This is Part 3 in a 4 part series on Securities Class Actions by Martin Chitwood.
Standards for Class Certification Under Rule 23
To promote private enforcement of the federal securities laws, courts endorse a liberal construction of Rule 23 in securities cases. See Kennedy, 710 F.2d at 717-18; In re KnowledgeWare, Inc. Shareholder Litig. Master File No. 1:92-CV-1651-JTC, at 11 (N.D. Ga. Jan. 31, 1993) (order granting class certification). Accordingly, “when a court is in doubt as to whether to certify a class action, the court should err in the direction of allowing the suit to go forward as a class action.” In re DCA Sec. Litig., Civil Action No. 1:89-CV-2195-RCF, at 4-5 (N.D. Ga. December 21, 1990) (order granting class certification) (hereinafter “DCA Sec. Litig. Order”); Eisenberg v. Gagnon, 766 F.2d 770, 785 (3d Cir. 1985).
Rules 23(a) and (b) contain the substantive requirements for certification of a class. In order to maintain a class action, the plaintiff bears the burden of establishing the four class requirements of Rule 23(a) — numerosity, commonality, typicality and adequacy — and must also demonstrate that one of the three fact situations of Rule 23(b) is present. Rule 23(b)(1) authorizes class action treatment where separate actions would “create a risk of inconsistent or varying adjudications” that would “establish incompatible standards of conduct” for the party opposing the class, or where separate adjudications would “as a practical matter be dispositive of the interests of the others” in the class who are not parties to that adjudication. Rule 23(b)(2) authorizes a class action when the party opposing the class has acted on grounds generally applicable to the class, making final injunctive or declaratory relief appropriate with respect to the class as a whole. Finally, Rule 23(b)(3) permits a class action to be certified when common questions of law and fact predominate as to all members of the class and a class action is superior to alternative methods for the fair and efficient adjudication of the controversy. Rule 23(b)(3) is the most frequently used basis for certifying a class in securities class actions; therefore it is the only section of Rule 23(b) that will be discussed herein.
In determining the propriety of a class action, “the question is not whether the . . . plaintiffs have stated a cause of action or will prevail on the merits, but rather whether the requirements of Rule 23 are met.” Eisen v. Carlisle & Jacquelin, 417 U.S. 156, 177-78 (1974) (quoting with approval Miller v. Mackey Int’l Inc., 452 F.2d 424, 429 (5th Cir. 1971)). See also Cox v. American Cast Iron Pipe Co., 784 F.2d 1546, 1557 (11th Cir). The most pertinent considerations in a court’s ruling on a motion pursuant to Rule 23 are the requirements of the rule itself and the allegations in the complaint, which must be accepted as true for the purpose of deciding whether a class should be certified. E.g., Shelter Realty Corp. v. Allied Maintenance Corp., 574 F.2d 656, 661 n.15 (2d Cir. 1978); Westlake v. Abrams, 565 F. Supp. 1330, 1337 (N.D. Ga. 1983); see also Kirkpatrick, 827 F.2d at 722-23; In re T2 Medical, Inc. Shareholder Litig., Civil Action No. 1:92-CV-1564-RLV, at 16 (N.D. Ga. Nov. 17, 1993) (order granting class certification). Consequently, the sole issue presented in a motion for class certification is whether Plaintiffs have fulfilled the requirements of Rule 23, not whether plaintiffs will prevail on the merits of their claims. DCA Sec. Litig. Order, at 4.
Furthermore, the policies underlying the need for class action litigation in general necessarily require that Rule 23 be interpreted liberally. “[For] the interests of justice require that in a doubtful case . . . any error, if there is to be one, should be committed in favor of allowing a class action.” Eisenberg v. Gagnon, 766 F.2d 770, 785 (3d Cir.) (quoting Esplin v. Hirschi, 402 F.2d 94, 101 (10th Cir. 1968)). See also Giles v. Ireland, 742 F.2d 1366, 1372 (11th Cir. 1984); Freeman v. Motor Convoy, Inc., 700 F.2d 1339, 1347 (11th Cir. 1983).
Each of the elements of Rule 23 is discussed more fully below.
- The Class Requirements of Rule 23(a)
Rule 23(a) provides:
One or more members of a class may sue or be sued as representative parties on behalf of all only if (1) the class is so numerous that joinder of all members is impracticable, (2) there are questions of law or fact common to the class, (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class, and (4) the representative parties will fairly and adequately protect the interests of the class.
