On Appeal from the United States District Court for the Eastern District of Pennsylvania D.C. Civil Action No. 03-cv-5336 (Honorable Legrome D. Davis)
The opinion of the court was delivered by: Scirica, Circuit Judge.
Before: SCIRICA and AMBRO, Circuit Judges, and JONES*fn1 , District Judge.
Investors in Diagnostic Ventures, Inc., brought this class action against multiple parties, alleging violations of § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. These interlocutory appeals under Fed. R. Civ. P. 23(f) present issues at the intersection of class action procedure and the securities laws. The District Court granted plaintiffs' motion for class certification with respect to all defendants but one. Parties from both sides filed cross-appeals. We will affirm.
I. Diagnostic Ventures, Inc., (DVI) was a healthcare finance company that extended loans to medical providers to facilitate the purchase of diagnostic medical equipment and leasehold improvements, and offered lines of credit for working capital secured by healthcare receivables. Founded in 1986, DVI was a publicly traded company with reported assets of $1.7 billion in 2003. Its common stock began trading on the New York Stock Exchange (NYSE) in 1992. It issued two tranches of 9 7/8% senior notes: the first, issued in 1997, totaled $100 million; the second, issued in 1998, totaled $55 million. The Notes were similar,*fn2 but the 1997 Notes were traded on the NYSE, while the 1998 Notes were traded over the counter.
On August 13, 2003, DVI announced it would file for Chapter 11 bankruptcy protection resulting from the public disclosure of alleged misrepresentations or omissions as to the amount and nature of collateral pledged to lenders. In the ensuing years, its common stock and 1997 Notes were de-listed from the NYSE, the Securities and Exchange Commission and Department of Justice undertook investigations, its former Chief Financial Officer, Steven Garfinkel, pleaded guilty to fraud, the bankruptcy trustee and multiple lenders filed lawsuits, and the company dissolved.
On September 23, 2003, Cedar Street Fund, Cedar Street Offshore Fund, and Kenneth Grossman*fn3 filed a class action lawsuit alleging violations of federal securities laws.*fn4 In their Fifth Amended Complaint, plaintiffs assert claims under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and the SEC's Rule 10b-5, 17 C.F.R. § 240.10b-5, against multiple defendants, of which only Deloitte & Touche LLP and Clifford Chance LLP are involved in these appeals.*fn5 Deloitte was DVI's certified public accountant from 1987 to June 2003. Clifford
Chance served as the company's lead corporate counsel, particularly advising on disclosure obligations under federal securities laws during the time period relevant to these appeals.
The Fifth Amended Complaint alleges that between August 10, 1999, and August 13, 2003, defendants engaged in a scheme designed to artificially inflate the price of DVI securities by: (1) refusing to write down millions of dollars of impaired assets; (2) double-pledging collateral and/or pledging ineligible collateral; (3) refusing to implement internal controls or to comply with those in place; and (4) concealing cash shortages by overstating revenues, assets, and earnings, and understating liabilities and expenses. Fifth Am. Compl. ¶ 9. Specifically, plaintiffs contend Deloitte committed securities fraud by wrongfully issuing unqualified, or "clean," audit reports for fiscal years 1999 to 2002, hiding DVI's improper accounting practices, and declining to force the company to disclose its fraudulent acts. Id. ¶¶ 424-85, 537-57. With respect to Clifford Chance, plaintiffs contend the law firm assisted DVI in its scheme by drafting fraudulent financial reports (in particular, DVI's 10-Q disclosure for the quarter ending September 30, 2002), conspiring with other defendants to hide material information about the company's financial condition, and deflecting inquiries from the SEC.*fn6 Id. ¶¶ Plaintiffs moved to certify a class under Fed. R. Civ. P. 23(b)(3) on behalf of DVI investors who purchased securities during the period in which the company allegedly made misrepresentations. The District Court granted plaintiffs' motion with respect to all defendants but Clifford Chance. The court analyzed the Rule 23 prerequisites and concluded that each was met. Specifically, it found plaintiffs met Rule 23(b)(3)'s predominance requirement by successfully invoking the fraud- on-the-market presumption of reliance. But the court found plaintiffs were not entitled to a presumption of reliance with respect to Clifford Chance because its conduct was not publicly disclosed and it owed no duty of disclosure to DVI's investors. Therefore, individual issues predominated over common issues and a class could not be certified against Clifford Chance. The court appointed lead plaintiffs as class representatives and defined the class as:
All persons and entities who purchased or otherwise acquired the securities of DVI, Inc. (including its common stock and 9 7/8% Senior Notes) between August 10, 1999 and August 13, 2003, inclusive and who were thereby damaged. Excluded from the class are Defendants; any entity in which a Defendant has a controlling interest or is a part or subsidiary of, or is controlled by a Defendant; the officers, directors, legal representatives, heirs, predecessors, successors and assigns of any of the Defendants; Lead Plaintiffs named in WM High Yield Fund, et al.v.O'Hanlon, et al., No. 04-CV-3423 (E.D. Pa.).
