Yesterday’s installment summarized the essential holdings of the Second Circuit’s two recent securities fraud class actions decisions, In re Petrobras Sec. Litig., 862 F.3d 250 (2d Cir. 2017) and Waggoner v. Barclays PLC, No. 16-1912-cv, 2017 U.S. App. LEXIS 22115 (2d Cir. Nov. 6, 2017), en banc petition pending, along with case law that informed their outcomes. Today’s article explores the decisions in depth, along with their ramifications for class certification motions.
Proof of 'General Efficiency'
Basic v. Levinson, 485 U.S. 224 (1988) and Halliburton II did not address how plaintiffs should demonstrate market efficiency at the class certification stage. [see note 1] District courts have constructed a set of factors to be considered, though circuit courts have routinely “declined to adopt any particular test for  market efficiency.” Petrobras, 862 F.3d at 278 (quotations and citation omitted). Generally referred to as the Cammer and Krogman factors, these are: (1) average weekly trading volume as a percentage of shares outstanding; (2) number of securities analysts following the stock; (3) existence and number of market makers and arbitrageurs; (4) eligibility to file Form S-3; (5) “cause and effect” relationship between new information and price; (6) total market capitalization; (7) bid-ask spread; and (8) percentage of shares available to the public. Cammer v. Bloom, 711 F. Supp. 1264, 1286-87 (D.N.J. 1989); Krogman v. Sterritt, 202 F.R.D. 467, 478 (N.D. Tex. 2001). Most of the debate among the courts over the last 30 years has centered on Cammer 5, cause and effect, which the courts have considered to be “direct” evidence of efficiency, in contrast to “indirect” evidence by way of the other factors. Satisfaction of Cammer 5 has generally been demonstrated by way of “event studies.” [see note 2] In Petrobras, the Second Circuit endorsed a “holistic analysis” of all Cammer/Krogman factors, expressly refusing to elevate Cammer 5 to a “necessary” condition for demonstrating market efficiency. The District Court (Judge Jed Rakoff) rejected defendants attacks on plaintiffs’ event study, but also found that the “indirect Cammer factors lay a strong foundation for a finding of efficiency.” Quoting In re Petrobras Sec. Litig., 312 F.R.D. 354, 371 (S.D.N.Y. 2016). The appellate court agreed:
We find that the district court’s conclusion “falls within the range of permissible decisions.” Roach, 778 F.3d at 405 (citation omitted). The district court properly declined to view direct and indirect evidence as distinct requirements, opting instead for a holistic analysis based on the totality of the evidence presented. See, e.g., In re JPMorgan Chase & Co. Sec. Litig., No. 12 CIV. 03852 (GBD), 2015 U.S. Dist. LEXIS 132181, 2015 WL 10433433, at *7 (S.D.N.Y. Sept. 29, 2015) (“Defendants’ criticisms of Plaintiffs’ event study distract from the central question: Does the weight of the evidence tip in favor of the finding that the market for JPMorgan’s common stock was efficient during the Class Period?”).
862 F.3d at 277. In Barclays, the Second Circuit went further, holding that “a plaintiff seeking to demonstrate market efficiency need not always present direct evidence of price impact through event studies” and that the district court’s failure to consider an event study was not reversible error. Barclays, 2017 U.S. App. LEXIS 22115, at **32-33. As such, Barclays marked the triumph of common sense over dogma, consistent with Halliburton II’s recognition that plaintiffs need only demonstrate that the market was “generally efficient.” After all, as the Second Circuit recognized, Barclays is “one of the largest financial institutions in the world,” its average weekly volume was much higher than that for other stocks deemed to be efficient, and its stock was “closely followed by many analysts.” [see note 3] The court noted that all seven of the indirect factors “weighed so clearly” in favor of efficiency that the defendants “did not even challenge them.” Id. at *35. The court distinguished the circumstance with Barclays stock with other cases, such as Bombardier, where the results of the indirect Cammer factors were far more equivocal. Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, 546 F.3d 196 (2d Cir. 2008). The court though did not rule out the use of event studies in some cases:
Direct evidence of an efficient market may be more critical, for example, in a situation in which the other four Cammer factors (and/or the Krogman factors) are less compelling in showing an efficient market.
