The Ninth Circuit Court of Appeals recently held that plaintiffs are not entitled to a presumption of reliance when they base their federal securities fraud allegations on both omissions and affirmative misrepresentations of material facts. In so holding, the Ninth Circuit joins other federal circuits that have limited the presumption of reliance established by the United States Supreme Court in Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972), to securities fraud cases based solely on omissions of material facts.
In September 1991, plaintiff Albert Binder purchased on the over-the counter ("OTC") market 3000 shares of Aqua Vie Beverage Corporation ("AVBC") at $4.00 per share. AVBC was the maker of a lightly flavored non-carbonated spring water and was touted by industry publications at the time as "a promising, if speculative investment." In 1992, however, AVBC's personnel allegedly reported to its CEO and consultant that there was instability in the product formulation that caused the product to turn brown sixty days after being bottled. When the problem was not corrected by the end of 1992, AVBC's lost its sole distributor, and its stock plummeted over the following year. Binder sold his AVBC shares at less than $1 per share in late 1993, after the shares began to be traded on the Boston Stock Exchange.
After AVBC suspended its operations in 1994, Binder instituted a class action lawsuit against AVBC and its officers, directors and accountants alleging violations of federal and state securities laws based on various misrepresentations and omissions of material facts. Default judgment was granted against certain defendants, and the action against AVBC was stayed pending bankruptcy proceedings. The case against the remaining defendants proceeded before a magistrate judge on consent, who decertified the class of AVBC investors and dismissed all state and federal claims.
According to the magistrate judge, dismissal of the class claims was required because the class could not demonstrate reliance, a necessary element of a claim under Section 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder. The magistrate judge reasoned that the class could only satisfy the reliance element through a presumption; otherwise, each plaintiff would have to demonstrate reliance individually, which would preclude class certification. Because Binder's securities fraud allegations were based on both affirmative misstatements and omissions, however, the magistrate judge concluded that no presumption of reliance was available under Affiliated Ute.
On appeal, the Ninth Circuit affirmed. Initially, the Court agreed with the magistrate judge's characterization of the action as "not primarily an omissions case," and stated that "at the very least" it must be characterized as "a mixed case of misrepresentations and omissions." The Court then observed that the issue of whether the Affiliated Ute presumption should apply in such mixed cases, or in cases involving misrepresentations only, was one of first impression in the Ninth Circuit. In analyzing the issue, the Court noted that the Ninth Circuit had embraced the Affiliated Ute presumption in omissions cases because of the "difficulty of proving 'a speculative negative' -- that the plaintiff relied on what was not said." This rationale, the Court reasoned, could not apply to affirmative misrepresentations. Thus, the Ninth Circuit held that the Affiliated Ute presumption should be confined to omissions cases, a result it noted that other circuits had reached. Moreover, the Court noted that other circuits confronted with mixed cases "analytically characterize" the action, as the magistrate judge had done, as either "primarily a non-disclosure case . . . or a positive misrepresentation case" for purposes of applying Affiliated Ute. Because the presumption of reliance was not available on the facts alleged, the Ninth Circuit affirmed dismissal of the class claims.
The Ninth Circuit also affirmed the magistrate judge's decision not to extend to plaintiffs a "fraud on the market" presumption of reliance. As the Court noted, the fraud-on-the-market presumption 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 rely directly on the misstatements." This presumption, the Court stated, is only available when a plaintiff alleges that a defendant made a material representation or omission concerning a security that is actively traded on an "efficient market." The Ninth Circuit then affirmed that the OTC market on which AVBC's stock was traded was not efficient -- the stock traded on pink sheets, the volume of sales and the actual prices investors were paying for the stock were unknown, and analysts did not follow the stock. That there were market makers and arbitrageurs for AVBC's stock was insufficient as a matter of law to establish that the OTC market was efficient, the Court affirmed.
After December 1993, when AVBC stock began trading on the Boston Stock Exchange, the Court noted that the class could have qualified for a "fraud-on-the-market" presumption of reliance. Nonetheless, the Court affirmed the magistrate judge's finding that there was "no showing of any material misrepresentations or omission made during that period that c[ould] be said to have caused any investor loss."
In dissent, Circuit Judge Reinhardt asserted that Affiliated Ute itself could be characterized as a "mixed" case of misrepresentations and omissions, since defendants in that case had made "at least one significant misstatement." Accordingly, Judge Reinhardt reasoned that its holding could clearly be extended to at least some mixed cases.
In addition, the dissent asserted that misrepresentations and omissions, as a matter of both law and logic, are not "mutually exclusive." "'[A]ll misrepresentations are also nondisclosures, at least to the extent that there is a failure to disclose which facts in the representation are not true." . . . [B]oth deprive the investor of truthful information relevant to the investment decision, and both result in the artificial pricing of stock," the dissent explained. Furthermore, the dissent opined that it is just as difficult to establish reliance on a misrepresentation as it is to establish reliance on an omission. Therefore, Judge Reinhardt concluded, "there is no logical reason to afford the presumption of reliance to plaintiffs in omissions cases but not in misrepresentations cases." *
Binder v. Gillespie, 172 F.3d 649 (9th Cir. 1999).