Fed. R. Civ. P. 23(a). All four of these class requirements must be met before a class may be certified under Rule 23.
Rule 23 does not define what a class is or how its members should be determined. In general, however, to satisfy the numerosity requirement, although a plaintiff need not prove the exact number or identity of class members, he must show that the number is exceedingly large and that joinder is impracticable. See Evans v. United States Pipe & Foundry Co., 696 F.2d 925, 930 (11th Cir. 1983); In re Carbon Dioxide Antitrust Litig., 149 F.R.D. 229, 232 (M.D. Fla. 1993). Class actions consisting of fewer than 150 members have been held to satisfy the numerosity requirement, e.g., Kreuzfeld, A.G. v. Carnehammar, 138 F.R.D. 594, 599 (S.D. Fla. 1991) (certifying a class of approximately 130 members and noting that the numerosity requirement has been satisfied with as few as 25 or 30 class members) as have class actions involving millions of class members, e.g., In re NASDAQ Market-Makers Antitrust Litig., 169 F.R.D. 493 (S.D.N.Y. 1996) (class of at least a million securities investors certified). Furthermore, where the putative class is geographically dispersed across the United States, as is the case in many securities actions, joinder of all class members is almost always considered impracticable.
Most plaintiffs in securities actions involving nationally traded securities are routinely able to satisfy the numerosity requirement, demonstrating that the class is sufficiently numerous so that joinder of all members is impracticable. See, e.g., Evans v. U.S. Pipe & Foundry Co., 696 F.2d 925, 930 (11th Cir. 1983); T2 Medical Order at 9 (granting certification even though the precise number of purchasers was unknown); DCA Sec. Litig. Order at 5 (“Numerosity is generally presumed when a claim involves nationally traded securities.”); Nat’l Data Corp. Order at 5.
Rule 23(a)(2) requires that in order for an action to be certified as a class action, the claims of the class members must involve common questions of law and fact. This “commonality” requirement of Rule 23(a)(2) is satisfied if the “named representatives’ claims have the same essential characteristics as the claims of the class at large.” Appleyard v. Wallace, 754 F.2d 955, 958 (11th Cir. 1985) (quoting De La Fuente v. Stokely-Van Camp, Inc., 713 F.2d 225, 232 (7th Cir. 1983)). The rule does not require that every question of law or fact be common to each class member, only that some questions be common, and those questions be central to the action. Cox v. American Cast Iron Pipe Co., 784 F.2d at 1557; Nat’l Data Corp. Order at 5-6; T2 Medical Order at 10. The plaintiff must show that class members share a “substantially identical factual situation” and that the “questions of law raised by the plaintiff are applicable to each class member.” In re Amerifirst Sec. Litig., 139 F.R.D. 423, 428 (S.D. Fla. 1991) (quoting Weiss v. York Hospital, 745 F.2d 786, 808 (3d Cir. 1984)). See also Powers v. Stuart-James Co., 707 F. Supp. 499, 502 (M.D. Fla. 1989).
In a typical securities class action under Section 10(b) of the Exchange Act and SEC Rule 10b-5, the commonality requirement is easily satisfied. Where the plaintiffs have alleged that the defendants made material misrepresentations about a company through uniform public statements or by a failure to disclose material facts, the common question requirement of Rule 23(a)(2) is ordinarily met. See, e.g., Lipton v. Documation, Inc., 734 F.2d 740, 743 (11th Cir. 1984); Blackie v. Barrack, 524 F.2d 891, 902-05 (9th Cir. 1975) (holding that common questions of law and fact abound where alleged fraud involves uniform written documents like news releases). As Judge Vining of the Northern District of Georgia observed in T2 Medical,
The plaintiffs assert claims of fraud on the market based on a continuous course of conduct by the defendants involving a series of misrepresentations and omissions, made by or on behalf of the defendants, over a period of approximately seven months. The plaintiffs allege that the defendants released such misinformation in order to artificially inflate the stock price for their own financial gain. The court finds that the alleged misrepresentations and omissions are common to all T2 Medical shareholders who owned stock during the period at issue. Moreover, there are questions of law common to all class members, including whether the defendants’ misrepresentations and omissions constituted fraud-on-the-market. The court finds that questions of both law and fact common to the members of the class exist.
T2 Medical Order at 10; see also 4 H. Newberg & A. Conte, Newberg on Class Actions, §18.05 (3d ed. 1992).