2017 U.S. App. LEXIS 22115, at *33. The court also noted that “several of our sister circuits have concluded that Cammer 5 is not necessary but nevertheless helpful.” [see note 4] Nonetheless, the co-dependency of FOM and event studies for every case has been ended. As discussed below, this recalibration was long overdue. Indeed, empirical studies have demonstrated that even stocks listed on presumably efficient markets such as the NYSE and NASDAQ react to new company-specific information less than 50 percent of the time. See Richard Roll, “R2,” Journal of Finance 43, (1988); Jacob Boudoukh et al., “Which News Moves Stock Prices? A Textual Analysis,” Working Paper No. 18725, National Bureau of Economic Research (Oct. 14, 2013); John M. Griffin, Nicholas H. Hirschey, Patrick J. Kelly, “How Important Is the Financial Media in Global Markets?” Review of Financial Studies (2011); David I. Tabak, “What Should We Expect When Testing for Price Response to News in Securities Litigation,” NERA Economic Consulting (August 2016).
Defendants’ Burden to Rebut Price Impact
As noted, Halliburton II afforded defendants the opportunity to rebut the presumption of reliance by showing that, regardless of the “efficiency” of a particular stock, the alleged misrepresentations did not “impact” its price. Left unsaid was defendants’ burden on rebuttal. In Barclays, the Second Circuit held that defendants must “demonstrate a lack of price impact by a preponderance of the evidence at the class certification stage.” 2017 U.S. App. LEXIS 22115, at **41-42 (emphasis supplied). In so doing, the court expressly rejected defendants’ citation to Rule 301, Federal Rules of Evidence, which provides that with certain exceptions, parties may rebut a presumption by merely producing some contra-evidence rather than citing persuasive contra-evidence. [see note 5] As the Second Circuit noted, Rule 301 expressly imposes a higher burden for rebuttal where a “federal statute … provide[s] otherwise,” and Basic’s presumption was “pursuant to federal securities laws.” 2017 U.S. App. LEXIS 22115, at *45. The Second Circuit added that Halliburton II held that to rebut the presumption of reliance, defendants must show “direct, more salient evidence” that the alleged misrepresentations did not impact the price of the stock. 134 S. Ct. at 2415-16 (citing Basic, 485 U.S. at 248). It stands to reason that if plaintiffs must produce evidence sufficient to satisfy a preponderance standard to trigger the presumption, then defendants must likewise satisfy that higher standard if they must produce “more salient” evidence than plaintiffs.
Risk of Undue Reliance on Event Studies
The seeds for severance of event studies from proof of market efficiency were first planted by Petrobras. There, defendants argued that while plaintiffs’ event study had demonstrated stock price reactions to new information, the price had at times been “directionally” contrary to the news (e.g., gone up even though lower earnings had been announced), thereby suggesting that the market for the stock was neither rational nor efficient. Echoing Judge Rakoff’s observation that this micro-analysis threatened to “let the perfect become the enemy of the good” (In re Petrobras Sec. Litig., 312 F.R.D. 354, 371 (S.D.N.Y. 2016)), the Petrobras court held that plaintiffs had satisfied their burden for class certification purposes, noting the risks of singular reliance on event studies to measure market efficiency:
Event studies offer the seductive promise of hard numbers and dispassionate truth, but methodological constraints limit their utility in the context of single-firm analyses. See generally Alon Brav & J. B. Heaton, Event Studies in Securities Litigation: Low Power, Confounding Effects, and Bias, 93 Wash. U. L. Rev. 583 (2015); see also id. at 588 n.11 (collecting academic criticism of single-firm event studies). Notably, small sample sizes may limit statistical power, meaning that only very large-impact events will be detectable. See id. at 589-605.
