions in securities cases, plaintiffs have lost all three motions for class certification that have been decided to date in cases involving CRMs, two of which have been decided largely on market efficiency grounds. 10Dean v. China Agritech, 2012 WL 1835708 (C.D. Cal. May 3, 2012); George v. China Auto. Sys., Inc., 2013 BL 178237 (S.D.N.Y. July 3, 2013). In an opinion following the court’s decision in China Agritech, the same court later denied certification for different plaintiffs alleging similar Exchange Act claims against China Agritech for the same class period in Smyth v. China Agritech, No. 2:13-cv-03008 (C.D. Cal. Sept. 26, 2013) (Dkt. #112) (Klausner, J.). This second decision denied class certification on the grounds of typicality and adequacy and did not address whether plaintiffs satisfied the requirements of Rule 23(b) or demonstrated market efficiency.Three other cases against CRMs in which motions for class certification have been brought were settled prior to a decision on the motions. Lewy v. SkyPeople Fruit Juice, Inc., No. 11-cv-2700 (S.D.N.Y. July 29, 2013); Henning v. Orient Paper, Inc., No. 10-cv-5887 (C.D. Cal. June 26, 2012); In re Advanced Battery Techs., Inc. Sec. Litig., No. 11-cv-2279 (S.D.N.Y. Oct. 11, 2012). Motions for class certification are pending in three additional cases. McIntire v. China MediaExpress Holdings, Inc., No. 11-cv-0804 (S.D.N.Y.); Brown v. China Integrated Energy, Inc., No. 11-cv-02559 (C.D. Cal); Sicav v. SmartHeat, Inc., No. 12-cv-6682 (S.D.N.Y.).
In Dean v. China Agritech, the plaintiffs sued the company for, among other things, allegedly misstating its revenue and income and filing false financial statements with the SEC. The court applied the Cammer test in response to the plaintiffs’ motion for class certification, concluding that the plaintiffs had amply demonstrated three of the five factors: (a) an average weekly trading volume of nearly 25 percent of outstanding shares, “well above the one percent required for a presumption that the market is efficient”; (b) at least 290 market makers in Agritech stock, far beyond the ten that would justify a “substantial presumption that the market for the security is an efficient one”; and (c) the company’s filing of an S-3 Registration Statement, which “implies efficiency.” 11China Agritech, 2012 WL 1835708, at *6. With respect to another of the factors, the number of securities analysts following and reporting on the company’s stock, the court found that the plaintiffs’ lack of evidentiary support for this factor meant that it could not support a finding of market efficiency. 12Id. at *7. Finally, the court turned to Cammer’s fifth factor and the two event studies prepared by plaintiffs’ experts. One of plaintiffs’ event studies found statistically significant correlation between events and stock price movements for only one of the four events analyzed in the study; and while the plaintiffs’ other study found a statistically significant correlation between China Agritech’s disclosures and movement in the stock price, it measured correlation in the aggregate, rather than measuring the movement in response to each event. 13Id. Moreover, the plaintiffs’ experts differed in their conclusions. The plaintiffs were therefore “unable to rely on the fraud-on-the-market presumption of reliance,” and the court denied class certification. 14Id. at *7-*8.
Similarly, in George v. China Automotive Systems Inc., a purported class alleged that the company violated accounting rules by reporting certain convertible notes as equity, and sought certification of their securities fraud claims against the company. 152013 BL 178237, at *2. After finding that “the presence of unique defenses” against lead plaintiffs “defeats adequacy, typicality, and predominance,” 16Id. at *1, *5-*7. the court turned to the question of whether plaintiffs had met the Rule 23(b)(3) “predominance” requirement. 17Id. at *7. Plaintiffs submitted five analyses, only one of which the court found “was methodologically akin to an event study,” which, the court stated, were “the most reliable way of demonstrating market efficiency.” 18Id. at *10. Plaintiffs urged that in five of seven news days in their event study, the stock price showed statistically significant returns in the expected direction (i.e., up for good news, down for bad news). The court, however, found 16 such news events during the class period, and that, of those, only seven days showed a statistically significant stock movement in the right direction. 19Id. at *11. Plaintiffs had failed to explain, “as a theoretical matter,” a basis for limiting their analysis to only those seven of those days. 20Id. at *12 n.12. The court denied class certification and found that the plaintiffs had failed to carry their burden of proof on the issues of market efficiency and predominance because none of the five analyses offered by the plaintiffs provided “a reliable basis upon which to rest an opinion or evidence of market efficiency.” 21Id. at *13.
