‘Amgen’: What Has Not Been Said So Far!
By Lassaad Adel Turki and Mark A. Allen, Cornerstone Research
The United States Supreme Court recently decided Amgen v. Connecticut Retirement Plans and Trust Funds,1 a major opinion relating to securities litigation. At issue in Amgen was whether proof of materiality is a prerequisite to certification of a class action under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5. In a 6–3 opinion, the Court ruled that it is not.
What Most Close Observers
Of Securities Litigation Realize
Most close observers of securities litigation realize that the real story behind Amgen may not be the holding of the majority opinion, but rather growing questions regarding the continued viability of the fraud-on-the-market presumption enunciated in Basic v. Levinson.2
Because Amgen Inc. had conceded that the market for its stock was efficient,3 market efficiency and the fraud-on-the-market theory were never issues properly before the Court. Thus, the main focus of the two dissents in Amgen was that the reasoning of the majority opinion was inconsistent with the fraud-on-the-market presumption as set forth in Basic. Still, the dissenting Justices voiced criticisms of Basic, while explicitly pointing out that “the Court has not been asked to revisit Basic’s fraud-on-the-market presumption.” 4
Justice Clarence Thomas, joined by Justice Anthony Kennedy, called the Basic decision “questionable,” 5 noted that only four Justices joined the portion of the opinion adopting the fraud-on-the-market theory,6 and echoed statements by the dissent in Basic that the Court is “not well equipped to embrace novel constructions of a statute based on contemporary microeconomic theory.” 7 Justice Antonin Scalia, in turn, was even more scathing, stating that “the fraud-on-the-market rule” was “invented” by the court in Basic.8 He concluded, “Today’s holding does not merely accept what some consider the regrettable consequences of the four-Justice opinion in Basic; it expands those consequences from the arguably regrettable to the unquestionably disastrous.” 9
Justice Samuel Alito concurred with the majority opinion, but only “with the understanding that the petitioners did not ask us to revisit Basic’s fraud-on-the-market presumption.” 10 He continued, “As the dissent observes, more recent evidence suggests that the presumption may rest on a faulty economic premise. In light of this development, reconsideration of the Basic presumption may be appropriate.” 11
Even Justice Ruth Bader Ginsberg’s majority opinion acknowledged new questions regarding the fraud-on-the-market theory while pointing out that the case was a “poor vehicle” for revisiting the Basic presumption.12Justice Ginsberg commented:
[M]odern economic research [tends] to show that market efficiency is not “a binary, yes or no question.” Instead, this research suggests, differences in efficiency can exist within a single market. For example, a market may more readily process certain forms of widely disseminated and easily digestible information, such as public merger announcements, than information more difficult to acquire and understand, such as obscure technical data buried in a filing with the Securities and Exchange Commission.13
Accordingly, because only four Justices need agree to take on a new case, the Court seems poised to revisit market efficiency, the fraud-on-the-market theory, and Basic’s rebuttable presumption of reliance given the right case.
Observers Do Not Realize
Notwithstanding the dissenting opinions in Amgen, under Basic, plaintiffs still have the burden of establishing market efficiency to invoke the fraud-on-the-market presumption of reliance.14 To do so, plaintiffs uniformly rely on the five-factor test of market efficiency enunciated in Cammer v. Bloom.15 The first four Cammer factors—trading volume, number of market makers, number of research analysts, and SEC Form S-3 eligibility—are not sufficient factors for market efficiency. The fifth factor, “cause and effect,” requires plaintiffs to establish “empirical facts showing a cause and effect relationship between unexpected corporate events or financial releases and an immediate response in the stock price.” 16
This fifth Cammer factor is the essence of market efficiency as defined by Professor Eugene Fama of University of Chicago’s Booth School of Business. Considered the father of efficient market theory, Fama defines an efficient market as one “in which prices always ‘fully reflect’ available information.” 17 He recognized that cause and effect is established by “precise measurement of the speed of the stock-price response—the central issue for market efficiency.” 18 Generally, most plaintiffs and their experts do not challenge that the fifth Cammer factor is most important in establishing market efficiency. Indeed, Cammer itself recognized that cause and effect “is the essence of an efficient market and the foundation for the fraud on the market theory.” 19
In order to test for the fifth Cammer factor, plaintiffs’ experts routinely conduct an event study. This analysis provides an objective measure of whether company-specific information caused a significant change in the stock’s price, as opposed to changes caused by industry or market effects or changes that simply reflect normal random movements in stock price. The main challenge plaintiffs face in trying to test for the fifth Cammer factor is first to establish the cause or causes, that is, the “unexpected corporate events or financial releases” 20 that are expected to have moved the price of the security, and then establish that the events caused “an immediate response in the stock price.” 21
Assuming that plaintiffs would be able to overcome the above challenge, they still have to establish that the security price consistently and fully responded to other new, value-relevant information—that is, that the market was efficient at all times during the putative class period.
As the Supreme Court has observed, “differences in efficiency can exist within a single market. For example, a market may more readily process certain forms of widely disseminated and easily digestible information, such as public merger announcements, than information more difficult to acquire and understand, such as obscure technical data buried in a filing with the Securities and Exchange Commission.” 22
Of particular interest is the information contained in the misrepresentations and/or omissions alleged by plaintiffs. Taking these allegations as true, one should test whether these events moved the security price, in a statistically significant manner, in the direction one would expect given the nature of the event, and in response to the event and not to confounding information. If they do not, then the security could not have traded in an efficient market.
Lassaad Adel Turki is a senior vice president in the Washington, D.C., office of Cornerstone Research and Mark A. Allen is a senior consultant in the firm’s Menlo Park, Calif., office. The views expressed in this article are solely those of the authors, who are responsible for the content, and do not necessarily represent the views of Cornerstone Research.
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