862 F.3d at 278-79. [see note 6] As noted, in Barclays, the Second Circuit revisited the need for event studies altogether in certain cases. Plaintiffs had presented an event study in support of class certification in the district court. Ever the prescient maverick, Judge Shira Scheindlin chose to ignore the event study, certifying the class exclusively on the indirect Cammer/Krogman factors. Strougo v. Barclays PLC, 312 F.R.D. 307, 321-23 (S.D.N.Y. 2016) (citing the Brav/Heaton article). On appeal, the circuit court agreed with Judge Scheindlin, noting the concerns regarding reliability of event studies that were expressed in Petrobras. 2017 U.S. App. LEXIS 22115, at *36 (citing Petrobras, 862 F.3d at 256).
Return to Basic(s)
Barclays’ decoupling of event studies and findings of efficient market for individual stock should come as no surprise to financial market economists. Event studies have been around for over 50 years, and were utilized by Professor Fama in his landmark studies to demonstrate market efficiency in the 1960’s. However, Fama relied upon reams of data from decades of stock market prices, crunching the data using then emergent computers at University of Chicago. When Basic cited the EMH in support of the FOM presumption of reliance, it did not do so exclusively, but rather as part of a number of reasons supporting the “common sense” presumption that modern markets reflect all information, including misinformation. 485 U.S. at 246 and n.24. Significantly, while Basic cited Professor Fischel’s article on market efficiency in support of proof of reliance, it was never Professor Fischel’s intention to use EMH as a predicate for class certification. Rather, his article was intended to constrain measuring damages, which (prior to Dura Pharm. v. Broudo, 544 U.S. 336 (2005)) was generally based on using the entire decline from the date of purchase until post-revelation. Similarly, the coupling of proof of FOM with event studies set forth in the article by Prof. Jonathan Macey et al. [see note 7] was prompted by a belief that Basic should have focused on materiality, rather than reliance (which the Supreme Court in Amgen subsequently held should be determined at trial, not at class certification (Amgen v. Conn. Ret. Plans & Tr. Funds, 568 U.S. 455 (2013)). Moreover, none other than Professor Fama has questioned the securities bar’s embrace of event studies. At a symposium in Chicago some years ago, he asserted that the paucity of “events” in single firm studies rendered them unreliable (anticipating Brav/Heaton). When asked how he would counter Professor Fischel’s embrace of such studies, the Nobel Laurate quipped, “Oh he’s just a lawyer.”
Petrobras and Barclays are unlikely to be the last words on these issues. Nonetheless, they represent a watershed moment in securities fraud class actions, and will undoubtedly be reference points for many other decisions to come. Endnotes:  In Halliburton II, the Supreme Court stated that the plaintiffs bear the burden of “proving” several factors at the class certification stage in order to trigger the FOM presumption of reliance, including the publicness of statement; that it was issued during the relevant period; the materiality of the statement; and market efficiency. This raises a question of whether plaintiffs must indeed prove, or simply produce sufficient evidence demonstrating market efficiency for purposes of class certification. Halliburton Co. v. Erica P. John Fund, 134 S. Ct. 2398, 2413 (2014) If “prove” was intended in its traditional sense, then this should be a binding decision, not reviewable at the trial stage. This is at odds with Amgen Inc. v. Conn. Ret. Plans & Tr. Funds, 568 U.S. 455 (2013) and Halliburton I (Halliburton Co. v. Erica P. John Fund, Inc.), 563 U.S 804 (2011), which make clear that questions of loss causation and damages should be addressed at the latter stage. The Second Circuit previously chose its words carefully when addressing plaintiffs burden at the class certification stage:
It would seem to be beyond dispute that a district court may not grant class certification without making a determination that all of the Rule 23 requirements are met. We resist saying that what are required are “findings” because that word usually implies that a district judge is resolving a disputed issue of fact. Although there are often factual disputes in connection with Rule 23 requirements, and such disputes must be resolved with findings, the ultimate issue as to each requirement is really a mixed question of fact and law.