Both China Agritech and China Automotive involved common stock traded on a major U.S. stock exchange, and neither involved an IPO, raising the question of whether these cases are statistical outliers due to the CRM nature of the companies involved. China-based companies that undergo reverse mergers to list on a U.S. exchange generally have smaller market capitalization and little or no track record. They rarely are popular among institutional investors and are not well-known in the U.S. Thus, CRMs are unlikely to have the same liquidity and market depth as other publicly-traded companies. These characteristics are apt to make the CRM fare worse under event studies, which look for swift and directionally accurate movement in share prices following important events. The effects can be self-reinforcing: CRMs are not marketed in an IPO and U.S. institutional investors are generally less interested; and when U.S. institutional investors have less interest, fewer analysts and investment firms will report on the stock. The result is that CRMs, generally, have characteristics that, under existing law, courts view as inconsistent with those of a company traded in an efficient market.
Moreover, some CRM cases, including China Agritech, involve claims that the defendant company is itself a sham. See Robert Pietrzak, Tom A. Paskowitz & Benjamin F. Burry, Securities Fraud Litigation Against China-Based Companies in the United States, 46:13 Rev. of Sec. & Commodities Reg. 157, 168 (July 17, 2013), available at http://www.rscrpubs.com/Cover_Pietrzak_Paskowitz_Burry_RSCR_7-17-13.pdf. (discussing “Phantom Corporations”). A complaint alleging that a CRM is a phantom corporation only reaches class certification after the court has denied defendant’s motion to dismiss—in other words, the court has found the claim plausible. If the court has found it “plausible” that a particular publicly traded company is a massive fraud, it seems less likely that the court will find that, up until that date, there a was a robust, efficient market for the company’s shares in which “the market price of a security fully reflects all publicly available, material information.” 22Countrywide, 273 F.R.D. at 611; see In re Initial Pub. Offerings Sec. Litig., 471 F.3d at 43 (“Plaintiffs’ own allegations as to how slow the market was to correct the alleged price inflation despite what they also allege was widespread knowledge of the scheme indicate the very antithesis of an efficient market.”). Many times in CRM cases, the alleged corrective disclosure is the publication of a short-seller report that disseminates already-public information. For example, in China Agritech the corrective disclosure was the publication of a short seller report concluding that the company’s largest plants “were completely shuttered,” the company’s “principal production facility” turned out to be “a small plant on a rutted road outside Bengbu, completely deserted,” that “there is no Agritech building at the company’s legally registered address,” and the companies Agritech claimed as suppliers of its raw materials “cannot be found in any directory under possible Chinese names.” 23LM Research, China Agritech: A Scam, at 3, 6, 8, Dean v. China Agritech, 2:11-cv-01331 (Dkt. #66-13) (available at http://lucasmcgeeresearch.files.wordpress.com/2011/02/china-agritech-a-scam.pdf). In theory, this was all public information, available to anyone who visited the addresses of the company’s production facilities or looked up its suppliers in local directories. In sum, the corrective disclosure for some CRMs consists of publicly available information that had not been incorporated into its share price by U.S. investors. In essence, the alleged fraud could not have been perpetrated in an efficient market.