In a typical securities class action for violations of the federal securities laws, each class member’s claims arise out of the same set of facts and are based upon common legal theories; therefore, satisfying the commonality requirement is rarely difficult. Some examples of the common questions of law and fact that are often present in shareholder class actions based on securities fraud include:
(a) Whether defendants violated §10 of the Exchange Act;
(b) Whether the Company’s publicly disseminated releases and statements during the Class Period omitted and/or misrepresented material facts, and whether defendants breached any duty to convey material facts or to correct material facts previously disseminated;
(c) Whether Defendants participated in and pursued the common course of conduct complained of in the Complaint;
(d) Whether, with respect to the claims of the Class asserted under the Exchange Act, Defendants acted knowingly or recklessly in omitting and/or misrepresenting material facts;
(e) Whether the market price of the Company’s common stock during the Class Period was artificially inflated due to the material nondisclosures and/or misrepresentations described in the Complaint; and
(f) Whether the members of the Class have sustained damages and, if so, what is the appropriate measure of damages.
The “typicality” element of Rule 23(a)(3) requires “a nexus between the class representative’s claims or defenses and the common questions of fact or law which unite the class.” Kornberg v. Carnival Cruise Lines, Inc., 741 F.2d 1332, 1337 (11th Cir. 1984). “A plaintiff’s claim is typical if ‘it arises from the same event or practice or course of conduct that gives rise to the claims of the other class members, and her or his claims are based on the same legal theory.’” In re Domestic Air, 137 F.R.D. at 698 (quoting 3 Newberg on Class Actions, §18.09 at 464). Obviously, in order to satisfy this requirement, the named plaintiff must be an actual member of the class, but typicality does not require that all claims or defenses be identical; where a strong similarity of legal theories is present, the typicality requirement will be satisfied despite the existence of substantial factual differences. Appleyard v. Wallace, 754 F.2d at 958; Kornberg, 741 F.2d at 1337 (“[a] factual variation will not render a class representative’s claim atypical unless the factual position of the representative markedly differs from that of other members of the class”) (citations omitted).
Ordinarily, the claims asserted by plaintiffs in a securities class action arise from the same events and practices and are based on the same legal theories as the claims of absent class members; the named plaintiff is seeking to prove that defendants committed the same unlawful acts against an entire class. Thus, in those situations, most courts have found that all members of the class have identical claims, and therefore, the typicality requirement of Rule 23(a)(3) is usually satisfied. See, e.g., Kirkpatrick v. J.C. Bradford & Co., 827 F.2d 718, 722-25 (11th Cir. 1987); Kennedy v. Tallant, 710 F.2d 711, 717 (11th Cir. 1983).
In the Eleventh Circuit, neither a named plaintiff’s degree of investment experience and sophistication nor his degree of reliance will usually preclude satisfaction of the typicality requirement. Kennedy, 710 F.2d at 717; AmeriFirst Sec. Litig., 139 F.R.D. 423, 429 (S.D. Fla. 1991).
Rule 23(a)(4) requires that the named plaintiffs fairly and adequately protect the interests of the class. Rule 23(a)(4) has been interpreted as imposing a two-fold standard: (1) the named plaintiffs must have interests in common with, and not antagonistic to, those of the other members of the class; and (2) the plaintiffs’ attorneys must be qualified, experienced, and generally able to conduct the litigation. Kirkpatrick, 827 F.2d at 726; Powers v. Stuart-James Co., 707 F. Supp. at 503; DCA Sec. Litig. Order at 13; T2 Medical Order at 13-14. The first aspect of the adequacy requirement is usually satisfied unless the named plaintiff has an interest that might be in some way adverse to other class members. In typical securities actions, however, the representative plaintiff’s interests are common with the interests of the class and are not adverse or antagonistic to any class member. In those situations, the named plaintiffs meet the adequacy requirement of Rule 23(a)(4) because their interests are directly aligned with the interests of absent class members — each plaintiff claims to have been damaged by the same alleged conduct, and each has precisely the same interest as members of the class to achieve the maximum possible recovery.
With respect to the second prong of the “adequacy” inquiry — the qualifications of counsel — the named plaintiff’s attorneys must exhibit that they are qualified and experienced in antitrust class action litigation, and “will pursue with vigor the legal claims of the class.” Kirkpatrick v. J.C. Bradford & Co., 827 F.2d at 727. As Judge Vining has noted: “The Court should focus its attention on counsel for the class, not the class representative, when determining adequacy of class representation . . . .” See In re T2 Medical, Inc. Shareholder Litig. Order, Civil Action No. 1:92-CV-1564-RLV, p.3 (N.D. Ga. Oct. 27, 1992) (citing Kirkpatrick, 827 F.2d at 727). In assessing the competence of counsel, the courts in the Eleventh Circuit have held that “there is a presumption of competence in the absence of proof to the contrary.” DCA Sec. Litig. Order at 14.
