The latest securities fraud class action to find its way to the United States Supreme Court—Goldman Sachs v. Arkansas Teacher Retirement System (ATRS)—was argued on March 29 and was decided on June 21. It arose because Goldman Sachs’ stock price fell from about $184 (April 15, 2010) to about $134 (June 10, 2010) in part because of an enforcement action filed by the SEC against the company on April 16, 2010. Plaintiff buyers of Goldman Sachs common stock (ticker: GS) argue that they were defrauded because the company held itself out as ‘dedicated to complying fully with the letter and spirit of the laws, rules, and ethical principles that govern us’ and affirmed that ‘our continued success depends upon unswerving adherence to this standard.’ Plaintiffs claim that this was a lie, that Goldman Sachs stock was overpriced as a result, and that as buyers they paid too much when they bought. According to plaintiffs, the lie was revealed when the SEC filed suit based on the firm’s marketing of a collateralized mortgage obligation called ABACUS. To be specific, plaintiffs claim that the SEC action exposed Goldman Sachs as a firm that was anything but committed to lofty ethical principles.

There is no doubt that much (or most) of the price decrease in GS was attributable to the government crackdown (Goldman Sachs ultimately paid a $550M fine to settle the matter with the SEC). Nevertheless, ATRS claims that revelation of the firm's true colors caused the loss they suffered, at least in part, and that they should be made whole to the tune of about $50 per share.

The ultimate question in Goldman Sachs is whether the alleged corrective disclosure made any difference at all to stock price. Goldman Sachs argues that the price decrease was attributable to the SEC announcement and not to any revelation that its earlier generic statements about compliance were false. Indeed, during oral argument, Justice Alito suggested that such statements were akin to the claim, ‘We are a nice company,’ and unlikely to matter much to investors. Moreover, Goldman Sachs had acknowledged that its business entails conflicts of interest, and the facts relating to ABACUS were well known to the market before the SEC filed suit.

If the loss was caused wholly by a new development (such as the SEC action), there can be no claim, because there was no lie or cover-up. But the Second Circuit ruled that even if most of the loss was attributable to the SEC enforcement action, it is enough that some of the price decrease can be attributed to corrective disclosure.[1] The Supreme Court (per Justice Barrett) implicitly agreed by holding that that ‘[I}n assessing price impact at class certification, courts should be open to all probative evidence on that question–qualitative as well as quantitative–aided by a good dose of common sense.’[2] On the other hand, the Court also stated that the ‘final inference—that the back-end price drop equals front-end inflation—starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure’. [3] Thus, the Court appears to agree with the many circuits that have held that an event can serve as corrective disclosure.

The Court also considered the question of what it takes to rebut the presumption of price impact—the presumption that a particular item of misinformation affected market price. Specifically, the question is whether the defendant's offering some rebuttal evidence is enough or whether the plaintiff must then offer other evidence to rebut the rebuttal. On this question, the Court ruled that the defendant bears the burden of proof (by preponderance) that the alleged corrective disclosure had no impact on price—over a vigorous dissent by Justice Gorsuch.

Both of these questions imply a logically prior question: What exactly do we mean by price impact in this context?

Stock prices fall for all sorts of reasons. How do we know how much market price fell because Goldman Sachs lied about its ethical standards and how much it fell for other reasons—like the government crackdown on practices previously thought to be kosher? Suppose I buy a used Ford Pinto for $1000 from a guy in a plaid suit and discover that I overpaid by $100 because the mileage had been rolled back. On my way to the dealership to demand a refund, I get bumped from behind, and the gas tank explodes, totaling the car. Can I sue the guy in the plaid suit for the entire $1000 purchase price?

The test in a case like Goldman Sachs is (or should be) whether the market would have reacted to corrective disclosure in the absence of the triggering event—if the company had simply fessed up as to the alleged lie. Suppose the firm had said: ‘We sometimes provide financial products for which there is investor demand even though as a firm we might not choose to invest in such products.’ How much would stock price have dropped? Not much (if any) since the statement is an apt description of a large segment of the securities business. It is as if Captain Renault arrived on the scene and exclaimed, ‘I'm shocked … shocked to find that market making is going on in here.’ Whatever the (minimal) decrease that might follow such a disclosure, that is the amount of price inflation—the excess price caused by the (supposed) deception.

Moreover, the remainder of the loss beyond correction of any price inflation is a loss suffered by the firm. If Goldman Sachs employees violated the law by dealing in such financial products, it is the company that should recover from individual wrongdoers for the harm they did to company reputation (not to mention the loss from the fine). Indeed, the SEC sued both Goldman Sachs and its vice president Fabrice Tourre (AKA Fabulous Fab) who designed and marketed ABACUS and who later paid an individual fine of more than $825,000. To be sure, a company is unlikely to sue its own employees. But the stockholders may sue derivatively to recover from the individual wrongdoers on behalf of the company. If the derivative action succeeds, the company recovers, and stock price is restored for the benefit of all the stockholders. 

Admittedly, it can be difficult to grasp the idea that Goldman Sachs as a firm suffered most of the harm in this case—especially since the firm likely made a ton of money from ABACUS. Nevertheless, the firm is an institution comprising more than 30,000 professional employees and thousands of stockholders. To be sure, one might argue that the firm has deep pockets and can afford to make buyer stockholders whole. But the firm—which was worth more than $93B before the SEC action was announced—lost more than $25B in value as a result of the events by which plaintiffs now claim another $13B in damages. Does it really make sense to compensate those who bought GS during the extraordinarily long forty-month alleged class period at the expense of legacy stockholders? As it turns out, there are powerful legal arguments as to why this case should be recast as a derivative action. But for that, you will need to read the long version of my article (forthcoming in the Villanova Law Review (online)). 

 

Richard Booth is the Martin G. McGuinn Chair in Business Law at the Charles Widger School of Law, Villanova University.

 

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[1] See also Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017).

[2] Slip op. at 7, quoting In re Allstate Corp. Securities Litig., 966 F. 3d 595, 613, n. 6 (CA7 2020) (quoting Langevoort, Judgment Day for Fraud-on-the-Market: Reflection on Amgen and the Second Coming of Halliburton57 Ariz. L. Rev. 37, 56 (2015); emphasis added).

[3] Slip op. at 8.