If China Agritech and China Automotive were the only recent cases denying class certification on the basis of market efficiency, one may be tempted to attribute them to the CRM context. But these cases are not alone. In Deutsche Bank, the plaintiffs moved for class certification of claims against Deutsche Bank in connection with the bank’s handling of certain financial derivatives. 242013 BL 299553, at *1. To establish market efficiency and predominance, the plaintiffs’ expert submitted an event study based on “12 dates during the Class Period on which [Deutsche Bank] released quarterly and annual financial information or on which [Deutsche Bank] changed its earnings guidance.” 25Id. at *5 (citation and internal marks omitted). According to the plaintiffs’ expert, “his study of the 12 [earning disclosure dates] indicates that statistically significant price movement occurred 25% of the time.” 26Id. at *6. The court scrutinized the expert’s studies and testimony, and outlined a number of methodological flaws with his data set and analysis. As relevant here, Judge Forrest ruled that plaintiffs had failed to prove by a preponderance of the evidence that the market for Deutsche Bank global registered shares was efficient. As in the two CRM cases, the plaintiffs’ “analysis of market efficiency was based an inadequate foundation of” selecting a small handful of dates during a lengthy class period and lacked adequate “analysis of the materiality of information released on those dates, or whether price movements were directionally appropriate.” 27Id. at *22. The court also noted plaintiffs’ expert’s “failure to analyze the primary market in which the [Deutsche Bank global registered shares] traded – namely, Germany” and that he “failed to take into account the three short sale bans in Germany and the U.S.” during the class period. Id. at *21. “In sum,” the court found that the plaintiffs’ expert’s “analysis falls short of what plaintiffs needed to present to support a determination of market efficiency.” 28Id. at *22.
The outcome in Deutsche Bank suggests that the denials of class certification in China Automotive and China Agritech did not stem from the CRM context of those cases, but rather portend tougher scrutiny for all securities fraud classes seeking class certification. Going forward, these cases, along with the Deutsche Bank case, warn plaintiffs seeking class certification that mere trading on a national market is insufficient to establish market efficiency and that plaintiffs must perform a serious event study.
IV. A Tougher Standard For Fraud-On-The-Market
The decisions in China Automotive, China Agritech, and Deutsche Bank demonstrate a judicial scrutiny of plaintiffs’ evidence in support of market efficiency. To the extent that they clarify plaintiffs’ burden in the context of common stock traded on a major U.S. stock exchange after the IPO quiet period, practitioners can take away two key propositions: (A) mere trading on a national market may be insufficient to establish market efficiency; and (B) plaintiffs may not be able to establish market efficiency without a serious event study.
A. Mere Trading on a National Market May Be Insufficient to Establish Market Efficiency.
As mentioned, it is often presumed that the market for securities traded on a major U.S. exchange is efficient. And, contrary to the teachings of the two CRM decisions, some courts appear to have used a listing on major U.S. exchange as basis to forgo a complete analysis of market efficiency. In re DVI Inc. Sec. Litig., 249 F.R.D. at 208 (noting that “neither Defendants nor this Court have been able to locate a single case where the market for a NYSE-traded security was deemed inefficient”), aff’d sub nom. In re DVI, Inc. Sec. Litig., 639 F.3d 623 (3d Cir. 2011); see also In re Merck & Co., Inc. Sec., Derivative & ERISA Litig., 2013 BL 24995, at *13 (D.N.J. Jan. 30, 2013) (holding that for Merck, a Dow 30 stock, “a Cammer analysis is not required for Plaintiffs to establish market efficiency”). Both China Automotive and China Agritech, however, carefully examine all five Cammer factors and find plaintiffs failed to demonstrate market efficiency for a CRM traded on a national exchange (NASDAQ). Building upon those holdings, the district court in Deutsche Bank similarly denied class certification in a non-CRM case for plaintiffs’ failure to demonstrate market efficiency for Deutsche Bank global registered shares, which traded on U.S. exchanges, including the NYSE, and the Frankfurt Stock Exchange in Germany. Deutsche Bank AG, 2013 BL 299553 at *22 (citing China Automotive). 29Cf. Freddie Mac, 1:09-md-02072, 281 F.R.D. at 182 (where defendant’s preferred shares traded on the NYSE (see Dkt. #122, at 10), plaintiffs did not establish market efficiency because Cammer’s fifth factor is “the sine qua non of efficiency” and that “[w]ithout evidence of the prompt effect of unexpected news on market price, the market cannot be called efficient”).