- The Requirements of Rule 23(b)(3): Common Questions of Law and Fact Predominate and a Class Action is Superior to Any Other Method of Adjudication
In addition to satisfying the four class requirements of Rule 23(a), a plaintiff seeking class certification must show that at least one of the conditions set forth in Rule 23(b) is also present. Rule 23(b) provides in relevant part:
An action may be maintained as a class action if the prerequisites of subdivision (a) are satisfied, and in addition:
* * *
(3) the court finds that the questions of law or fact common to the members of the class predominate over any questions affecting only individual members, and that a class action is superior to other available methods for the fair and efficient adjudication of the controversy.
- Common Questions of Law and Fact Predominate
By its terms, Rule 23(b)(3) requires only that the common issues “predominate”; they need not be dispositive of the entire litigation. See 7A Wright, Miller & Kane, Federal Practice and Procedure: Civil 2d § 1778 at 528 (1996). “Rule 23 does not require that all the questions of law and fact raised by the dispute be common.” Kirkpatrick v. J. C. Bradford & Co., 827 F.2d at 725, (quoting Cox v. American Cast Iron Pipe Co., 784 F.2d 1546, 1557 (11th Cir. 1986)). See also In re Domestic Air Transp. Antitrust Litig., 137 F.R.D. 677 (N.D. Ga. 1991).
The Northern District of Georgia has recognized that in cases where (1) the named plaintiffs allege that a series of misrepresentations and omissions by the defendants resulted in an artificially inflated price of the defendants’ common stock and (2) the named plaintiffs are entitled to the presumption of reliance, as they often are in shareholder class actions involving securities traded on a national market, “the common questions of law and fact easily predominate over questions affecting individual class members.” DCA Sec. Litig. Order at 8, 15-16. Moreover, “Courts generally focus on the liability issue in deciding whether the predominance requirement is met, and if the liability issue is common to the class, common questions are held to predominate over individual questions.” In Re: Alexander Grant & Co. Litig., 110 F.R.D. 528, 534 (S.D. Fla. 1986) (quoting Dura-Bilt Corp. v. Chase Manhattan Corp., 89 F.R.D. 87, 89, 93 (S.D.N.Y. 1981)).
Where the claims involve securities that are actively traded on a national market, plaintiffs in securities class actions are usually entitled to a presumption of reliance under the “fraud-on-the-market” theory. Furthermore, where plaintiffs’ claims of securities violations under § 10(b) of the Exchange Act allege, inter alia, a fraud-on-the-market claim, courts have held that such claims are ideally suited to class action treatment. See Tapken v. Brown, No. 90-691-CIV-MARCUS, 1992 WL 178984, at *17 (S.D. Fla. March 13, 1992). The fraud-on-the-market theory was expressly endorsed by the United States Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224, 227 (1988) and has been explained by Judge Vining as follows:
The fraud-on-the-market theory is based on the idea that information about a corporation’s expected future value is quickly and accurately incorporated into the price at which the corporation’s securities trade in public markets. The defendants are liable for any material misrepresentation which is proved to have caused the price of a security traded on an open and developed securities market to deviate from the security’s efficient price. The security’s efficient price is assumed to be the price at which the security would have traded in the absence of the misleading information. Individuals who purchase or sell the security during the period of price deviation, and who are injured as a result, are entitled to recover regardless of whether those individuals knew of the misrepresentation or misleading omission. Persons seeking to recover under the fraud-on-the-market theory need not prove individual reliance. The inquiry in a fraud-on-the-market case is not whether an individual investor was fooled but rather if the market as a whole was fooled.
T2 Medical Order at 15-16 (citations omitted). Because reliance is not an individual issue, but an issue that is presumed for a class as a whole upon certain showings, the fraud-on-the-market theory provides a predominant common issue in most securities fraud cases. Lipton, 734 F.2d at 745.