Of the many defendants, initially, only Deloitte filed a petition for leave to appeal. See Fed. R. Civ. P. 23(f). After the District Court denied plaintiffs' motion for partial reconsideration of the court's order with respect to Clifford Chance, they too filed a petition for leave to appeal under Rule 23 (f).*fn7
To certify a class, the proposed class representative must satisfy each of the four requirements in Rule 23(a)--numerosity, commonality, typicality, and adequacy--and the putative class action must meet the requirements of one of the subsections of Rule 23(b).*fn8 Fed. R. Civ. P. 23. Plaintiffs seek certification under Rule 23(b)(3), which requires that (1) "the questions of law or fact common to class members predominate over any questions affecting only individual members," and (2) "that a class action is superior to other available methods for fairly and efficiently adjudicating the controversy." Fed. R. Civ. P. 23(b)(3). These twin requirements are known as predominance and superiority.
The only Rule 23 requirement raised on appeal is predominance.*fn9 Predominance requires that "[i]ssues common to the class . . . predominate over individual issues . . . ."
Hydrogen Peroxide, 552 F.3d at 311 (quotation omitted). Each element of a claim is examined "through the prism" of Rule 23(b)(3). Id. "[T]he task for plaintiffs at class certification is to demonstrate that the element of [the legal claim] is capable of proof at trial through evidence that is common to the class rather than individual to its members." Id. at 311-12. Although the requirement is "readily met in certain cases alleging consumer or securities fraud or violations of the antitrust laws," Amchem Prods., Inc. v. Windsor, 521 U.S. 591, 625 (1997) (citing Advisory Comm. notes, 1966 amendments), "it does not follow that a court should relax its certification analysis, or presume a requirement for certification is met, merely because a plaintiff's claims fall within one of those substantive categories," Hydrogen Peroxide, 553 F.3d at 322.
Plaintiffs assert claims under § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.*fn10 The elements of a § 10(b) private action are: "(1) a material misrepresentation or omission by the defendant; (2) scienter; (3) a connection between the misrepresentation or omission and the purchase or sale of a security; (4) reliance upon the misrepresentation or omission; (5) economic loss; and (6) loss causation."
Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 157 (2008).
The parties dispute the reliance element of plaintiffs' claims. Reliance, also known as transaction causation, "establishes that but for the fraudulent misrepresentation, the investor would not have purchased or sold the security." Newton, 259 F.3d at 172. Reliance may be proven directly, but "[r]equiring proof of individualized reliance from each member of [a] proposed plaintiff class effectively would [prevent plaintiffs] from proceeding with a class action, since individual issues then would . . . overwhelm the common ones." Basic, Inc. v. Levinson, 485 U.S. 224, 242 (1988). If reliance must be individually proven, a proposed class cannot meet the Rule 23(b) predominance requirement.
In order to facilitate securities class-actions, the Supreme Court established a rebuttable presumption of class-wide in connection with the purchase or sale of any security. reliance based on the fraud-on-the-market theory.*fn11 Id. at 245-47. "'The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the available material information regarding the company and its business. . . Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.
.'" Id. at 241-42 (quoting Peil v. Speiser, 806 F.2d 1154, 1160-61 (3d Cir. 1986)) (alteration in original). This hypothesis is known as the efficient capital market hypothesis.
The Supreme Court appears to have endorsed the semi- strong version of the efficient capital market hypothesis. See Schleicher v. Wendt, 618 F.3d 679, 685 (7th Cir. 2010); In re PolyMedica Corp. Sec. Litig., 432 F.3d 1, 10 n.16 (1st Cir. 2005). That version assumes stock prices reflect all publicly available information, but not privately held information.*fn12 See Schleicher, 618 F.3d at 685. Accordingly, investors who buy or sell securities at the price set by "an impersonal, well-developed market" do so "in reliance on the integrity of that price." Basic, 485 U.S. at 247. "Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations . . . may be presumed . . . ." Id.
Thus, when the presumption of reliance is successfully invoked, the predominance requirement is met with respect to the element of reliance.
To invoke the fraud-on-the-market presumption of reliance, plaintiffs must show they traded shares in an efficient market, Semerenko v. Cendant Corp., 223 F.3d 165, 178 (3d Cir. 2000), In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1419 n.8 (3d Cir. 1997), and the misrepresentation at issue became public, Stoneridge, 552 U.S. at 159. Once the presumption of reliance is successfully invoked, the court presumes "(1) that the market price of the security actually incorporated the alleged misrepresentations, (2) that the plaintiff actually relied on the market price of the security as an indicator of its value, and (3) that the plaintiff acted reasonably in relying on the market price of the security." Semerenko, 223 F.3d at 178-79. But a defendant may rebut the presumption of reliance by "[a]ny showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price . . . ."
Basic, 485 U.S. at 248; see also Semerenko, 223 F.3d at 179 ("The fraud on the market theory of reliance . . . creates only a presumption, which a defendant may rebut ...