B. Plaintiffs May Not Be Able to Establish Market Efficiency Without a Serious Event Study.
Historically, some courts have certified classes without a rigorous approach to event studies. See, e.g., In re Computer Sci. Corp. Sec. Litig., 288 F.R.D. 112, 120 (E.D. Va. 2012) (“to the extent that Cammer itself may be read to require an event study, it is not persuasive”); Lehocky v. Tidel Techs., Inc., 220 F.R.D. 491, 506 (S.D. Tex. 2004) (finding adequate showing of market efficiency because, among other things, “a general review of the effect of Tidel’s corporate news on common stock price shows that news was immediately integrated into the market”—the only example noted by the court was that the stock price fell 45 percent on the day of the alleged corrective disclosure ending the class period); Bovee v. Coopers & Lybrand, 216 F.R.D. 596, 607 (S.D. Ohio 2003) (holding, without an event study, that “[b]ecause MAW was traded on the NYSE during the class period, the Court is satisfied that plaintiffs have established … the fraud on the market theory”).
In contrast, the courts in China Agritech, China Automotive, and Deutsche Bank each found that the plaintiffs failed to prove a cause and effect relationship between company disclosures and movements in stock price, emphasizing the inadequacies of plaintiffs’ event studies. See China Automotive, at *13 (“None of the tests utilized by [plaintiffs’ expert] provides a reliable basis upon which to rest an opinion or evidence of market efficiency.”); China Agritech, at *7; Deutsche Bank, at *21-*22.
In particular, these decisions demonstrate skepticism of event studies by plaintiffs’ expert that measure correlation in the aggregate. China Agritech, at *7 (“it is unclear how meaningful this finding [from plaintiffs’ event study] is, as the level of correlation was measured in the aggregate”). Further, the courts emphasize that dates used for an event study must be selected based on criteria that have been objectively defined. China Agritech, at *7 (the inference from an event study that new information causes price movement “is stronger … the more objectively defined the event is [and] the better the study controls for nonfraud factors”); China Automotive, at *13, n.13 (rejecting study where plaintiffs’ expert linked largest single day price movements to news events because he provided no basis for “choosing a sample of ten” and this approach “methodologically is backwards”). Moreover, plaintiffs cannot establish market efficiency by a preponderance of the evidence when their event study finds a statistically significant correlation for only a fraction of news releases. China Agritech, at *7 (refusing to accept market efficiency where plaintiffs’ expert “found correlation at a statistically significant level for only one of four events”); China Automotive, at *12 (“showing that only seven out of sixteen days resulted in a market reaction is an insufficient foundation upon which to pronounce market efficiency”).
V. Conclusion
While the analysis of market efficiency that led to the denials of class certification in China Agritech and China Automotive may have been influenced by the CRM nature of the defendant companies, they were notable for the courts’ refusal to rely on the exchange-traded nature of the companies’ stock to presume market efficiency. The rigor of the analyses in these cases and in Deutsche Bank suggests that plaintiffs may have a harder time satisfying Rule 23(b) going forward. Whether this trend continues remains to be seen, but these cases at least provide additional bases to challenge expert studies proffered with a class certification motion where those studies do not produce robust, statistically significant results based on a logically sound and comprehensive examination of class period data, and supported by convincing testimony that the study is free of methodological flaws. 30This landscape of class certification may further change in light of the U.S. Supreme Court’s recent grant of certiorari in Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317, in which the defendants’ petition invited the Court to “overrule or substantially modify the holding of Basic Inc. v. Levinson, 485 U.S. 224 (1988), to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory.”
