In Waggoner v. Barclays PLC, No. 16-1912 (2d Cir. Nov. 6, 2017), the United States Court of Appeals for the Second Circuit, in a Rule 10b-5 securities fraud action, affirmed the district court’s order granting class certification and, in the process, made a number of significant rulings including concluding that direct evidence of price impact is not always necessary to demonstrate market efficiency and confirming that defendants seeking to rebut the fraud-on-the-market presumption must do so by a preponderance of evidence. The decision will potentially make it easier for securities fraud plaintiffs seeking class certification to demonstrate market efficiency, including, for example, when the securities at issue are not traded on national exchanges.

Barclays PLC, through its American subsidiary, operated an alternate trading system known as Barclay’s LX. LX belongs to a subset of alternative trading systems known as “dark pools,” which permit investors to trade securities in a largely anonymous matter. The anonymous nature of dark pools makes them popular with institutional investors, who seek to avoid high-frequency traders who detect patterns in large incoming trades and execute their trades before the incoming trades are completed (a practice known as “front running”).

The plaintiffs seeking class certification consist of investors who purchased Barclays’ American Depository Shares (“ADS”) between August 2, 2011 and June 25, 2014. The plaintiffs contend that, in addressing concerns that high-frequency traders may have been front running, certain Barclays officers made public misstatements or omitted material information that allegedly caused the price of Barclays ADS to be maintained at an inflated level. The plaintiffs allege that the truth was disclosed when the New York Attorney General sued the bank on June 25, 2014, causing its share price to fall by 7.4 percent the next day. The district court granted the plaintiffs’ class certification motion. Defendants appealed.

On appeal, Barclays contended that the district court erred in granting class certification by: (1) concluding that the presumption of reliance for omissions of material information, as recognized in Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972), applied; (2) determining, alternatively, that the fraud-on-the-market presumption of reliance set forth in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), applied without considering direct evidence of price impact; (3) requiring Barclays to rebut the Basic presumption by a preponderance of the evidence (and concluding that Barclays had failed to do so); and (4) concluding that the plaintiffs’ proposed method for calculating class-wide damages was appropriate.

The Second Circuit agreed with Barclays that the district court erred in applying the Affiliated Ute presumption, holding that the presumption did not apply because the plaintiffs’ claims are primarily based on misstatements, not omissions. Nevertheless, the Second Circuit rejected the remainder of Barclays’ arguments, recognizing that the Basic presumption permits investor reliance to be presumed in cases based on alleged misrepresentations if the plaintiff satisfies certain requirements. The Second Circuit pointed out that only one of the requirements, i.e. whether the stock at issue traded in an “efficient market,” was at issue in this appeal.

The Second Circuit rejected Barclays’ argument that the district court erred by failing to consider whether direct evidence of price impact showed that Barclays’ ADS traded in an efficient market. Price impact is the fifth of five factors identified in Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989), a decision that courts uniformly consider when assessing market efficiency. In doing so, the Second Circuit concluded that a plaintiff seeking to demonstrate market efficiency need not always present direct evidence of price impact through event studies. Still the Court was careful not to imply that direct evidence of price impact is never important and pointed out that it may be more critical when other factors relevant to analyzing market efficiency are less compelling.

The Second Circuit next concluded that defendants seeking to rebut the Basic presumption must demonstrate a lack of price impact by a preponderance of the evidence at the class certification stage rather than merely meet a burden of production. The court found that it would be inconsistent with the Supreme Court’s decision in Haliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014) (Halliburton II), to require plaintiffs to affirmatively satisfy the predominance requirement of class certification, while allowing defendants to rebut the Basic presumption by simply producing some evidence of market inefficiency, but not demonstrating its inefficiency to the district court. Finally, the Second Circuit concluded that the plaintiffs’ damage methodology posed no obstacle to certification.

The Second Circuit’s decision may make it more difficult for securities fraud defendants to oppose class certification on the grounds of lack of price impact. However, the decision does not foreclose defendants from successfully raising such arguments when other factors relevant to analyzing market efficiency are less compelling, or at the merits stage, where the burden belongs to the plaintiffs.