Thus, the predominant issues for claims asserted under the Exchange Act are most often the defendants’ state of mind in making the alleged misrepresentations and/or omissions and the effect of their statements or omissions on the market for the Company’s stock, which together determine the defendants’ overall liability. Issues of defendants’ liability to the class are virtually always common to each member of the class. Therefore, with the exception of individual damages calculations, the respective factual and legal elements of liability in most securities class actions will predominate over individual issues.
“Individual” issues such as the amount of damage suffered by each class member are generally considered subordinate to the common issues concerning the defendants’ liability. Most courts have consistently held that the existence of individual damage issues is insufficient to preclude class certification. See In re: Alexander Grant & Co. Litig., 110 F.R.D. at 534 (“[O]nce liability and the relevant dates are established, assignment of damages becomes a ministerial task.”); see also Bogosian v. Gulf Oil Corp., 561 F.2d 434, 456 (3d. Cir. 1977) (“[I]t has been commonly recognized that the necessity for calculation of damages on an individual basis should not preclude class determination when the common issues which determine liability predominate.”); Presidio Golf Club v. National Linen Supply Corp., 1976-2 CCH Trade Cases ¶61,221 at 70,630-31 (N.D. Cal. 1976), (quoting Blackie v. Barrack, 524 F.2d 891, 906 n.22 (9th Cir. 1973) (“The fact that a defendant may be able to defeat the showing of causation as to a few individual class members does not transform the common question into a multitude of individual ones; plaintiffs satisfy their burden of showing causation as to each by showing [generalized damage] as to all.”)); 4 Newberg on Class Actions §18.27 at 18-89 (“Individual damages questions do not preclude a Rule 23(b)(3) class action when the issue of liability is common to the class.”).
- A Class Action is Superior to Other Available Methods of Adjudication
Rule 23(b)(3) further requires that the class action be superior to other available methods for the fair and efficient adjudication of the controversy. In many securities class actions, not only does certification of a class provide a superior method with which to adjudicate the action, it may be the only realistic method for redress. Absent a class action, the individual claims of many class members may be so small that the cost of litigation would be far greater that the value of those claims.
As the Supreme Court has recognized, “Class actions . . . permit the plaintiffs to pool claims which would be uneconomical to litigate individually . . . . [M]ost of the plaintiffs would have no realistic day in court if a class action were not available.” Phillips Petroleum, 472 U.S. at 809. Multiple lawsuits by individual class members would be costly and inefficient, and the exclusion of those class members that cannot afford separate representation would be neither fair nor provide an adjudication of their claims. Northwestern Fruit Co. v. A. Levy & J. Zentner Co., 116 F.R.D. 384 (E.D. Cal. 1986).
Courts have repeatedly recognized the general superiority of class treatment in securities fraud actions involving large numbers of investors. See, e.g., Escott v. Barchris Constr. Corp., 340 F.2d 731, 733 (2d Cir. 1965); Nat’l Data Corp., Order at 4; Werfel v. Kramarsky, 61 F.R.D. 674, 682-83 (S.D.N.Y. 1974). In addition, “separate actions by each of the class members would be repetitive, wasteful, and an extraordinary burden on the courts”. Kirkpatrick, 827 F.2d at 725.
In addition, Rule 23(b)(3) requires the court to consider the following factors:
(1) the interest of members of the class in individually controlling the prosecution of separate actions;
(2) the material differences between the present litigation and litigation concerning this controversy already commenced by potential class members;
(3) the desirability of concentrating the litigation in the particular forum; and
(4) the difficulties likely to be encountered in litigation as a class action.
See Fed. R. Civ. P. 23(b)(3).
First, the class action is often the only feasible method of adjudication where those who have been injured are in a poor position to seek legal redress because they do not have enough information or because redress is disproportionately expensive. Nat’l Data Corp. Order at 4. Thus, in many, if not most securities class actions, few members of the class would, as a practical matter, be in a position to proceed individually.
Additionally, actions based on large-scale securities fraud are almost always better managed as class actions. Prosecution of these actions on a class basis is much more efficient than individual adjudication of thousands of claims. Further, because shareholders may find individual litigation cost-prohibitive, the class mechanism provides a means for fair and efficient resolution of these claims. Finally, there are seldom any significant or unusual difficulties in the management of securities fraud cases. Therefore, the class action device is almost always the superior method for adjudicating the claims of shareholders in an action based on allegations that the defendants have violated the federal securities laws, particularly those actions involving claims asserted under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5.
As discussed above, the other two subsections of Rule 23(b) are rarely invoked in the securities class action context; therefore, only Rule 23(b)(3) will be discussed herein.