In re Initial Pub. Offerings Sec. Litig., 471 F.3d 24, 40 (2d Cir. 2006) (IPO) (emphasis supplied). In its most recent iteration, the Second Circuit used the term “satisfied” when referring to these factors, and omitted any reference to Halliburton II’s choice of “prove.” Barclays, 2017 U.S. App. LEXIS 22115, at *23 and n.25.  See Macey, Miller, Mitchell, & Netter, “Lessons from Financial Economics: Materiality, Reliance & Extending the Reach of Basic v. Levinson,” 77 Va. L. Rev. 1017 (Aug. 1991). Event studies are “regression analyses that seek to show that the market price of the defendant’s stock tends to respond to pertinent publicly reported events.” Halliburton II, 134 S. Ct. at 2415. Such studies consider several factors, including contemporaneous general market and industry specific price movements, as well as the historic volatility of the company’s stock price, in order to measure the probability that the company’s stock price routinely responded rapidly to new, company-specific information.  Id. at **35-36. The court noted that all seven of the indirect factors “weighed so clearly” in favor of efficiency that the defendants “did not even challenge them.” Id. at *35. The court distinguished the circumstance with Barclays stock with other cases, such as Bombardier, where the results of the indirect Cammer factors were far more equivocal. Teamsters Local 445 Freight Div. Pension Fund v. Bombardier, 546 F.3d 196 (2d Cir. 2008).  Id. at 54 n.30; see Local 703, I.B. of T. Grocery & Food Emps. Welfare Fund v. Regions Fin., 762 F.3d 1248, 1256 (11th Cir. 2014) (“Neither are we persuaded by [the defendant’s] argument that a finding of market efficiency always requires proof that the alleged misrepresentations had an immediate effect on the stock price … . [The defendant] does not point us to any court that has adopted the unwavering evidentiary requirement it urges upon us. Nor could it. Even the Cammer court itself did not establish such a strict evidentiary burden at the class certification stage.”); Unger v. Amedisys Inc., 401 F.3d 316, 325 (5th Cir. 2005) (explaining that the district court improperly used three of the Cammer factors, including Cammer 5, “as a checklist rather than an analytical tool”); see also Gariety v. Grant Thornton, LLP, 368 F.3d 356, 368 (4th Cir. 2004) (explaining that courts “should consider factors such as” the Cammer factors (emphasis added)); Cammer, 711 F. Supp. at 1287 (stating only that it would be “helpful” for a plaintiff to demonstrate “a cause and effect relationship between unexpected corporate events … and an immediate response in … stock price”).  Rule 301 states:
In a civil case, unless a federal statute or these rules provide otherwise, 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.
Thus, the Rule literally could be read to provide a “bursting bubble” standard, i.e., any production of contra-evidence could rebut presumption regardless of how many hurdles the presumption’s beneficiary needed to overcome to trigger it in the first place. But see Committee Notes to the Rule, which expressly reject the “bursting bubble” interpretation, and the Amicus Brief of Evidence Professors submitted on the Barclays appeal.  The court added:
Brav and Heaton caution courts against misinterpreting studies that fail to find statistically significant price changes: “[W]hile a statistically significant reaction to a firm-specific news event is evidence that information was reflected in the price (absent confounding effects), the converse is not true—the failure of the price to react so extremely as to be [detectable] does not establish that the market is inefficient; it may mean only that the effect size was not large enough to be detected in the available sample. Brav & Heaton, 93 Wash. U. L. Rev. at 602 (emphasis added). “While some courts have been sensitive to this distinction … , other courts have remained inattentive to this fact, which has generated inaccurate findings in some securities cases.” Id. (footnote omitted).
Id. at 279 n.30.  See Macey, Miller, Mitchell, & Netter, Lessons from Financial Economics: Materiality, Reliance & Extending the Reach of Basic v. Levinson, 77 Va. L. Rev. 1017 (Aug. 1991). Event studies are “regression analyses that seek to show that the market price of the defendant’s stock tends to respond to pertinent publicly reported events.” Halliburton II, 134 S. Ct. at 2415. Such studies consider several factors, including contemporaneous general market and industry specific price movements, as well as the historic volatility of the company’s stock price, in order to measure the probability that the company’s stock price routinely responded rapidly to new, company-specific information. Marc I. Gross and Jeremy A. Lieberman are partners at Pomerantz LLP, plaintiffs’ lead counsel in 'Petrobras' and 'Barclays'. Mr. Lieberman argued both appeals.