Securities - 2nd Circuit Holds No Heightened Evidentiary Standard in Class Action Alleging Fraud on the Market

In a class action suit the United States Court of Appeals for the Second Circuit held that the district court had not erred in certifying the class in the Section 10(b), Rule 10b-5 securities fraud action.

The complaint alleges that Citigroup defendants, Salomon Smith Barney, and Solomon's research analyst, Jack Grubman, defrauded investors in Metromedia Fiber Network by issuing and disseminating research reports on Metromedia that contained materially false and misleading statements and omissions of material facts. A question raised in the context of class certification was whether in alleging fraud on the market there is a presumption that the market relied on the statements of a research analyst. Specifically, to determine whether common questions predominated to allow class certification the court's analysis rests on whether the fraud on the market presumption applies to suits against research analysts.

The court relied on the case of Basic, Inc., v. Levinson, 285 U.S. 224 (1988), which had set forth a test for determining when to presume investor reliance on a statement in a fraud analysis. Basic held that to satisfy the requirement, the defendant must have (1) publicly made (2) a material misrepresentation (3) about stock traded on an impersonal, well-developed (efficient) market. The court found no reason to exempt research analysts from the Basic test and limit it to issuers only.

The Second Circuit also rejected the defendants' invitation to require the plaintiffs to prove that the alleged misrepresentations actually effected the market to satisfy the materiality requirement for fraud. The court relied on Basic and TSC Indus., Inc., v. Northway, Inc., 426 U.S. 438 (U.S. 1976), to hold that materiality is a reasonableness standard.

Thus, the court firmed the class certification of the district court.